Can I Afford To Borrow? Understanding Debt Issuance Iowa League of Cities Annual Conference September 26, 2013

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1 Can I Afford To Borrow? Understanding Debt Issuance Iowa League of Cities Annual Conference September 26, 2013

2 What affects the cost of debt? Can your City s revenues support the debt associated with a project? Changing Market Conditions Discussion/Questions Presentation Overview 2

3 Constitutional Debt Limit = 5% of 100% Valuation The following count against the debt limit: GO Debt TIF Obligations These types do NOT count against debt limit: Revenue Debt Can I Issue Bonds? 3

4 To investors Negotiated sale Competitive sale To a bank Direct sale Private placement To another unit of government State Revolving Fund USDA loan Strength/weakness of each approach How Can I Issue Bonds? 4

5 Amount borrowed Length of repayment Security Tax exempt status Rating Market conditions On going costs What Affects the Cost of Debt? 5

6 At a minimum: Funds needed from borrowing Bond counsel (legal) Typically only applies to direct bank and government agency borrowing Other costs: Underwriting or placement fee Bond rating Registrar paying agent Financial advisor Capitalized interest Debt service reserve (only revenue bonds) Amount Borrowed 6

7 Impact on cost of debt? Bond issue: $1,000,000 paid over 20 years at average interest rate of 3.25% Average annual payment: $68,779 Est. total interest paid: $375,578 Savings from borrowing less? Every $5,000 reduction in amount of debt: Approximately $344 less annual P&I Approximately $6,878 less total payment Approximately $1,878 less total interest paid Amount Borrowed 7

8 Typically interest rates increase with length of repayment (ascending scale) Degree of increase varies over time (yield curve) Today steep curve rates increase rapidly over time Amount 1,000,000 1,000,000 1,000,000 Rate 3.25% 2.65% 2.00% Term Annual 68,779 81, ,327 Total P&I 1,375,578 1,224,905 1,113,265 Total Interest 375, , ,265 Length of Repayment 8

9 General Obligation (G.O.) Full faith and credit Pledge to levy property taxes as/if needed to repay bonds May actually use other revenues to pay debt service Most secure = lowest interest rates Security 9

10 Revenue Backed solely by pledged revenues Typically municipal utilities No requirement to use other revenues to cure shortfall Requires net revenues in excess of annual debt service 120% to 150% depending on project and revenues May need to borrow additional money for debt service reserve fund One year P&I or 10% of issue Use to make final year payment Less security = higher rates than G.O. Security 10

11 Utility rate study is an important part of Revenue borrowing Establishes required coverage ratio Allows for long term planning of potential rate adjustments Rate Study 11

12 Impact on cost of debt? No set guideline for spread between G.O. and Revenue Bonds Influenced by variety of factors: Financial condition and characteristics of utility Financial condition and characteristics of city Nature of project to be financed Market conditions Investor objectives/interests Security 12

13 Interest on Iowa municipal bonds is exempt for Federal income taxation Note This status is under review as Congress attempts tax reform Not all tax exempt bonds are the same Bank qualified (BQ) and not bank qualified (NBQ) Bank qualified bonds Tax incentive for banks to buy bonds Cities may issue not more than $10 Million in taxexempt bonds in calendar year to designate BQ Tax Exempt Status 13

14 Bonds can also be taxable May make sense to blend taxable and BQ if alternative is all NBQ Tax Exempt Status 14

15 6.00 Estimated G.O. Interest Rates Interest Rate % BQ NBQ Taxable Year Tax Exempt Status Interest rate projections are estimates (for August 14, 2013) prepared by Northland Securities. Charts are for illustration only and are not an offer to buy or sell securities. 15

16 Tax exempt status makes significant difference in cost of debt Total estimated interest expense is 22% greater for NBQ compared with BQ in example below BQ NBQ Taxable Amount 1,000,000 1,000,000 1,000,000 Rate 3.25% 3.90% 4.15% Term Annual 68,779 72,932 74,562 Total P&I 1,375,578 1,458,633 1,491,248 Total Interest 375, , ,248 Tax Exempt Status 16

17 Independent evaluation of creditworthiness Additional comfort for investor Is a requirement for some investors Two primary rating agencies for Iowa Moody s Investors Service Standard & Poor s Key Factors Economic and Valuation Data City Financial Data Demographic Info Bond Rating 17

18 Interest Rate % Estimated G.O. Interest Rates (BQ) Year AAA/Aaa AA/Aa2 A/A2 Not Rated Bond Rating Interest rate projections are estimates (for August 14, 2013) prepared by Northland Securities. Charts are for illustration only and are not an offer to buy or sell securities. 18

19 Impact (higher interest rates) varies over time Currently greater impact is on longer maturities AAA/Aaa AA/Aa2 A/A2 Not Rated Amount 1,000,000 1,000,000 1,000,000 1,000,000 Rate 2.90% 3.00% 3.15% 3.50% Term Annual 66,596 67,216 68,151 70,361 Total P&I 1,331,916 1,344,314 1,363,026 1,407,222 Total Interest 331, , , ,222 Bond Rating 19

20 6.00% Bond Buyer's 20 Year Index 2006 to Present 5.50% 5.00% 4.50% 4.00% 3.50% 3.00% Market Conditions 20

21 Rising interest rates increase the cost of borrowing Amount 1,000,000 1,000,000 1,000,000 Rate 3.25% 4.25% 5.25% Term Annual 68,779 75,220 81,952 Total P&I 1,375,578 1,504,397 1,639,046 Total Interest 375, , ,046 Market Conditions 21

22 Continuing Disclosure Types of CD EMMA Website (emma.msrb.org) Paying Agent On Going Costs 22

23 Important document for investors/lenders May become a requirement to receive credit rating Moody s in New York New audit examination law for small cities City Audited Financials 23

24 Commercial Rollback to 90% Impact on TIF Multi residential class Same as residential by 2022 Growth Restriction from 4% to 3% Impacts residential rollback How will this impact your City? Property Tax Reform 24

25 Interest Rate Changes Importance of Rating Marketability of Unique Financing Changing regulatory environment Changing Market Environment 25

26 Conclusions 26

27 Jeffrey Heil Northland Securities, Inc Westown Parkway, Suite 255 West Des Moines, Iowa The information contained in this presentation has been derived from sources believed to be reliable, but is not guaranteed as to accuracy and completeness and does not purport to be a complete analysis of the material discussed. The opinions expressed herein do not necessarily reflect those of Northland Securities, Inc., and are subject to change without notice. 27

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