Bonds for Beginners. WELCOME!! Atlanta, April 3, National Association of Local Housing Finance Agencies. Gene Slater, CSG Advisors

Size: px

Start display at page:

Download "Bonds for Beginners. WELCOME!! Atlanta, April 3, National Association of Local Housing Finance Agencies. Gene Slater, CSG Advisors"

Asher Morgan
6 years ago
Views:

1 Bonds for Beginners National Association of Local Housing Finance Agencies WELCOME!! Atlanta, April 3, 2014 Gene Slater, CSG Advisors

2 2 What You Will Learn 1. Bonds are Debt Instruments 3 2. Bonds are Regulated Securities 7 3. What Makes Bonds Attractive to Investors 9 4. Credit Worthiness and Credit Enhancements Municipal Bonds and Requirements How Bonds Are Issued and Repaid Big Questions that often Come up for Issuers 30

3 3 1. Bonds Are Debt Instruments Key Components Principal or Face Value: amount to be repaid Interest Rate or Coupon Rate: to be paid semiannually (or in some cases monthly) until principal is paid Term or Maturity Date: when principal will be repaid Payment Schedule Prepayment or Redemption ( Call ) Provision Legal Obligation of the Issuer

4 4 What is a Bond? Bond Loan Bond Investor Issuer Project Borrower Bond principal and interest Loan principal and interest Public Agency must be issuer for bond to be tax-exempt

5 5 Bonds & Notes Both Bonds & Notes are negotiable (can be bought or sold) Pay interest until maturity (e.g. until the principal is repaid) A Bond issue can have multiple interest rates & maturity dates Maturity amount = principal due to be paid each year (like a home mortgage) e.g. a 2014 bond issue may have principal maturities (or payments) from 2015 to 2044

6 6 Bonds & Notes (cont.) A Note is the same as a bond but is the name generally used if 2 years or shorter and a single maturity e.g. a 2014 note comes due on a given date in 2015 (In this presentation we simply call all of these bonds ) Interest may be either tax-exempt or taxable

7 7 2. Bonds Are Regulated Securities 1929 Market Crash Congress regulates securities to insure the integrity & efficiency of commerce [Commerce Clause] The issuance, trade, evaluation and tax treatment of bonds are regulated by the: SEC (and in case of municipal bonds, the Municipal Securities Rulemaking Board) IRS

8 8 Municipal Bonds Are Regulated Differently Than Corporate Bonds Do not have to be registered securities with the SEC Do have to provide accurate disclosure of publicly sold securities - initially: offering statement, approved by the issuer - ongoing: continuing disclosure Certain requirements for bond underwriters (e.g. investment bankers) and, now, Municipal advisors

9 9 3. What Makes Bonds Safety Attractive to Investors? Risk of financial loss is low Predictable revenue stream Interest is paid semi-annually Tailored bond mix Different types of maturities & interest rates to meet bond purchasers needs Yield Interest earned on Municipal Bonds can be tax-exempt

10 10 Taxable vs. Tax-Exempt Yields Effect of Federal Income Taxes on After-Tax Yields of Tax-Exempt and Taxable Instruments (Illustrative Example) 5% Tax-Exempt Bond 6% Taxable Investment Cash Investment $100,000 $100,000 Annual Interest $5,000 $6,000 Federal Income Tax on this interest (39.6% Marginal Tax Bracket) 0 ($2,376) Net After-Tax Income $5,000 $3,624 After-Tax Yield on Investment 5.0% 3.624% If in 33% Marginal Tax Bracket 5.0% 4.02%

11 11 4. Credit Worthiness Comparison to a Loan Character Capacity to pay Credit Collateral Cash Loan Application Income Ratios Credit Reports Appraisal Downpayment/ Closing Costs

12 12 Evaluating Credit Worthiness for a Bond Character Capacity Reputation of Issuer Market history, management, contractor, issuer & bond counsel opinions Cash Flows Worst case assumptions for origination, prepayments, reinvestment of funds

13 13 Evaluating Credit Worthiness for a Bond (cont.) Credit Rating Moody s/standard & Poor/Fitch Collateral of Revenues Mortgages, Rents & MBS Cash needed to complete the transaction Underwriting & marketing fees Bond Rating Moody s / Standard & Poors / Fitch Pledge of Revenues Mortgages, Rents & MBS Cost of Issuance Underwriting & marketing fees Any non-bond $ for the project

14 14 Enhancement of Credit Worthiness Purpose is to get a lower interest cost, and make bonds more saleable to investors who: - don t want to evaluate the detailed underlying credit, - want a highly rated security - want to be able to resell in future

15 15 Enhancement of Credit Worthiness (cont.) Types of credit enhancement mortgage-backed security bond insurance bank letter of credit (multi-family) loan insurance

16 16 5. Municipal Bonds GO Bonds & Revenue Bonds General Obligation bond is paid back by the full faith & credit of the issuer Revenue bond is paid back from particular, pledged revenue stream For housing bonds, the primary revenue stream is the monthly note payments from the mortgage(s) Conduit revenue bond : issuer lends the bond proceeds to a particular borrower/ project, and bondholder is paid only from repayment of that loan

17 17 Who Can Issue Tax-Exempt Bonds? State and local government agencies, but only for a public purpose History: 1919 Income Tax Act exempted municipal securities Increasingly restricted by Congress Why: correct (over-correct?) abuses assure public purpose reduce cost to Federal government

18 18 What is Required for a Bond to be Tax-Exempt Public purpose bonds: publicly owned projects (e.g. schools, city hall) - including housing entirely owned by a public agency (no tax credits) Non-profit bonds: project owned by a 501(c)3 - including housing entirely owned by a 501(c)3 (no tax credits) (often used for student and some senior housing)

19 19 What is Required for a Bond to be Tax-Exempt (cont.) Private Activity volume cap bonds: finance loans for privately owned homes and projects if they meet specific requirements includes almost all housing bonds Private activity means more than 10% of bond issue finances privately owned or used facilities (e.g. individuals homes, apartment buildings with a for-profit owner or even simply tax credit investor)

20 20 What are the Requirements for Private Activity Housing Bonds Private Activity bond volume cap From each state s annual volume cap: greater of $95 per capita or $278 million Need allocation for the amount of the bonds (or Mortgage Credit Certificates) Effective impact: when demand is heavy (e.g ): very restrictive currently, plentiful in most states

21 21 Requirements for Single-Family Private Activity Housing Bonds Single-Family Bonds For 1 st time homebuyers (haven t owned a home in 3 years)* Below 100% of area median income (up to 2 persons) or 115% of median (3 or more persons) (easier rules in limited IRS target areas )* Rate on the loan can t be more than 1 1/8% above rate on the bonds * Special exemptions or rules for loans in limited IRS Target Areas

22 22 Requirements for Multi-Family Private Activity Housing Bonds Multi-Family Bonds Rental housing where either: - 20% or more of tenants are below 50% of area median income, or - 40% or more of tenants are below 60% of area median income New construction or acquisition-rehabilitation (rehab. cost must at least equal 15% of bond proceeds)

23 23 Multi-Family Bonds Also Provide 4% Low Income Housing Tax Credits Multi-Family Bonds 4% credits are often more important than lower interest rate (if any) on tax-exempt bonds (4% credit equity often pays for about 30% of the cost of the affordable units) To receive credits: tax-exempt bonds must: - pay for at least half of project cost, and - remain outstanding until project placed in service * Cannot be used with 9% tax credits

24 24 6. How Bonds Are Issued and Repaid Bond Sale Choices Public Sale Bond Investor Underwriter Issuer Bank or Other Investor Private Placement Bond Counsel Municipal Advisor

25 25 Basic Flow of Funds Single-Family (7) Pay Interest & Principal (6) Pass thru Loan (5) Pay Interest & Principal on Bonds thru DTC Payments on Mortgage Loans BONDOWNERS TRUSTEE SERVICER BORROWERS (3) Buy MBS (1) Pay for Indenture & Bonds Assignment (2) Bond Additional Security (4) Make Loans Funds Bond Purchase UNDERWRITER Agreement ISSUER CREDIT ENHANCER LENDER

26 26 Basic Flow of Funds Multi-Family LENDER/ BONDOWNERS TRUSTEE SERVICER DEVELOPER/OWNER (1) Pay for Bonds Indenture* & Assignment Bond Purchaser (2) Bond Funds to Trustee (3) Trustee Buys Loan (4) Lender Makes Loan Exchange MBS for Mortgage Agreement UNDERWRITER ISSUER CREDIT ENHANCER

27 27 Process to Issue & Sell Bonds Identify public purpose Hire quality bond counsel & financial advisor (Municipal Advisor) Hire quality underwriters Work with quality multi-family developer or singlefamily lenders & servicers Review & test bond structure Conduct TEFRA public hearing Acquire volume cap allocation from state Hire trustee bank to hold bond proceeds and pay bond holders

28 28 Process to Issue & Sell Bonds Acquire credit enhancement Authorize issuance & sale of bonds including offering statement Acquire bond rating Price and sell bonds and sign bond purchase agreement Close the bonds: (execute all documents, wire funds) After Bond Closing: Monitor the origination of loan and repayment of principal & interest to bondholders Perform continuing SEC disclosure, IRS rebate calculations (and if multiple loans, cash flow analysis)

29 29 Roles of Underwriter and Municipal Advisor Buy bonds from issuer and sell bonds to public SEC requirement Fiduciary responsibility to issuer Fair dealing (and disclosure) May provide advice to issuer Strict limitations on campaign contributions Yes Bond Underwriter Registered with SEC as dealerbroker No Yes Only (a) in responding to RFP, (b) after being selected to underwrite a specific transaction, or (c) issuer is represented by independent registered Municipal Advisor ( IRMA exception) Yes No Municipal Advisor Registered with SEC (and Municipal Securities RuleMaking Board) as Municipal Advisor Yes Yes Yes Yes

30 30 7. Some Big Questions That Come Up for the Public Agency Should we issue single-family bonds or sell Mortgage-backed Securities (and/or use Mortgage Credit Certificates) How will multi-family project be feasible, including 4% v. 9% tax credits (can t be used with tax-exempt bonds)

31 31 Some of the Big Questions That Come Up for the Public Agency Will multi-family bonds either be: Credit-enhanced and rated, or If not, only privately placed with a bank (or similar entity) and with controls on number and type of bondholders, defaults: To help avoid a bond default To make certain the project is: - one whose credit is strong enough to be privately financed - being financed through the public agency only to obtain a tax-exempt rate (and/or tax credits), - not to use the agency s name to make a questionable credit easier to sell (e.g. not have buyers with limited information take risks that an informed bank making a loan wouldn t)

32 32 Some of the Big Questions That Come Up for the Public Agency Will the bond issue fully carry out the issuer s objectives and policies, including: - policies on eligible projects & borrowers - indemnification of issuer - process - will fees be adequate, and - will the issuance strengthen what the agency s capacity to do more in several years (v. weaken it) Is the finance team one the agency can fully trust to carry out its objectives

33 33 What We Have Learned Bonds are Debt Instruments Bonds are Regulated Securities SEC, IRS (for tax-exempt bonds) Bonds Are Attractive to Investors Safety; Revenue; Tailored Mix & Yield It s All About Credit Worthiness Character, Capacity, Credit, Collateral, Cash

34 34 What We Have Learned Credit Enhancements Are Good MBS, Insurance, Bank Letter & Guarantee What s Needed to Issue Bonds Public Purpose; Volume Cap Process of Issuing Bonds Quality Professionals; Sound Financing Structures; Post-Closing Due Diligence Simple Flow of Funds Who gets the money for what service

35 35 National Association of Local Housing Finance Agencies THANK YOU VERY MUCH!! Gene Slater, CSG Advisors

Accrued Interest A currently unpaid amount of interest that has accumulated since the last payment on a bond or other fixed-income security.

Accrued Interest A currently unpaid amount of interest that has accumulated since the last payment on a bond or other fixed-income security. Ad Valorem Tax Translated as according to value, it is a levy