An Introduction to Municipal Bonds for NALEO

Transcription

1 An Introduction to Municipal Bonds for NALEO May 19, Wells Fargo Bank, N.A. All rights reserved. Member FDIC.

2 Wells Fargo Public Finance Team Charles Peck Managing Director Public Finance - West & Midwest Region Wells Fargo Securities 333 South Grand Ave., 5th Floor Los Angeles, CA Tel Cell charles.peck@wellsfargo.com Scott Gorzeman Director Public Finance - West Region Wells Fargo Securities 333 South Grand Ave., 5 th Floor Los Angeles, CA Tel Fax scott.gorzeman@wellsfargo.com Municipal Bonds for NALEO 1

3 Wells Fargo Securities Public Finance Group has a National Presence Wells Fargo Public Finance consists of 100 team members in 18 office locations Public Finance Office Locations Wells Fargo has become a major underwriter of municipal bonds throughout the United States In 2017, WFS senior managed $23.1 billion of bonds 1 Public Finance teams include: West Midwest Southwest Southeast Northeast Healthcare Energy & Corporate Education & Nonprofit Infrastructure & Transportation Affordable Housing Wells Fargo Notable Senior Manager Transactions New York University Los Angeles Department of Water and Power Los Angeles County Museum of Art Kaiser Permanente LaGuardia Airport Terminal B Redevelopment Los Angeles Unified School District $592,585,000 GO Bonds $354,440,000 Revenue Bonds $171,500,000 Floating Rate Notes $2,075,000,000 Taxable Revenue Bonds $2,410,380,000 Revenue Bonds $1,226,355,000 GO Bonds Senior Manager May 2018 Co-Senior Manager April 2018 Sole Manager December 2017 Co-Senior Manager April 2017 Joint-Bookrunner May 2016 Co-Senior Manager March 2016 (1) Source: Securities Data Corp; Represents competitive and negotiated long-term municipal new issues during 1/1/ /31/2017 by Wells Fargo Bank, N.A. True Economics to bookrunner Municipal Bonds for NALEO 2

4 Why Do Governments/Municipalities Issue Bonds? State and local governments issue municipal bonds to pay for relatively large infrastructure projects Schools, courthouses, airports, roads, power plants, ports, wastewater treatment plants, hospitals and many other types of public projects Municipal bonds are a popular tool, with $408 billion of municipal bonds issued in 2017 and $423.6 billion issued in 2016 There are approximately $3.9 trillion of municipal bonds outstanding (Municipal Securities Rulemaking Board Muni Facts as of March 1, 2018) There is approximately $15.3 trillion of U.S. Treasury bonds outstanding (treasurydirect.gov as of April 30, 2018) Should an issuer use Pay-As-You-Go funds or issue municipal bonds to pay for a new infrastructure project? Can an issuer afford to pay 100% of a project s cost upfront and: Maintain healthy reserves Effectively manage rate/tax increases Would an issuer need/prefer to finance multiple projects instead of just one project at the same time with a much lower annual payment amount (debt service vs pay as you go amount)? Intergenerational equity all of the people that benefit from the project over time pay for the project Long-term bonds should not be used to finance current operations or routine maintenance though occasionally this does happen (restructuring bonds, pension bonds, Detroit, Puerto Rico ) Municipal Bonds for NALEO 3

5 History of the Municipal Bond Market Municipal debt predates corporate debt by centuries First U.S. municipal bond was issued in 1812 for the construction of the Erie Canal Explosion of railroad debt, followed by the panic of 1873 and subsequent defaults, gave rise to a number of surviving institutions: e.g., state legal debt limits, bond counsel and rating agencies Many of the most productive and iconic elements of our national infrastructure were originally financed with municipal bonds The Golden Gate Bridge, the New York Subway System, the Rose Bowl in Pasadena, Chicago O Hare Airport, the Orange County Convention Center in Orlando FL, the Long Beach Aquarium along with many, many others Tax laws, product innovations and technology have changed Municipal (Public) Finance Municipal bond insurance: protecting investors from an issuer default or bankruptcy The municipal bond issuer pays an insurance premium to a bond insurer to guarantee the payment of principal and interest on the bonds Municipal bond insurance protection reached 57% of all bonds issued in 2005 The 1980 s saw the creation of variable rate bonds (to manage soaring interest rates) The 1986 tax act (TEFRA) limited the use of municipal bonds to benefit private parties such as individuals and corporations through various Federal tax law revisions (to manage perceived abuses) The recent 2017 tax law eliminated advance refunding bonds Municipal Bonds for NALEO 4

6 What are Municipal Bonds? Municipal governments that issue bonds receive a cash payment (project funds) at the time of issuance in exchange for a promise to repay investors principal plus interest over time Bonds to finance long-term municipal infrastructure projects are typically repaid over 20 to 30 years Rather than getting a loan from one institution (e.g. a commercial bank), municipal bonds are sold in the public capital markets to many buyers/investors A bond is a large loan that is broken up into many pieces The pieces or bonds are sold in amounts as small as $5,000 Accessing the capital markets generally results in getting the lowest cost of capital (interest rate) for projects of size Municipal bonds are a type of security - Stocks & Bonds Provides a series of ongoing cash flows to the investors Typically interest is paid to the bondholders semiannually Principal is paid at the bond maturity Investment grade municipal bonds have a much lower default rate than investment grade corporate bonds 0.18% for municipals to 1.74% for corporates (Moody s U.S. Municipal Bonds Defaults and Recoveries, ) Municipal Bonds for NALEO 5

7 What are Municipal Bonds? A bond issue is divided into different bond maturities A 20-year bond issue will likely have bonds maturing in each year, i.e. 20 different annual maturities Bonds then would mature in 2019, 2020, 2021, 2022, 2023, 2024.with a final bond maturing in 2038 Each bond maturity will carry its own interest rate For example, in a recent municipal bond sale the 2019 maturity had a coupon interest rate of 2.00% While the 2038 bond maturity had a coupon interest rate of 5.00% For a $10,000 investment the 2019 bond maturity would pay the investor $200 in tax exempt interest per year (the principal of $10,000 is paid back in 2019) While the 2038 bond maturity would pay an investor that owns $10,000 of bonds $500 in tax exempt interest per year (the principal amount of $10,000 is paid back in 2038) Different bond maturities may appeal, and are often designed to appeal, to different segments of municipal bond investors Interest on most municipal bonds is exempt from federal taxation Interest is also exempt from state and local taxation typically only in the state where issued Municipal Bonds for NALEO 6

8 Who Issues Tax-Exempt Bonds? General Municipal Issuers Private Activity Bonds States Cities Towns Counties Transportation agencies School districts Water districts 501(c)(3) (non-profit) organizations Hospitals/healthcare facilities Certain facilities for airports, ports Multifamily/single family housing Student loan bonds Environmental facilities Industrial development bonds Special districts Municipal Bonds for NALEO 7

9 Bond Issuance Process The bond financing team works together to create a marketable and credit-worthy structure to attract investor demand The bond underwriter manages the bond sales process Markets the bonds to various investor segments Investors buy the bonds from the issuer through the bond underwriter Makes an offer to the issuer to buy bonds at certain prices based on investor demand and the issuer receives the bond proceeds (project funds) from the bond underwriter Legal documentation outlines the (limited) rights of the bondholders and the mechanics for repayment; provides disclosure information about the issuer and the specific source of bond repayment (the credit) to potential investors Issuer uses the bond proceeds (project funds) to finance/construct the project Other key players include financial (municipal) advisors, bond counsel, disclosure counsel, bond trustee, and rating agencies Issuer $ Bonds Bond Underwriter (Investment Banks) $ Bonds Investors Municipal Bonds for NALEO 8

10 Buyers of U.S. Municipal Securities Most bonds are purchased by professional buyers Mutual funds Exchange traded funds (ETF s) Professional money managers Trusts Insurance companies Individual Investors Direct retail ( mom and pop ) Professional retail (Separately Managed Accounts SMAs ) High net worth retail Indirect retail (mutual funds) Banking Institutions 7% Insurance Companies 12% Mutual Funds 26% Other 3% Individuals 52% Banking Institutions 15% Insurance Companies 14% Other 5% Individuals 41% Mutual Funds 25% Other includes non-financial corporations, non-financial non-corporation businesses, foreign banking offices in the U.S., credit unions, banks in U.S. affiliated areas and GSEs, ETFs, State & Local Govt. Source: Federal Reserve System Municipal Bonds for NALEO 9

11 Unique Characteristics of Municipal Bonds Interest on most municipal bonds is tax-exempt at the Federal and state (where issued) level Tax-exempt investors accept lower rates than available on taxable investments to achieve the same after-tax return Tax-exempt interest is more valuable to individuals in higher tax brackets Tax-exempt interest rates are also lower in states with high income tax rates (CA, NY), all else being equal Typically, tax-exempt bonds carry lower interest rates than taxable bonds of similar credit quality Tax Equivalent Yield Tax-Free Yield 100% - Marginal Tax Rate = Taxable Equivalent Yield 7% 7% = = 10% 100% - 30% 70% Municipal Bonds for NALEO 10

12 Debt Issuance Restrictions for State and Local Governments There are state constitutional debt limits in all states Unless an issuer meets an exception to the State Constitutional debt limitation, it must get voter approval to issue bonds Government Level State Local State of California Voter Approval Requirement 50% - General Fund secured 55% - Property Tax secured School Districts 2/3rd s - Property Tax secured Other Three major exceptions to the State s debt limitations have been recognized by California Courts and are commonly used Lease Special Fund Obligation Imposed by Law Debt service payments subject to beneficial use & occupancy Debt service is subject to abatement if no beneficial use & occupancy Revenue bond debt service supported by revenues related to the project(s) Case law allows for other special fund obligations Involuntary obligation, such as one imposed by a legal judgment Ex: Judgment Obligation Bonds, Pension Obligation Bonds & Teeter Financings Municipal Bonds for NALEO 11

13 Types of Municipal Bonds and Bond Repayment Sources Dedicated Taxes Type of Bond General obligation bonds (GOs) Dedicated tax revenue bonds Mello-Roos bonds Redevelopment tax allocation bonds Source of Repayment Unlimited ad valorem property tax Voter-approved additional sales tax Parcel tax Property tax increment General Fund Obligations Lease revenue bonds/cop s Pension obligation bonds State-level GOs Annually appropriated lease payments Required pension contributions General fund payments Special Fund Bonds Enterprise revenue bonds Assessment bonds Water, sewer and other utility fees Special benefit assessments Non- Governmental Activities 501(c)3 revenue bonds Private Activity bonds Loan repayments from non-profit corporations like hospitals and universities Loan repayments from exempt business Municipal Bonds for NALEO 12

14 Additional Bond Security Features (Covenants) Covenants: bonds and other bond-like securities contain promises made to the bond investors/buyers Covenant (make a promise) to take actions necessary to repay the bonds Levy a property tax for local government general obligation bonds Budget and appropriate lease payments for lease revenue bonds or COPs Set rates to pay operating costs, debt service, and usually a margin of safety for revenue bonds Promise to maintain tax-exemption (if tax-exempt) Promise to use proceeds on the project discussed and disclosed Expectations are to spend the bond proceeds (project funds) within three years Other promises to protect investors may include Maintenance of the revenue generating system (power plant, sewer pipes, water pipes, toll road) Limitations on additional debt Maintain insurance on assets to guard against destruction of the revenue generating asset Annual financial audits Continuing disclosure information Municipal Bonds for NALEO 13

15 Uses of Municipal Bond Proceeds New Money Construction of the capital project(s) Costs of bond issuance Refundings (Refinancings) Tax-exempt municipal bonds are usually callable; i.e., can be redeemed by an issuer prior to their final maturity (most typically after ten years ten-year-par-call ) Refunding bonds are usually issued at lower rates to generate debt service savings from the debt service costs of the old bonds The new tax law eliminated tax-exempt advance refundings and limits any refunding to a current refunding Working Capital Tax and Revenue Anticipation Notes are used for annual cash-flow borrowings (non-capital project related debt) Long-term working capital (deficit borrowings) Interim Financing (often used in connection with very large and lengthy projects) Bond anticipation notes or commercial paper used for project funds Most often sold in anticipation of a long-term bond issue Municipal Bonds for NALEO 14

16 $ Billions Total Annual Municipal Issuance Over the Past Decade YTD New Money Refunding New Money & Refunding 10 Y Average (Total Issuance) Source: Thomson Reuters as of May 14, 2018 Municipal Bonds for NALEO 15

17 % of Time MMD has been Lower than Current Levels 19.17% 14.16% 12.08% 9.41% 9.12% 31.29% 42.73% Current MMD (%) Jan-01 Jan-08 Jan-15 Jan-22 Jan-29 Feb-05 Feb-12 Feb-19 Feb-26 Mar-05 Mar-12 Mar-19 Mar-26 Apr-02 Apr-09 Apr-16 Apr-23 Apr-30 Interest Rates Have Declined in the Past Decade to Near Historical Lows 10-, 20- and 30-Year AAA MMD 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Yr MMD 10-Yr MMD 20-Yr MMD 30-Yr MMD % of Time MMD Has Been Lower Than Current Levels Since Jan. 2, % 3.00% 2.50% 2.00% 1.50% 1.00% MMD Yield Curve 5-Yr MMD 44 bps 10-Yr MMD 45 bps 20-Yr MMD 42 bps 30-Yr MMD 43 bps 3.03% 2.92% 2.51% 2.08% 100% 80% 60% 40% 20% % 2.50% 2.00% 1.50% 1.00% 0.50% 1.74% 0.98% 3.03% 2.97% Yield Curve Steepness Current 1/3/ Yr MMD - 1-Yr MMD % % Source: Thomson Reuters as of May 14, /3/2017 Current Municipal Bonds for NALEO 16

18 Recent Trends and Topics in the Municipal Bond Industry Tax law changes Infrastructure investment Green bonds Bank direct purchases Increased regulation Public/private partnerships (P3) Rising interest rates Pensions/OPEB Municipal Bonds for NALEO 17

19 Tax Reform: Key Impacts to Municipal Market 1 Elimination of Tax- Exempt Advance Refundings Renewed focus on shorter call features (increase optionality) Alternative refunding strategies (look to replicate lost PV savings) Taxable advance refunding Forward delivery refundings Cash Optimization 2 Reduction in Corporate Tax Rate Corporate tax reduced to 21% from 35% Decreased demand from insurance companies and banks Increased costs for bank facilities 3 Cap on State and Local Tax ( SALT ) Deduction Limited state and local property and income tax deduction to an aggregate of $10,000 per year Greater retail demand particularly for high-income/high tax states such as California Sources: U.S. Congress. The bill text is available here: Municipal Bonds for NALEO 18

20 Summary The U.S. municipal bond market is large and very well-established Municipal bonds are very popular investments for millions of investors Municipal bonds are a useful and cost-effective method to raise capital for infrastructure projects As with any debt, it is important to make sure that both the debt service as well as the operating costs of the resulting project are affordable Hire a strong team of qualified financial professionals to assist you in developing a credit-worthy and costeffective bond structure to finance and to move your project forward to completion Municipal Bonds for NALEO 19

21 Important Disclosures This communication is for informational purposes only, is not an offer, solicitation, recommendation or commitment for any transaction or to buy or sell any security or other financial product; and is not intended as investment advice. The information contained herein is (i) derived from sources that Wells Fargo Securities ("WFS") in good faith considers reliable, however WFS does not guarantee the accuracy, reliability or completeness of this information and makes no warranty, express or implied, with respect thereto; and (ii) subject to change without notice. WFS accepts no liability for its use or to update or keep it current. Products shown are subject to change and availability. WFS and/or one or more of its affiliates may provide advice or may from time to time have proprietary positions in, or trade as principal in, securities that may be mentioned herein or other securities issued by issuers reflected herein; or in derivatives related thereto. Wells Fargo Securities is the trade name for certain securities-related capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including Wells Fargo Securities, LLC, member NYSE, FINRA, NFA, and SIPC, and Wells Fargo Bank, N.A., acting through its Municipal Products Group. Commercial banking products and services provided by Wells Fargo Bank, N.A. ( WFBNA ). Investment banking and capital markets products and services provided by WFS are not a condition to any banking product or service. Municipal Derivatives solutions are provided by WFBNA, a swap dealer registered with the CFTC and member of the NFA. This communication is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations and does not constitute advice within the meaning of Section 15B of the Securities Exchange Act of You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment, and other aspects of this communication. Neither WFS nor any person providing this communication is acting as a municipal advisor or fiduciary with respect to any transaction described or contemplated therein unless expressly agreed to in a written financial advisory or similar agreement. 2Q2018 Municipal Bonds for NALEO 20