MUNICIPAL BONDS IN TEXAS and THE BOND SALE PROCESS

Transcription

1 MUNICIPAL BONDS IN TEXAS and THE BOND SALE PROCESS Government Treasurers Organization of Texas Winter Seminar December 5, :30 AM 10:30 AM Robert W. Baird & Co. Incorporated ( Baird ) is providing this information to you for discussion purposes. The materials do not contemplate or relate to a future issuance of municipal securities. Baird is not recommending that you take any action, and this information is not intended to be regarded as advice within the meaning of Section 15B of the Securities Exchange Act of 1934 or the rules thereunder.

2 INTRODUCTION: TODAY S PRESENTER Brian Kelso Managing Director Baird Public Finance bkelso@rwbaird.com Baird is a leader in Texas municipal finance serving issuers across the state, by providing underwriting services and support throughout the bond issuance process. 2

3 CONTINUING PROFESSIONAL EDUCATION -LEARNING OBJECTIVES Learning objectives include: What are municipal bonds and why are they used by local governments Types of municipal bonds legally available to Texas local governments Bond sale methods and the bond sale process Basic types of investors that buy municipal bonds What is an Official Statement ( OS ) and what information is required to be in the OS Documents required for a bond sale 3

4 DISCUSSION CONTENTS What is a Municipal Bond? Why Would you Sell Bonds? The Official Statement ( OS ) and Other Bond Documents The Bond Sale Process Who Buys Municipal Bonds How are Interest Rates Determined? Important Disclosures Q&A 4

5 WHAT IS A MUNICIPAL BOND?

6 WHAT IS A MUNICIPAL BOND? A bond is an instrument of indebtedness of a bond issuer to the holders of the bond, similar to a traditional loan between a bank and an individual. A municipal bond is a bond issued by a state or local governmental entity. The repayment of bonds consist of both principal and interest. Principal The amount borrowed and still owed on a bond or loan, separate from interest (also known as Face Value ) Interest The compensation paid or to be paid for the use of money, expressed as an annual percentage rate 6

7 WHAT ARE TAX-EXEMPT BONDS? Short Answer: Legal Tax Shelters Congress and the Internal Revenue Service ( IRS ) allow purchasers of taxexempt bonds to deduct the interest they receive from their income when calculating their Federal income taxes. Because of this deductability, interest rates on tax-exempt bonds are typically lower than interest rates on taxable debt, and result in considerable cost savings to the issuing municipality. Disadvantages: The IRS has very strict rules on the projects for which taxexempt bonds can be issued, which are generally limited to public projects. If a project built with proceeds, from an issuance of tax-exempt bonds are ever used in violation of these rules before the bonds are fully repaid, the tax-exempt bonds are deemed taxable as of their date of issuance. Reasonably expect to spend 85% of proceeds within three years Earnings on bond proceeds must be monitored and any earnings in excess of the borrowing cost must be rebated back to the IRS. 7

8 WHY WOULD YOU SELL BONDS? Why Would You Sell Bonds? Types of Bonds Available to Texas Municipalities

9 WHY WOULD YOU SELL BONDS? Municipal Bonds are Issued to Finance a Broad Range of Projects Including: School buildings and facilities Streets and roads Governmental buildings Transportation facilities and infrastructure Power generation and transmission facilities Water and sewer pipelines and treatment Healthcare facilities 9

10 WHY WOULD YOU SELL BONDS? (CONTINUED) Security for Municipal Bonds: Generally Speaking General Obligation or Revenue Bonds General Obligation ( GO ) Bonds o Full Faith and Credit taxing power o Property tax backed o Require voter approval o Limited or Unlimited Tax GOs (cities vs. school districts) o For home rule cities with a total taxing authority of $2.50/$100 of taxable value of property, the Attorney General imposes a maximum tax rate of $1.50 for debt service at the time of issuance o For school districts, the Texas Attorney General imposes a $0.50/$100 of taxable value maximum test at the time of issuance o Issuers include school districts, cities and towns, and special districts (water environmental, hospital, community college, etc.) 10

11 WHY WOULD YOU SELL BONDS? Revenue Bonds Payable from a specific stream or streams of revenue other than property taxes Common revenue bonds include water and sewer, sales tax, airport, electric and hotel taxes 11

12 COMMON TYPES OF BONDS AVAILABLE TO TEXAS MUNICIPALITIES Voter Cities & Counties Approval Required? Maximum Maturity Limited Tax GO Bonds Yes 40 years Certificates of Obligation ("C/O") No 40 years 30 day notice required - local newspaper, at least two publications Petition of 5% of qualified voters to require C/O to go to an election Pledge of revenues or revenues plus general obligation Can't be used for projects turned down by voters in GO election during last 3 years Limited Tax Notes (also available to ISDs) No 7 years No election or publication process Limited uses (e.g. construction of public work, the purchase of materials, buildings and professional services, etc.) Revenue Bonds No Various Various revenues can be pledged (e.g. water/wastewater, drainage, electric, sales tax, hotel tax) Development tools such as Tax Increment Reinvestment Zone Bonds and Public Improvement District Assessment Bonds Pass Through Toll Bonds No 40 years Proceeds must be used for state highway system projects TxDOT pays issuers a per vehicle "toll" which are pledged to bondholders in addition to property tax pledge 12

13 TYPES OF BONDS AVAILABLE TO TEXAS MUNICIPALITIES (CONTINUED) Voter Cities & Counties (continued) Approval Required? Maximum Maturity Additional Tool -- Self Supporting Debt Internally paying debt from source not pledged (e.g. paying C/Os from water revenues) If revenues are insufficient, property tax must be levied Common for refunding revenue bonds with GO credit Voter Counties Only Approval Required? Maximum Maturity Unlimited Tax GO Bonds (Road Bonds) Yes 40 years Voter School Districts Approval Required? Maximum Maturity Unlimited Tax GO Bonds Yes 40 years Maintenance Notes No 20 years Can be repaid from maintenance tax or other funds Proceeds used to pay maintenance expenses 13

14 WHY WOULD YOU SELL BONDS? Tax-Exempt Bonds Interest is exempt from federal income taxes (state tax exemption not applicable in Texas) Tax exemption provides a lower borrowing cost to the issuer Taxable Bonds Certain uses are not eligible for tax exemption Do not provide a significant benefit to the public at large Elect to use taxable bonds when managing tax code for certain projects is difficult (e.g. arenas, convention center, multi-use facilities) 14

15 THE OFFICIAL STATEMENT ( OS ) AND OTHER BOND DOCUMENTS The Official Statement Key Documents to a Bond Sale Post Issuance Compliance Responsibilities

16 THE OFFICIAL STATEMENT ( OS ) The OS is used to market the bonds to prospective investors The OS needs to contain all the material information about an issuer s credit that allows an investor to make an informed decision Omitting material information can result in regulatory actions In October 2016, the City of Miami agreed to a $1 million settlement with the Securities and Exchange Commission ( SEC ) for not disclosing the City s full financial picture. A federal jury also found the budget director guilty of Securities Act violations. (Source: The Bond Buyer, October 14, 2016) Key information to include in an OS Summary of the issuer including location, governance, population, and educational opportunities Use of bond proceeds Bond terms including maturities, interest rates, redemption features, and interest payment dates Details on the credit pledged (e.g. tax-backed versus water and wastewater revenue) 16

17 THE OFFICIAL STATEMENT ( OS ) (CONTINUED) Key financial information included in an Official Statement For GO Debt o Tax valuations o Assessed value broken down by category o Tax rates and collection rates o 10 largest taxpayers o Aggregate annual debt service o Statement of revenue and expenditures from the general fund For Revenue Debt o Description of the revenue generation (e.g. water and wastewater) o Usage of the revenue generating system (e.g. water in millions of gallons per day) o Debt service coverage ratio o 10 largest users o Statement of revenues and expenditures 17

18 KEY DOCUMENTS TO A BOND SALE Ordinance/ Trust Indenture Bond or Delegation* Document authorizing the issuance of the bonds and sets forth basic terms of the transaction. A Trust Indenture may be used for an issuance of revenue bonds. Pricing Certificate Only used with a delegation authority. Executed by authorized staff and sets forth final terms that have been delegated. Bond Purchase Agreement Paying Agent Agreement A legally binding document between a bond issuer and an underwriter establishing the terms of a bond sale. Terms include sale price, interest rates, bond maturity, redemption provisions and conditions under which the agreement may be cancelled. Document between the issuer and a bank that details how bondholders will be paid. Escrow Agreement Applicable for refundings only Document between issuer and escrow bank that details how defeased bonds are to be paid with escrow securities. * There are limitations on who can use delegation authority for new projects (there are no restrictions on refundings). For example, a City with less than 50,000 population cannot use delegation authority. School districts can also use delegation if they have at least 50,000 in average daily attendance or $100 million of debt outstanding, including the proposed debt. 18

19 POST-ISSUANCE COMPLIANCE RESPONSIBILITIES State Law Proceeds spent only for purposes authorized Securities Law Tax Law Issuer files continuing disclosure reports and material event notices Proceed expenditure requirements Investment earnings on unspent proceeds Restrictions on use of bond-financed property 19

20 THE BOND SALE PROCESS Financing Participants Bond Ratings Type of Sale Negotiated vs. Competitive Sale Sample Timetable

21 FINANCING PARTICIPANTS ISSUER A state, political subdivision, agency, or authority that borrows money through the sale of bonds or notes. BOND COUNSEL Attorneys retained by the issuer/borrower to give an expert and objective legal opinion with respect to the validity of bonds and other subjects, particularly the federal income tax treatment of interest on the bonds. FINANCIAL ADVISOR Consultant who advises an issuer/borrower on matters pertinent to an issue, such as structure, timing, marketing, fairness of pricing, terms, and bond ratings. May also prepare the official statement. UNDERWRITER Dealer which purchases a new issue of municipal securities for resale. TRUSTEE Financial institution which acts in a fiduciary capacity for the benefit of bondholders in enforcing the terms of the bonds. Maintains accounts related to the bonds such as a debt service fund or debt service reserve fund. More common for complex revenue bonds. 21

22 FINANCING PARTICIPANTS (CONTINUED) PAYING AGENT/REGISTRAR Entity responsible for transmitting payments to bondholders. A bond has either a paying agent or a trustee, not both. RATING AGENCY Organization which provides publicly available ratings of the credit qualities of securities. CREDIT ENHANCER Bond insurer, commercial bank, or other financial institution issuing an insurance policy or a supporting letter of credit in order to improve an issue s credit rating. PSF serves as credit enhancement for school district bonds UNDERWRITER S COUNSEL Attorneys representing the underwriter in connection with the purchase of a new issue of municipal securities through a negotiated sale. 22

23 BOND RATINGS Moody s S&P Fitch Investment Grade Ratings Aaa AAA AAA Highest Possible Rating Aa1 AA+ AA+ Aa2 AA AA High Grade Aa3 AA- AA- A1 A+ A+ A2 A A Upper Medium Grade A3 A- A- Baa1 BBB+ BBB+ Baa2 BBB BBB Lower Medium Grade Baa3 BBB- BBB- Speculative Ratings Ba BB BB Non Investment Grade B B B Highly Speculative Caa CCC CCC Extremely Speculative Ca CC CC Default Imminent C C C No Longer Paying Interest D DDD In Default DD D Most Texas cities, counties and ISDs have underlying ratings that range from AAA to A category Bond insurance companies are rated AA and the Texas Permanent School Fund is rated AAA 23

24 TYPE OF SALE Competitive Issue Bonds are advertised for sale (notice of sale) Any broker-dealer or bank may bid at the designated date and time Bonds are awarded to the bidder offering the lowest True Interest Cost ( TIC ) Can be one broker-dealer or a group of broker-dealers called a syndicate Negotiated Issue Underwriter selected by Issuer in advance of the sale Issuer and underwriter agree upon a yield level at which the underwriter will offer bonds to potential investors Initial interest scale may be adjusted depending on investor demand One or more underwriters depending on par size Private Placement Bonds are sold to one investor at negotiated terms Typically smaller transactions Includes state and federal lending programs such as those from Texas Water Development Board and United States Department of Agriculture Factors to consider: Credit rating Market Volatility Timing flexibility Structuring flexibility Refinancing savings targets Political considerations 24

25 NEGOTIATED VS. COMPETITIVE SALE Negotiated Competitive Advantages Disadvantages Advantages Disadvantages Opportunity for significant pre-sale marketing (preliminary scales offered to investors prior to ensure market visibility and access investor interest) Ability to time sale to minimize interest costs (Supply vs. Demand) Ability to rapidly respond to changing market conditions and investor demand Ability to utilize innovative, cost savings proposals from the investment banking community No guarantee of lowest bid in the market that day Potential accusation of favoritism Awards aggressive bids from underwriters Discourages political lobbying from underwriters No charges of favoritism Less presale marketing, could result in risk premium (higher interest rates) Reduced issuer flexibility, by locking in issue size, maturity structure and offering terms in accordance with the public notice of sale (some flexibility) No control over the distribution of bonds Few or no bids in periods of market uncertainty (unusual) 25

26 NEGOTIATED VS. COMPETITIVE SALE (CONTINUED) 1 WEEK PRIOR TO SALE 1 DAY PRIOR TO SALE DAY OF SALE COMPETITIVE SALE: - Notice of Sale and Preliminary Official Statement posted for underwriters and investors - Financial Advisor receives bid forms - Bids received and winning bid awarded. - Bond Purchase Agreement executed NEGOTIATED SALE: - Preliminary Official Statement posted for underwriters and investors - Pre-pricing conference call (optional) - Order period to offer the bonds - Investors submit orders - Post order period conference call (optional) - Underwriter makes offer to buy the bonds after making any proposed adjustments - Bond Purchase Agreement executed 26

27 SAMPLE TIMETABLE FOR A NEGOTIATED SALE Number of weeks prior to sale 8 Weeks Council approves notice of intent to issue C/Os (if applicable) Rating applied for 7 Weeks Official Statement ( OS ) reviewed by all parties 6 Weeks Credit materials (offering document, audits, budget) sent to rating agency 4 Weeks Rating agency conference call 2 Weeks Rating released Due diligence conference call with underwriter 1 Week OS posted for investors 27

28 SAMPLE TIMETABLE FOR A NEGOTIATED SALE (CONTINUED) Number of weeks after sale Sale Date Bond Sale: Interest rates set by underwriter Final OS distributed Council approves sale of the Bonds (if not a delegation authority) 1 Week Final OS reviewed by all parties Final OS posted for investors 2 Weeks Bond counsel distributes draft bond documents All parties review draft bond documents 3 Weeks Bond documents signed by the issuer, underwriter and financial advisor 4 Weeks Closing Underwriter wires funds to issuer 28

29 WHO BUYS MUNICIPAL BONDS?

30 WHO BUYS MUNICIPAL BONDS? Typical investors in municipal bonds include: Retail or mom-and-pop investors Vehicles for retail investment (mutual funds, money market funds, separately managed accounts, money managers, and bank personal trust departments) Property and casualty insurance companies Commercial banks Arbitrage accounts 30

31 WHO BUYS MUNICIPAL BONDS? (CONTINUED) Yield Years Retail/ Individuals Investors Along the MMD Yield Curve < 15 Years Money Managers/Trusts Separately Managed Accounts 5 YR 10 YR Years Intermediate Bond Funds Insurance Companies 15 YR 20 YR Years Insurance Companies Bond Funds Retail/Individuals 25 YR 30 YR What is MMD? MMD is an acronym for Municipal Market Data Index The Index, compiled by Thomson Reuters, is published each afternoon for maturities ranging from 1 year to 30 years The Index is comprised by input from market participants and banks that buy and sell municipal bonds The yields are reflective of AAA rated national general obligation bonds The MMD is considered the industry benchmark 31

32 WHO BUYS MUNICIPAL BONDS? (CONTINUED) OVERVIEW OF INVESTORS SERVED First-Tier Investors Second-Tier Investors Third-Tier Investors Retail Typically trade in blocks of $5 million and greater Often extremely price sensitive Actively trade securities in the secondary market Typically trade in blocks of $2 million to less than $5 million Less price sensitive than first tier investors Typically not active in the secondary market Typically trade in blocks of $500,000 to less than $2 million Least price sensitive Buy and hold securities Concerned about quality Typically trade in blocks of $100,000 or less Concerned about quality Name and in-state driven Not price sensitive Buy and hold securities Investors Include Investors Include Investors Include Investors Include Bond funds Property and casualty insurance companies Money managers Large bank trust accounts Small insurance companies Bank trust accounts Unit investment trusts Money managers Corporations Specialty state funds Small insurance companies Small bank trust accounts Money managers Small Corporations Individuals (high net worth and mom and pop investors) 32

33 HOW ARE INTEREST RATES DETERMINED? What Drives Interest Rates The Municipal Market Data Index ( MMD ) What Causes Interest Rates to Move Up and Down Type of Bonds: Par, Premium & Discount The Day of the Bond Sale

34 WHAT DRIVES INTEREST RATES? NET INFLOWS/OUTFLOWS FOR BOND FUNDS Market dynamics Global Local Supply & demand Federal Reserve One Year Snapshot Date ICI Fund Flow November 8, 2017 $825,000,000 November 1, 2017 $287,000,000 October 25, 2017 $663,000, Avg Avg YTD Avg.* $292,505,385 $522,923,077 $544,155, Year Historical Net Municipal Bond Flow of Funds SOURCE: Investment Company Institute Data as of November 15,

35 THE MUNICIPAL MARKET DATA INDEX ( MMD ) The Municipal Market Data Index ( MMD ) Represents highest grade or implied AAA rated GO interest rates nationally Benchmark Index for the municipal bond market Bonds are typically priced at a spread (in basis points) to the MMD Index The size of the spread is based on several factors including Credit quality Security type and source of repayment Maturity date Redemption or call features State specific supply and demand Liquidity of the securities 35

36 THE MUNICIPAL MARKET DATA INDEX ( MMD ) (CONTINUED) MMD Yield Curve Comparison for November 2016 vs. November Yield (%) Year 11/16/ /16/2017 SOURCE: Thomson Municipal Market Data (TM3) 36

37 THE MUNICIPAL MARKET DATA INDEX ( MMD ) (CONTINUED) Tax-Exempt Credit Spreads for 20-year Maturity Comparison of AA, A and BBB Spreads to AAA MMD November 2012 to November y Baa Spread to 20y Aaa 20y A Spread to 20y Aaa 20y Aa Spread to 20y Aaa 20y MMD Spread (basis points) Yield SOURCE: Thomson Municipal Market Data (TM3) as of November 10,

38 TYPE OF BONDS: PAR BONDS A bond that is issued or trades with a coupon rate that is equal to its yield Price equals to 100% Example: Coupon of 3.00% and Yield of 3.00% Typical Investors Banks Trust companies Certain retail investors Benefits for Investors Easier for investors to understand Yield: 3.00% Coupon: 3.00% Price = 100% 38

39 TYPE OF BONDS: PREMIUM BONDS A bond that is issued or trades with a coupon rate that is higher than its yield Price greater than 100% Example: Coupon of 5.00% and Yield of 3.00% Typical Investors Professionally managed retail (5% coupons) Large bond funds Benefits for Investors Yield: 3.00% Protection from rates rising and prices falling More interest up-front Higher yield to maturity for callable premium bonds Coupon: 5.00% Premium Price > 100% Yield to Maturity: The rate of return to the investor earned from payments of principal and interest, with interest compounded semi-annually at the stated yield, presuming that the security remains outstanding until the maturity date. Yield to maturity takes into account the amount of the premium or discount at the time of purchase, if any, and the time value of the investment. Source: MSRB 39

40 TYPE OF BONDS: DISCOUNT BONDS A bond that is issued or trades with a yield that is higher than its coupon rate Price less than 100% Example: Coupon of 2.00% and Yield of 3.00% Typical Investors Retail (Mom and Pop) o Closer to par, easier to understand Arbitrage accounts Benefits for Investors Yield: 3.00% Coupon: 2.00% Discount Price < 100% Buy at discount, receive more principal upon maturity Less money out of pocket up-front 40

41 THE DAY OF THE BOND SALE Order Priority Determines the order in which the underwriter must allocate the orders for bonds The order priority also plays a significant role in determining underwriter compensation One of two order priorities is typically selected: Group Net Takedown revenue shared among underwriters at liability Advantage: Ensures underwriters are compensated fairly Disadvantage: Underwriters may not be as motivated to find orders Net Designated Investors determine what percentage of takedown is paid to underwriters (within parameters determined by the issuer) Examples: Maximum designation of 50%; Minimum designation of 10%; All firms must be designated Advantage: Incentivizes all syndicate members to call investors Disadvantage: Underwriters may not be fairly compensated for their work A retail priority can also be utilized. Allows retail (such as local residents) to have their orders filled first 41

42 THE DAY OF THE BOND SALE (CONTINUED) Underwriter(s) offer the bonds to the market at proposed interest rates that are spread off the MMD Index The bonds are offered to investors during an order period Typical order period last 1½ hours City of Rockwall, Texas GO Refunding and Improvement Bonds, Series 2016 Preliminary Pricing Amortization MMD Spread to Maturity (000s) (1/28) Coupon Yield MMD 8/1/2017 $2, /1/2018 $3, /1/2019 $5, /1/2020 $5, /1/2021 $4, /1/2022 $5, /1/2023 $5, /1/2024 $5, /1/2025 $5, /1/2026 (2) $1, /1/2026 (2) $5, /1/2027 $5, /1/2028 $4, /1/2029 $2, /1/2030 $1, /1/2031 $1, /1/2032 $1, /1/2033 $2, /1/2034 $2, /1/2035 $2, /1/2036 $1, /1/2037 $ $78,355 42

43 THE DAY OF THE BOND SALE (CONTINUED) At the end of the order period the amount of orders is evaluated to determine what, if any, adjustments to interest rates are appropriate City of Rockwall, Texas General Obligation Refunding and Improvement Bonds, Series 2016 In most maturities there were more orders than bonds, known as oversubscribed ORDERS by Investor Type Amt Money Co- Trust Dealer Bank Arbitrage Fund Insurance Retail Mat. Coup. (000s) Manager Managers Total 1-Aug Orders Orders Orders Orders Orders Orders Orders Orders Orders Orders ,525 8,075 2, ,275 12, ,705 7, ,455 5,705 16, ,445 7,145 5,210 8,945 21, ,315 5,660 8,315 13, ,830 13, ,580 18, ,070 3,300 4,820 3,000 11, ,335 10,060 5,090 2,000 17, ,625 6,475 5,370 2,000 13, ,920 7,150 5, ,000 15, (1) ,000 1,000 1, (1) ,220 19,035 2,000 21, , ,515 5,895 5,945 17, , ,525 4,715 4,715 14, ,495 2,495 2,495 4, ,775 1,775 1,775 3, ,840 1,840 1,100 2, ,900 6,195 1,000 7, ,000 3, ,000 3,500 10, , ,065 2,865 5, ,140 1, ,140 2,640 7, , ,610 1, TOTAL: 78, ,125 23,490 2, ,205 25,430 16, , ,960 (1) Bifurcated maturity 43

44 THE DAY OF THE BOND SALE (CONTINUED) After any adjustments are made, bond sizing numbers are finalized and the pricing process is completed The Bond Purchase Agreement is signed by authorized staff or the governing board City of Rockwall, Texas GO Refunding and Improvement Bonds, Series 2016 Preliminary Pricing Final Pricing Amortization MMD Spread to Maturity (000s) (1/28) Coupon Yield MMD Coupon Yield Spread 8/1/2017 $2, /1/2018 $3, /1/2019 $5, /1/2020 $5, /1/2021 $4, /1/2022 $5, /1/2023 $5, /1/2024 $5, /1/2025 $5, /1/2026 (2) $1, /1/2026 (2) $5, /1/2027 $5, /1/2028 $4, /1/2029 $2, /1/2030 $1, /1/2031 $1, /1/2032 $1, /1/2033 $2, /1/2034 $2, /1/2035 $2, /1/2036 $1, /1/2037 $ $78,355 (2) Bifurcated maturity 44

45 IMPORTANT DISCLOSURES Robert W. Baird & Co. Incorporated ( Baird ) is providing this information to you for discussion purposes only. The information does not contemplate or relate to a future issuance of municipal securities. Baird is not recommending that you take any action, and this information is not intended to be regarded as advice within the meaning of Section 15B of the Securities Exchange Act of 1934 or the rules thereunder. In providing this information, Baird is not acting as an advisor to you and does not owe you a fiduciary duty pursuant to Section 15B of the Securities Exchange Act of You should discuss the information contained herein with any and all internal or external advisors and experts you deem appropriate before acting on the information. This presentation is for informational and educational purposes only and should not be used or construed as legal advice. 45

46 Q & A