11/8/2013. Bonds 101. Presentation Overview. What is a Municipal Bond?

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1 Bonds 101 Gary Olsen, Senior Financial Advisor/Vice President Jodie Zesbaugh, Financial Advisor Ehlers 2013 MASBO Fall Conference November 15, Presentation Overview Introduction and Background Information Participants Involved in Issuing Debt Debt Options, Rules and Regulations Bond Ratings Methods of Bond Sales Questions 2 What is a Municipal Bond? A pledge to repay a debt issue Contract between the issuer and the bond holder Typically, the pledge is a general obligation which is a full faith and credit debt pledge 3 1

2 Guiding Principles Debt Issuance and Management is most successful when you, the issuer Understand your financing options Receive clear information on implications of decisions Have a basic understanding of the rules and regulations Know who the participants are, their roles, whom each party works for, and how they are compensated Generally understand how bonds are sold in the market 4 Why Borrow? May be the only way the district can afford the cost of a project, improvement, or equipment Few districts have sufficient funds available to pay for larger capital expenditures Cost is spread out over a number of years May allow for better management of tax rates Avoids roller coaster effect on taxes Matches the useful life of asset or improvement with who pays 5 Tax-Exemption Interest paid to holders of many municipal obligations enjoys exemption from federal income taxation An implicit subsidy exists from the U.S. Treasury to taxexempt issuers IRS has extensive rules and regulations regarding the issuance of tax-exempt obligations In Minnesota, exempt from State income taxes 6 2

3 Tax Exempt vs. Taxable Rates 11/04/ Tax-Exempt AAA Taxable AAA Difference Bloomberg, Municipal Market Data Yields Debt Planning Basic Topics to Discuss Amount to borrow Include all construction, cost of issuance, and soft costs May be other items to capitalize Sources of revenue Tax levy (impact on taxes) Other funding sources (impact on budget) Term of repayment Type of bond or borrowing and sources of revenue may dictate longest available term Should not exceed useful life of asset financed 8 Debt Planning Basic Topics to Discuss Call provision Determining which bonds can be called (redeemed prior to maturity), when they can be called and at what price Existing and future debt considerations Debt service impact on tax levy Flexibility based on future financing needs 9 3

4 Key Participants in Issuing Municipal Debt Issuer (School District) Financial Advisor / Municipal Advisor Bond Counsel / Attorney Rating Agencies Purchaser (Underwriters, Broker/Dealers, Commercial Banks) Paying Agent Bond Insurers Insurance for bond payments Investors What are their roles, whom do they represent, and how are they paid? 10 Financial / Municipal Advisor Professionals who offer advice on financial matters Assists issuer in developing a finance plan and conducting the bond sale Conducts a detailed assessment of client s financial position, preferences, and objectives Advises appropriate action(s) to meet client's objectives Recommends one or more suitable financial solutions to match client s needs Coordinates financing and debt issuance process Prepares official statement on behalf of issuer Receives and evaluates proposals (competitive sale) or negotiates with purchaser (negotiated sale) Coordinates closing of issue 11 Financial/Municipal Advisor Represents the interests of the issuer exclusively in dealing with financial markets Has a Fiduciary Duty to Issuer Duty of Loyalty Duty to deal honestly and in good faith with the municipal entity and to act in the municipal entity s best interests Duty of Care Duty to exercise due care in performing its responsibilities Advises in both debt and non-debt solutions Provides official documentation for the bond issue 12 4

5 Bond Counsel Drafts required legal documents (i.e. notices, resolutions, certificates, etc.) on behalf of Issuer Provides various legal opinions to the benefit of both Issuer and Buyer of debt obligations Legal, valid and binding obligation of Issuer (valid contract) Interest on bonds is exempt from federal and state income taxation Opinions as relates to state and federal securities laws Assists in preparation of closing documentation and actual closing of the transaction Issuer pays Bond Counsel a flat fee for services, but the firm s opinions accrue to the benefit of all parties to a transaction in one form or another 13 Rating Agencies Three major rating agencies Moody s Investors Service Standard & Poor s Fitch Investors Service Provides an independent evaluation of the credit quality of each municipal debt issue Called a bond or credit rating Credit rating attempts to measure the risk of default on a debt issue 14 Purchaser Firms that are initial purchasers of bonds are called Underwriters Includes Broker/Dealers and Commercial Banks Purchases bonds from issuer and generally resells to investors Underwriter has financial and other interests that differ from those of issuer Represents interest of investors, not issuer Does not have a fiduciary duty to issuer 15 5

6 Paying Agent Tracks and coordinates debt service payments for issuer Submits invoices to issuer for principal and interest payments Receives debt service payments from issuer Makes principal and interest payments to bondholders on behalf of issuer Required for Minnesota school districts participating in the state s credit enhancement program Not required if issuer is not participating in credit enhancement program 16 Debt Options, Rules and Regulations Issuing Authority Comes from State Law Spread throughout statutes based on issuer and obligation type Tax Exemption Comes from Federal Tax Code IRC Sections 103 and Statutory Authority To Issue Debt Building Bonds MN Statutes Chapter 475 Authorized by voter approval at special election / referendum Used to finance purchase or construction of school buildings & facilities, renovation & improvement projects, infrastructure, and equipment 18 6

7 Statutory Authority To Issue Debt Alternative Facilities Bonds MN Statutes Section 123B.59 Authorized by approval of the Commissioner Two programs Full: repairs, maintenance, improvements and health & safety projects Limited: health & safety projects greater than $500,000 per site 19 Statutory Authority To Issue Debt Capital Notes / Certificates of Indebtedness MN Statutes Section 123B.61 Authorized by resolution of the Board Used to purchase vehicles and equipment Capital Facilities Bonds MN Statutes Section 123B.62 Authorized by approval of the Commissioner Used to finance improvements to existing buildings, facilities, and sites 20 Statutory Authority to Issue Debt Tax and Aid Anticipation Certificates MN Statutes 123B.78 Authorized by resolution of the Board Used to cover cash flow operational deficits Lease Purchase MN Statutes Authorized by resolution of the Board Used to finance the purchase of buildings, facilities, land, and equipment, construction & improvement projects 21 7

8 Other Statutory References Chapter Bond Issue Purposes Limit on Net Debt 15% of full market value of taxable property Limitation on Term and Amount Maturing in Each Year Generally 30 years Complex rules regulating bond structure 22 Other Statutory References Chapter Elections to Determine Issue Tax Levies Assess tax levy at 105% of debt service payments, less available funds Refunding Bonds For tax exempt general obligation refunding bonds issued more than 90 days prior to call date (advance refundings) 3% present value savings requirement OR Extend the maturity by at least three years 23 State and Federal Regulations Credit Enhancement Program Bank Qualification Arbitrage Continuing Disclosure Reimbursement Regulations Municipal Advisor 24 8

9 State Credit Enhancement Program Program adopted in early 1990s by State of MN No cost for district to participate State guarantees principal & interest payments on bonds Bonds assigned credit enhancement program rating Moody s: Aa2 S & P: AA+ Lower interest rates Paying agent required as part of program Simple process Resolution Application District required to make debt service payments 3 days in advance 25 Federal Regulations - Bank Qualification District may designate tax exempt debt as bank qualified if issuing $10 million or less in total during a calendar year Bank qualification creates tax advantages for financial institutions purchasing debt When purchased by a commercial bank for its portfolio, bank may receive a tax deduction for interest cost Can expand the number of potential buyers Bank qualified debt generally has lower interest rates than non-bank qualified debt How much lower depends on the market 26 Federal Regulations - Arbitrage Arbitrage is profit that results from investing proceeds of tax-exempt issue in higher yielding taxable securities Complex federal rules; failure to comply could lead to penalties or even loss of tax exemption on the bonds District may need to rebate (pay to IRS) arbitrage earned in construction funds; exceptions to requirement Small issuer exception issue no more than $15M in tax-exempt debt in a calendar year 24 month spending exception Other less commonly used exceptions Investment earnings in debt service funds may also be subject to arbitrage rebate 27 9

10 Federal Regulations - Continuing Disclosure Increasing Federal role in regulating disclosure (SEC Rule 15c2-12) Disclosure requirements are determined at time of sale, based on Size of issue Total debt outstanding For many issues, district must provide annual financial reports and updates of other information Can contract for this service Information is posted on MSRB web site (emma.msrb.org) 28 Federal Regulations - Reimbursement Issuer may reimburse itself with proceeds of taxexempt bonds only if it complies with complex rules Rules generally don t apply to preliminary expenditures (e.g. architect, engineering, surveying fees) Different attorneys recommend slightly different procedures and practices 29 Federal Regulations Municipal Advisor July 21, 2010 Dodd-Frank Act Signed Amended Section 15B of the Securities Exchange Act of 1934 Includes Section 975 Regulation of Municipal Securities October 1, 2010 Temporary Rules Required Municipal Advisors to register with SEC & MSRB About 1,150 municipal advisors are registered December 20, 2010 SEC Proposed Rules with Concerns Treatment of appointed board members of municipal entities Investments of all municipal funds (versus bond proceeds) Impact on traditional banking activities Lack of guidance on what is advice September 18, 2013 Final Rules Adopted Rules effective 60 days after publication in the Federal Register July 1, 2014 Phase-in of Permanent MA Application 30 10

11 Federal Regulations Municipal Advisor Municipal Advisor Definition Rule 15Ba1-1(d) Provide Advice OR Solicitation To a Municipal Entity OR Obligated Person RE: Muni Securities Issue OR Muni Financial Products Includes Advice Regarding Structure, Timing, Terms, or Other Similar Matters 31 Federal Regulations Municipal Advisor Municipal Entity Definition Rule 15Ba1-1(g) State and political subdivisions Agencies, authorities and instrumentalities Plan, program, or pool of assets sponsored or established by State or political subdivision Any other issuer of municipal securities 32 Federal Regulations Municipal Advisor Exclusions and exemptions from MA definition Public Officials, Boards, Committees, employees of a municipal entity or obligated person (conduits) while acting within the scope of their official capacities Registered Investment Advisors providing investment advice Registered Commodity Trading Advisors providing advice related to swaps Banks providing investment and credit advice Accountants providing audit opinion or other services (e.g. preparation of financial statements, issuance of letters for underwriters) Engineers providing services related to certain feasibility studies, cash flow modeling, and projections (e.g., output capacity, utility project rates, project demand or revenues) Attorneys providing services of traditional legal nature 33 11

12 Federal Regulations Municipal Advisor Intended to provide protections and benefits to municipal issuers and obligated persons Fiduciary duty Reduced Borrowing & Issuance Costs Better Financing Terms Positive Impact on Taxpayers Regulatory oversight over standards, training and conduct Requirements regarding maintenance and storage of books and records 34 Bond/Credit Ratings Ratings Are Indicators of Risk Willingness and ability to pay bonds in full and on time Probability of default Independent opinions Ratings Are Not Indicators of quality of life Static 35 Bond/Credit Ratings Who uses ratings? Institutional investors, individual investors, issuers, media, politicians, political candidates Impact on Investor Better / Higher rating = less risk Ultimately for you, the issuer Better / Higher rating = lower interest costs 36 12

13 Bond Rating Scales 37 Rating Impact on Yield Curve Tax Exempt AAA Tax Exempt AA Tax Exempt A Municipal Debt Yield Curves 11/1/2013 Bond Rating Factors Management Economy Debt Profile 39 Financial Operations 13

14 Methods of Debt Sales Competitive Bid Process coordinated by financial advisor Issuer solicits multiple bids Sells issue to underwriter that offers lowest financing cost to the District Intended to result in lower financing cost than other sale methods, due to competitive nature of bidding process Preferred method of sale of most school bonds General Obligation A or better rating 40 Methods of Debt Sales Negotiated Sale A financial advisor may or may not be involved Issuer selects an underwriter with whom to place the debt Negotiates the terms and conditions with underwriter Beneficial for unique circumstances or low credit rating Debt may carry unusual features, structure, or other provisions Story Bond requires active marketing efforts of underwriting firm to draw investor interest 41 Methods of Debt Sales Limited Proposal Involves a financial advisor to coordinate Issuer selects several underwriting firms from which to solicit proposals Accepts proposals from firms at a specified time Incorporates a moderate level of competition into purchasing process 42 14

15 Methods of Sales - GFOA Recommendations Due to the inherent conflict of interest, issuers should not use a broker/dealer or potential underwriter to assist in the method of sale selection unless that firm has agreed not to underwrite that transaction. If a negotiated sale is selected, the Issuer should, in consultation with its Financial Advisor Select the underwriter(s) through an RFP process Utilize a Financial Advisor unrelated to the underwriter(s) to provide advice on all aspects of sale The Financial Advisor should not be allowed to resign and serve as underwriter for transaction Source: GFOA Recommended Practice, Selecting and Managing the Method of Sale of State and Local Government Bonds (1994 and 2007) 43 Gary Olsen Ehlers (651) golsen@ehlers-inc.com Jodie Zesbaugh Ehlers (651) jzesbaugh@ehlers-inc.com 44 15

REGULATORY CHANGES IN THE MUNICIPAL BOND MARKET: CONSIDER THE IMPACT ON YOU

REGULATORY CHANGES IN THE MUNICIPAL BOND MARKET: CONSIDER THE IMPACT ON YOU ILLINOIS COMMUNITY COLLEGE CHIEF FINANCIAL OFFICERS SPRING CONFERENCE TAMMIE BECKWITH SCHALLMO MANAGING DIRECTOR PMA SECURITIES,