Municipal Bonds in the Lone Star State

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1 Municipal Bonds in the Lone Star State An overview of the Texas Municipal Bond Market Kimberly Edwards Vice President, Municipal Finance CFA Society of Houston January 19, 2011 For investment professional use only. Fidelity Capital Markets is a division of National Financial Services LLC, Member NYSE, SIPC

2 Fidelity Investments - Overview FIDELITY INSTITUTIONAL ASSET MANAGEMENT RETAIL/401K INTERMEDIARY MUTUAL FUND SALES INSTITUTIONAL PLATFORMS FIDELITY MANAGEMENT RESEARCH PERSONAL WORKPLACE AND INVESTING FIDELITY INVESTMENTS INSTITUTIONAL SERVICES (FIIS) FIDELITY CAPITAL MARKETS (FCM) FIDELITY INSTITUTIONAL WEALTH SERVICES (IWS) Institutional Trading Prime Services Electronic Brokerage Services Over 572 million shares/day Approximately 3,300 advisors Over $464B in assets Over 1,200,000 accounts Investment Advisor to Fidelity s family of mutual funds. Mutual Fund Assets as of $1,270.2 billion 407 Total Funds Managed Helps millions of people save and invest through individual retail accounts and workplace savings plans. Total PWI Administered Assets of $1,864.1 billion Total Customer Accounts 12.4 million Investment Management Services Fidelity Advisor Funds, Variable Insurance Product (VIP) Portfolios, systematic investment plans, and institutional money market funds $343.7 billion in assets NATIONAL FINANCIAL (NF) Over 300 broker/dealers servicing over 85,000 brokers Over 4.3 million accounts Over $440 billion in assets FIDELITY FAMILY OFFICE SERVICES (FFOS) Investment Mgt. Solutions Alternative Asset Solutions Trust & Charitable Services Fidelity unaudited Data as of September 30, 2010

3 Fidelity s Distribution Channels Powerful Distribution Through Fidelity s Brokerage Channels Muni Bond Issuer Individual Retail Investors Institutional Wealth Services Institutional Accounts Correspondent Broker/Dealers $952.5 billion in brokerage assets 12.4 million brokerage accounts 150 Investor Centers in US 1.5 million daily website hits Over 2,100 registered reps Fidelity unaudited data as of Sept. 30, 2010 Over $464.1 billion in assets 1,200,000 ending client accounts Approximately 3,300 RIAs, bank trusts, and TPA firms FCM covers the universe of recognized Tier 1 Tier III institutional accounts Insurance companies, mutual funds, property and casualty companies 12 sales professionals on desks in Boston, NYC and Chicago $443 billion in assets 4.3 million ending client accounts More than 300 brokerage firms or advisors.

4 The Municipal Market - National Perspective What is the New Normal? What was the Old Normal? Volume has remained steady at around $400 billion a year. Interest Rates are still at historically low levels, but the relationship between taxable and tax-exempt rates has changed : Financial crisis impacted municipal bond insurance, variable rate debt, auction rate securities, letters of credit, liquidity; interest rate swaps : Build America Bonds, taxable munis and tax credit bonds; alternative approaches to variable rate debt. Questions for 2011: Interest rates; Decreased supply; Impact of Basel III on banks and liquidity for variable rate debt; Reauthorization of BABs and other ARRA provisions for munis; Dodd-Frank Rulemaking. Source: TM3, January 6, 2011

5 National Municipal Market Volume Build America Bonds increased market share of taxable municipals in Taxable Bonds traditionally represented about 20% of the municipal market. Dollar Volume (in billions) BAB AMT Taxable Tax-exempt Source: The Bond Buyer and Source Media Inc., January 6, 2011

6 Historical Interest Rates Interest rates are at historical lows, but the relationship between taxable and tax-exempt rates has changed dramatically.

7 The Municipal Market - Texas Perspective Texas is the 3rd largest issuing state, behind California and New York. Total Volume of $46.3 billion in 2010 Over 3,500 issuers in Texas; about 1,200 to 1,400 issues per year Texas Municipal Issuance by Issuer Type % 9% 23% 16% 22% 10% City/County Schools State Higher Ed Water 5% 11% 9% 17% Roads Hlth/Hsg/EcoDev 7% 24% 25% 15% Source: Municipal Advisory Council of Texas; TM3; January 2011

8 Texas Municipal Market Volume Economic and Demographic growth has spurred demand for infrastructure Dollar Volume (in billions) Dollar Volume (billions) Lowest Yld to Mat. Source: The Bond Buyer and Source Media Inc., Texas Municipal Advisory Council; January 2011

9 Texas: School District Finance Schools are funded primarily through local property tax, state aid and Federal funds Bonds are typically supported by property tax; Guaranteed by the Permanent School Fund PSF was created in 1854 by the Legislature with a $2 million appropriation. In 1874 the State Constitution dedicated certain lands and sale of proceeds of these lands to create an endowment. Endowment administered by the State Board of Education (statewide elected body); authorized to use outside money managers. Texas Permanent School Fund Asset Allocation as of 08/31/ % 11% 0% Domestic Equity International Equity 48% Fixed Income 19% Absolute Return Unallocated Cash Market Value as of 10/31/2010 is $28.9 million Source: Texas Education Agency, January 2011

10 Texas: School District Finance PSF Bond Guarantee Program Guarantees the timely repayment of debt service Natural AAA credit enhancement Capacity is limited by state law and IRS ruling to 5x of the total costs of assets held on Dec.16, $117.3 billion. $50.3 billion guaranteed as of 10/31/2010; 2,500 bond issues for 780 school districts. Districts must meet eligibility requirements to qualify for the guarantee: academic accreditation, financial criteria; outstanding debt of $1,650/ADA. Weighted Average of underlying ratings is A1 (Moody s) Maximum daily payouts are on February and August 15; $1.96 billion. Source: Standard & Poor s Texas Permanent School Fund, January 29, Moody s Investor Service, Texas Permanent School Fund (PSF) April Texas Education Agency; October 31, 2010.

11 Texas: Higher Education Higher Education Finance consists of: Community Colleges: Funding/financing sources are Tuition/Fees, State Appropriations, and Property Taxes. State University Systems: Funding/financing sources are Tuition/Fees, State Appropriations, Grants, Donations and Endowments. University of Texas System Texas A&M System Permanent University Fund All the others: Texas Tech, University of Houston, Univ. of North Texas, etc. Higher Education Assistance Fund Private Universities: Funding/financing sources are Tuition/Fees. Issue Tax Exempt Debt through Higher Education Facility Corporations. Houston Higher Education Finance Corp. (Rice University) Trust Indenture/Loan Structure Limited obligation pledge of all available revenues except restricted funds Source: Texas Education Code. 2010

12 Texas: Public Higher Education Financing Programs Permanent University Fund PUF Public Endowment Created by Constitution in 1800 s. 2.1 million acres, primarily in West Texas produce mineral income; $10 billion market value. Annual Distribution is split 2/3 UT and 1/3 to A&M; can be used for programs and pledged to bond debt service. Rated Aaa/AAA/AAA Higher Education Fund HEF Constitution amendment in 1984 and amended in the 1990 s to create a $2 billion permanent endowment from legislative appropriations. Funds allocated every five years by the Legislature Can be used for programs and a portion pledged to debt service. HEF bonds are a State GO: Aaa/AA+/AAA Revenue Financing System General Obligation pledge of all legally available revenues (basically everything except State appropriations and restricted funds such as grants and donations.) Tuition Revenue Bonds University issues RFS bonds, but Legislature makes an offsetting appropriation of debt service to the university. Separate Rating for Each University Source: Texas Higher Education Coordinating Board; January 2010

13 Texas: State Agency Issuers There are 10 State Agencies and 11 Universities that issue debt Texas Transportation Commission/Texas Department of Transportation Texas Water Development Board Texas Veteran s Land Board (Housing) Texas Department of Housing & Community Affairs Texas Higher Education Coordinating Board (Student Loans) Texas Public Finance Authority Loan Programs Loan Programs often use self supporting General Obligation Debt Legal Security Pledge and Credit rating is based on State s General Obligation Rating (Aaa/AA+/AAA), but actual debt service is paid from loan repayments) Source: Texas Bond Review Board. January 2011

14 Texas: Transportation Road projects are financed in a variety of ways Texas Department of Transportation City/County Roads: GO Bonds; Pass-through financing program with TxDoT; special districts Regional Mobility Authorities Toll Road Authorities: - Harris County Toll Road Authority - North Texas Tollway Authority Airports Most are a City enterprise (Houston, Austin, San Antonio) Dallas Ft. Worth Airport (joint enterprise of Cities of Dallas and Ft. Worth) Mass Transit (Bus and Rail) Local Authorities: DART, Houston Metro, Capital Metro Source: Texas Government Code; 2010.

15 Top Texas Muni Bond Issues 2010 Issuer Bond Issue Rating Par Amount Date State of Texas Tax & Revenue Anticipation Notes ( TRAN ) $7,800,000,000 August Texas Transportation Commission (State Highway Fund) SHF First Tier Revenue Bonds (Taxable Build America Bonds) $1,500,000,000 August Texas Transportation Commission (State Highway Fund) Highway Improvement GO Bonds (Taxable Build America Bonds) $977,810,000 August Texas Private Activity Bond Surface Transportation Corp. Sr Lien Rev Bonds (LBJ Infrastructure Group LLC IH-635 Managed Lanes Project) $615,000,000 December Texas Public Finance Authority (Texas Workforce Commission) Unemployment Obligation Assessment Revenue Bonds $1,959,880,000 Oct./Dec. University of Texas System Revenue Financing System (Taxable Build America Bonds) $1,837,350,000 March/April/ June/ Sept Dallas Area Rapid Transit Sr Lien Sales Tax Rev Bonds (Taxable Build America Bonds) $824,625,000 October Dallas Independent School District Unlimited Tax School Building Bonds (Taxable Build America Bonds) $1,020,380,000 November Lower Colorado River Authority Revenue Refunding Bonds/ LCRA Transmission Service Corp. $997,015,000 Jan/May/Nov City of San Antonio CPS Energy Electric & Gas System Revenue Bonds (Taxable Build America Bonds) $880,000,000 February/Oct North Texas Tollway Authority NTTA System First Tier Revenue Refunding/ Subordinate Lien Taxable Revenue Bonds (Build America Bonds) $642,225,000 May/Dec Love Field Airport Modernization Corp Special Facilities Rev Bonds (Southwest Airlines Co. Love Field Project) $310,000,000 November Source: Texas Municipal Advisory Council; January 6, 2011

16 Texas: Outlook State Budget Total budget is $182 billion Federal Funds $65.5b; General Revenue $80.6b Projected Shortfall is $27b (based on budget requests) 2011 Legislative Session will be dominated by: The Budget Redistricting Policy Issues: Immigration; School Finance; Transportation; Water $9 billion Rainy Day Fund Economy Texas entered recession later than other states (high oil prices in 2008) Diversified economy Stable Housing Market no boom/no bust Favorable demographics growing and young population Overall fiscal health of state and local governments Source: Texas Legislative Budget Board Fiscal Size Up ; Standard & Poor s Corp., Lone Star State Recovery: Why We Think Texas Will Emerge from the Recession Faster and Stronger Than Most States. October 21, Susan Comps, Texas Comptroller of Public Accounts, Biennial Revenue Estimate, January 10, 2011.

17 Questions? Kimberly Edwards Vice President, Municipal Finance Fidelity Capital Markets 7000 N. Mopac Expressway, Suite 2101 Austin, TX Although bonds generally present less short-term risk and volatility than stocks, bonds do entail interest rate risk (as interest rates rise, bond prices usually fall and vice versa) and the risk of default, or the risk that an issuer will be unable to make upcoming or principal payments. Additionally, bonds and short-term investments may entail greater inflation risk, or the risk that the return of an investment will not keep up with increases in the prices of goods and services, than stocks. Any fixed-income security sold or redeemed prior to maturity may be subject to substantial gain or loss.