New Regulations Impact How to Evaluate Municipal Investments

Transcription

1 New Regulations Impact How to Evaluate Municipal Investments 1

2 Municipal Bonds General Obligation - A Municipal Bond, backed by the full faith and credit of the issuer, which is repaid from either the issuer s limited or unlimited ad valorem taxing power. (Ad valorem - tax placed on real property) Revenue Bond - A Revenue Bond that is backed by a tax placed on a special project, such as the construction of a toll road. Industrial Development Bond - A Municipal Bond issued to raise money for the construction of fixed assets that are subsequently leased to private firms, whose payments then amortize the debts. Certificate of Participation (COP) - A type of financing where an investor purchases a share of the lease revenues of a program rather than the bond being secured by those revenues. 3

3 Risk Factors 3 As with all Debt Securities, Municipal Bonds entail inherent risk, including prepayment, market, and credit risk. Prepayment Risk The payment of a debt obligation prior to its due date (i.e. Sinking Fund, Traditional Call Feature, Extraordinary Redemption). Interest Rate Risk In the event of an interest rate move upward or downward, the market price of the bonds may be affected. As interest rates rise, secondary prices go down. Inversely, when rates decrease, secondary prices increase. Market/Systemic Risk The market price of the bonds may move higher or lower depending on the prevailing market conditions. Sale of the bonds prior to maturity may cause principal gain or loss. Credit Risk Any changes in laws or regulations, or disclosable events such as upgrades/downgrades or financial disclosures, may have an impact on the market price of the bonds in the open market, which may cause a principal gain or loss if the bonds are sold prior to maturity.

4 Municipal Ratings A bond rating performs the isolated function of credit risk evaluation. A bond rating does not constitute a recommendation to invest in a bond, and does not take into consideration the risk preference of the investor. Bond ratings may be subject to change over time. A credit rating should not be the sole basis for any investment decision. 4

5 Revision to Rule on Permissible Investments NCUA Rule 12 CFR (e) Previous Provision: A Federal credit union may purchase and hold a municipal security, as defined in Section 107(7)(K) of the Act. Only if a nationally-recognized statistical rating organization has rated it in one of the four highest rating categories. Revised Provision: A Federal credit union may purchase and hold a municipal security, as defined in section 107(7)(K) of the Act. Only if it conducts and documents an analysis that reasonably concludes the security is at least investment grade. Effective on June 11,

6 New Definition of Investment Grade NCUA Rule 12 CFR Investment grade means the issuer of a security has an adequate capacity to meet the financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has an adequate capacity to meet financial commitments if the risk of default by the obligor is low and the full and timely repayment of principal and interest on the security is expected. 6

7 New Definition of Investment Grade NCUA Rule 12 CFR (continued) A Federal credit union may consider any or all of the following factors, to the extent appropriate, with respect to the credit risk of a security: Credit spreads Securities-related research Internal or external credit risk assessments Default statistics Inclusion on an index Priorities and enhancements Price, yield, and/or volume Asset class specific factors This list is not meant to be exhaustive or mutually exclusive. 7

8 OCC Examiner Handbook Factors for general obligation municipal bonds: Debt burden of municipality: Relationship of debt burden to property valuation Reasonableness of debt burden on a per capita basis Sinking fund provisions Historical trends of debt Future debt service requirements Tax burden of municipality: Assessed valuation, including basis of assessment Relationship of tax burden to property valuation Tax collection record Recent trends in tax rates 8

9 OCC Examiner Handbook (cont.) Quality of budgets: Requirement for balanced budget Recent trends in budget deficits or surpluses Cash flow requirements Accuracy of past estimates of revenues and expenses Accounting policies Character of community: Economic background Debt paying ability Population trends 9 Factors peculiar to revenue issues include: The number of times gross revenues covers debt service (coverage) The segregation of revenue funds from general funds The flow of revenues to specific reserve accounts Special covenants that may limit default remedies

10 Regulatory Burden Dodd-Frank included a number of provisions that I think many in the industry thought would not apply to community institutions... It s very hard to argue with the intent of the law, which was to prevent financial institutions from relying on credit ratings without any due diligence of their own. But that provision had a particularly severe impact on community institutions that legislators may not have foreseen 10 -Thomas J. Curry, Comptroller of the Currency Before the Florida Bankers Association October 23, 2012

11 Key Statistics Factors that should be reviewed when analyzing a municipal security: Issuer description: Includes location of the municipality, population, unemployment rates. Purpose of funds: What the monies are being used for. Sources of funds: Where the funds are coming from to pay debt service and principal. Assessed valuation: The value of a property as determined by an appraisal conducted by a municipality. Full value per capita: Full value per capita is the value of all taxable real property in a municipality divided by population. 11

12 Key Statistics (con t) Per capita income or average income or income per person: is the mean income within an economic aggregate, such as a country or city. Direct debt: The sum of the total bonded debt and any short-term debt of the issuer. Overlapping debt: Total direct debt plus the issuer s applicable share of the total debt of all overlapping jurisdictions. Payout of principal: Calculated as a percentage of the municipality s debt that is being matured over the next ten years. Current debt outstanding: Total amount of debt a municipality has outstanding. Tax payer concentrations: Is the tax base dependent on one or two key employers. 12

13 Discussion Example Loveland Ohio School District (547252PA8) Unlimited General Obligation 4.00% Price: $ ; Yield to maturity ( YTM ): 2.75% 12/01/2023 final maturity Moody s: Aa2 underlying with stable outlook Non-Callable Debt Service on the Series 2012 bonds is secured by the district s GOULT pledge, which includes a levy on all taxable property in the School District, in addition to all other taxes. Proceeds will be used to refund the district s outstanding bonds, Series 2005, for a net present value savings. 13

14 Discussion Example: Key Statistics Loveland Ohio School District (547252PA8) 2010 Census population: 26,276 (5.0% increase since 2000) 2012 full valuation: $2.1 billion (0.0% five-year average annual growth) Estimated full value per capita: $80, per capita income (as % of U.S.): 154% 2010 estimated median family income (as % of U.S.): 176% Fiscal 2011 general fund balance: $9.3 million; 23% of revenues Fiscal 2011 cash-basis reserves: $6.3 million; 16% of receipts Fiscal 2012 cash-basis reserves: $4.2 million; 11% of receipts Overall debt burden: 1.6% (1.2% direct) Long-term GO unlimited tax bonds outstanding: $20.6 million Long-term GO limited tax bonds outstanding: $4.5 million 14

15 Bloomberg Screen - Description Source: Bloomberg 15

16 Bloomberg Screen Yield Analysis Source: Bloomberg 16

17 Bloomberg Screen Shock Analysis Source: Bloomberg 17

18 Muni Points Download this one PDF for the digital investment file Click here for Muni-Docs Online 18

19 Muni Points 19

20 Muni Docs Online Click here for Official Statement 20

21 Muni Docs Online History Back to

22 Muni Docs Online Official Statement 22

23 Muni Docs Online Official Statement 23

24 Muni Docs Online Official Statement 24

25 Muni Docs Online Official Statement 25

26 Muni Docs Online Official Statement 26

27 Muni Docs Online Material Events and Rating Changes Would Be Indicated Here 27

28 Muni Docs Online Click Here for Current Financial Information 28

29 Muni Docs Online Financials 29

30 Muni Docs Online Financials 30

31 Muni Docs Online Financials 31

32 Red Flags for Credit Risk Economic stagnation that leads to further declines in the tax base, increase in unemployment levels, or deterioration of the city s resident income profile. Material declines in the city s financial reserves and liquidity. Increases in debt burden. Credit Rating downgrades. 32

33 Credit Analysis Required NCUA Rule 12 CFR A Federal credit union must conduct and document a credit analysis on an investment and the issuing entity before purchasing it. Except for investments issued or fully guaranteed as to principal and interest by the U.S. government or its agencies, enterprises, or corporations or fully insured (including accumulated interest) by the National Credit Union Administration or the Federal Deposit Insurance Corporation. A Federal credit union must update this analysis at least annually for as long as it holds the investment. 33

34 Municipal Information Worksheet 34

35 Municipal Information Worksheet - Top 35

36 Municipal Information Worksheet - Bottom 36

37 New Concentration Limits NCUA Rule 12 CFR (e) (continued from slide 6) The Federal credit union must also: Limit its aggregate municipal securities holdings to no more than 75 percent of the Federal credit union s net worth. Limit its holdings of municipal securities issued by any single issuer to no more than 25 percent of the Federal credit union s net worth. Regulation effective June 11,

38 Investment Policy Sample Language Authorized Investments: Municipal Obligations. In the obligations (general obligations or revenue supported obligations) of, or issued by, any State or political subdivision thereof (including any agency, corporation, or instrumentality of a State or political subdivision), including callable obligations. Investments in municipal obligations are limited, in the aggregate, to 75.00% of the Credit Union s net worth, while investments in the obligations of any one obligor must not exceed 25.00% of the Credit Union s net worth. Revenue bonds in the aggregate are limited to XX.00% of municipal investment portfolio. Additionally, the maturity of the investment should not exceed XX years. Management will consider the geographic diversification of the municipal portfolio. The Credit Union will conduct and document an internal analysis that reasonably concludes that the security is at least investment grade by evaluating the capacity of the issuer to meet its financial commitments even under adverse economic conditions for the projected life of the obligation (credit analysis) before the purchase of the investment. An issuer has an adequate capacity to meet financial commitments if the risk of default by the obligor is low and the full and timely repayment of principal and interest on the security is expected. General obligation bonds are supported by the full borrowing and taxing authority of the issuing government. Sources of revenue may include property taxes, sales taxes, income taxes, or other taxes. Considerations for evaluating a general obligation bond include factors such as the debt level of the municipality, the issuer s budget, sources of revenue, and the overall economic health of the community. Revenue bonds are repaid from the cash flow generated by the operating projects being financed. Management must understand what the bond proceeds are to be used for and what revenues are available for repayment. The Credit Union may consider any or all of the following factors, to the extent appropriate, with respect to the credit risk of a security: credit spreads; securities related research; internal or external credit risk assessments (including credit ratings); default statistics; inclusion on an index; priorities and enhancements; price, yield, and/or volume; and asset class specific factors. This list of factors is not meant to be exhaustive or mutually exclusive. The analysis must be updated at least annually as long as the Credit Union holds the municipal investment(s). If the security and/or issuer has been rated, it must be rated in one of the XXXX highest rating categories by at least one Nationally Recognized Statistical Rating Organization (NRSRO) and not rated below investment grade by any NRSRO. Changes in credit ratings will be monitored at least quarterly. A downgrade in any credit rating of a purchased municipal bond will be reported to the ALCO within 30 days of notification. A rating downgrade below investment grade by any NRSRO will prompt an update of the Credit Union s internal credit analysis within 30 days of the downgrade notification. The above Investment Policy Language is a general example which may or may not be applicable to your specific business. First Empire Securities, Inc. is not a law firm, does not render legal services, and does not provide legal advice. If you are interested in updating your business Investment Policy in light of recent regulatory changes, please contact regulatoryaffairs@1empire.com. 38

39 Thank You! The information in this document has been obtained from sources we believe to be reliable, however, we do not guarantee it is accurate or complete. Parts of this document are based on assumptions, which we believe to be reasonable and supportable, however, future events may influence actual performance. The projections contained herein are hypothetical in nature, and do not reflect actual balance sheet or investment results and are not guarantees of future results. This document is not and should not be construed as an offer or solicitation of an offer to buy or sell any security or securities. From time to time officers, employees of the firm, or the firm itself holds a position in the securities referred herein, or acts as principal in transactions referred to herein. As with all debt securities, sale prior to maturity may cause principal gain or loss. Securities have inherent risk, including credit, prepayment, extension and market risk. This information is subject to change without notice. First Empire Securities, Inc., Member FINRA/SIPC.