Emerging Debt Regulations and Best Practices

Emerging Debt Regulations and Best Practices Michael G. Sudsina (216) 215-7753 fax (216) 803-2280 mike@sudsina.com Stephen Szanto (440) 773-5090 fax (216) 803-2280 szanto@sudsina.com www.sudsina.com Page 1 Presentation Objective Update on new SEC regulations governing the use of municipal advisors and bond underwriters. Overview of best practices for debt planning, execution and ongoing management. Page 2 1

SEC Regulation The financial meltdown of 2008 caused Congress to enact the Dodd Frank Wall Street Reform and Consumer Protection Act. Dodd Frank required that financial advisor, or now called municipal advisors be registered for the first time and be subject to new regulations, qualifications and testing. With those regulations comes the requirement that the MA has a fiduciary duty to the issuer which means it must put the issuer s interests before its own. The underwriter has a fiduciary duty to the investor, not the issuer, although it does have a fair dealing obligation to issuers. Page 3 Regulation Update SEC continues to roll out its practices for oversight of Dodd Frank regulations and how they will monitor municipal debt market. SEC expect to make on-site examinations of all 700 MSRB registered municipal advisory firms by end of 2016. Only once that is complete will we know more about their expectations for market participant compliance. Approximately 50% of all registered MA s sat for the pilot Series 50 test administered by the MSRB in January & February this year. Reportedly 85% of those that took the pilot test passed it. Page 4 2

GFOA s Recommendations for Use of Advisors State and local governments may use financial professionals to assist in the debt management process. These financial professionals may include: Financial (municipal) advisors roles may vary. For competitive sales, financial advisors have a more active role throughout the debt issuance process. They will assist the government entity to determine the structure and timing of the issue, prepare bond documents and rating agency presentation, evaluate and select the best offers, and to close the transaction. For negotiated sales, the financial advisors role is to ensure that the issuer's goals and interests are represented and protected in the structuring of the transaction and establishing of the borrowing rates and yields. Bond counsel advises a government on whether a proposed borrowing is legally permitted and assures compliance with borrowing requirements. The bond counsel will assist in drafting materials required for the debt issuance and ordinances or resolutions to authorize the sale. Underwriters purchase securities from a government issuer and resell them to investors. Underwriting firms bid against one another for a government issuer's bonds for competitive sales. For negotiated sales the underwriters will work with an issuer and potential investors to sell the bonds. Page 5 GFOA s Recommended Debt Issuance Practices The Policy should provide guidance regarding the issuance process, which may differ for each type of debt. These practices include: Selection and use of professional service providers, including an independent financial advisor, to assist with determining the method of sale and the selection of other financing team members, Criteria for determining the sale method (competitive, negotiated, private placement) and investment of proceeds, Use of comparative bond pricing services or market indices as a benchmark in negotiated transactions, as well as to evaluate final bond pricing results, Criteria for issuance of advance refunding and current refunding bonds, and Use of credit ratings, minimum bond ratings, determination of the number of ratings, and selection of rating services. Page 6 3

Looking to the GFOA s Best Practices In the article Ensuring a Successful Bond Sale published in GFOA s Government Finance Review, Eric H. Johansen debt manager for the City of Portland, Oregon, suggested that The GFOA s best practices on the sale of bonds contain several common themes and recommendations that finance officers should bear in mind when preparing to sell bonds: The roles of financial advisor and underwriter are separate and distinct. The same firm cannot serve both roles on the same bond issue. A key difference between the financial advisor and the underwriter is that the financial advisor has a fiduciary responsibility to the issuer. The underwriter s responsibility is to bond investors. Early in the bond sale process, issuers should hire an outside financial advisor to advise them on selecting the appropriate method of sale for the bonds. The method of sale decision should be based on an analysis of the relevant characteristics of the proposed bonds and should not be influenced by parties with a vested interest in the outcome of the decision. Issuers should not permit their financial advisor to resign in order to serve as underwriter of a negotiated sale. Financial advisors and negotiated sale underwriters should be selected primarily on the basis of relevant experience with the bonds proposed by the issuer. When bonds are sold through negotiation, issuers and their financial advisor should be actively involved in the negotiation and not be reliant solely upon information provided by the underwriter. Page 7 MSRB* Rule G-17 In the conduct of its municipal securities or municipal advisory activities, each broker, dealer, municipal securities dealer, and municipal advisor shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice. INTERPRETIVE NOTICE CONCERNING THE APPLICATION OF MSRB RULE G- 17 TO UNDERWRITERS OF MUNICIPAL SECURITIES - August 2, 2012 unlike a municipal advisor, the underwriter does not have a fiduciary duty to the issuer under the federal securities laws and is, therefore, not required by federal law to act in the best interests of the issuer without regard to its own financial or other interests; * - Municipal Securities Rulemaking Board Page 8 4

MA Regulation Bonds Issuer $$$$$ Tax Exempt Municipal Advisor Fiduciary Duty Fair Dealing Duty Underwriter Page 9 MA Regulation This recognition of the MA s role to protect the issuer s interest has caused GFOA to modify recommended practices to re-emphasize that an MA should be on the financing team to provide the issuer expertise that they do not have inhouse. Since the underwriter holds the investor s best interest first, the new regulations are designed to ensure that the issuer has expertise on its side early in the planning process or acknowledges that it is going it alone without. Page 10 5

MA Regulation If an underwriter does not comply with the new regulations it could be considered the municipal advisor which would exclude it from underwriting the bonds. The regulations provide 3 ways for an underwriter to ensure that it is not deemed the MA: 1. The issuer has already engaged a registered municipal advisor to represent its interests 2. Undertake an RFP process by which it selects an underwriter 3. Formally engage the underwriter directly without an RFP process or the presence of an MA Page 11 Methods of Sale Direct/Private Placement Work directly with a specific investor to place the bonds Competitive Sale Advertise bonds for sale as pre-determined date and time; lowest interest rate wins Negotiated Sale Work through pre-selected broker/dealer to market bonds to investors through their sales network Page 12 6

Direct/Private Placement Participants Issuer and Municipal Advisor Banks & Institutional Page 13 Direct/Private Placement Volume of direct placements has escalated in recent years as local banks have come to better understand the attributes of municipal debt and the value of the investment. May save time, effort and expense resulting in overall lower borrowing costs if transaction is executed effectively. Competition should be made part of the process by soliciting bids from a number of potential investors in order to obtain the best available terms and interest rates. Major push underway to ensure placement are disclosed to the investing public, preferably on the MSRB s EMMA website. Page 14 7

Competitive Sale Participants Issuer and Municipal Advisor Broker/Dealers Money Managers, Insurance Companies & Other Corporations Banks Individuals Page 15 Competitive Sale GFOA Recommended Practices The GFOA recommends that the competitive method of sale be chosen when conditions favoring this method of sale are present. Such conditions include the following: The market is familiar with the issuer, and the issuer is a stable and regular borrower in the public market. There is an active secondary market with a broad investor base for the issuer s bonds. The issue has an unenhanced credit rating of A or above or can obtain a credit enhancement prior to the competitive sale. The debt structure is backed by the issuer s full faith and credit or a strong, known or historically performing revenue stream. The issue is neither too large to be easily absorbed by the market nor too small to attract investors without a concerted sales effort. The issue is not viewed by the market as carrying complex or innovative features or requiring explanation as to the bonds soundness. Interest rates are stable, market demand is strong, and the market is able to absorb a reasonable amount of buying or selling at reasonable price changes. Page 16 8

Competitive Sale Attributes Less than 10% of issues in Ohio are sold competitively; General Obligation Debt is not all that complicated; Demand has never been higher; Gives everyone an opportunity to bid on your issue; Opens up the market for your debt; When you think about this type of transaction it is no different than selling municipal equipment, or opening construction bids, etc. These are typically done on a competitive basis; With a negotiated sale, the underwriting firm will get you the best deal their firm can on the day of the sale; But a competitively sold transaction will be the best and lowest interest rate available in the tax-exempt world that day. Page 17 Competitive Sale Attributes Competitive issues push the envelope that may not happen in a negotiated scenario: Shorter Call features and other structuring changes; Rating strategies; Moody s and S&P have recently changed their respective rating methodologies; Insurance versus no insurance issues; Bank qualified strategies; Demand has out stripped supply for at least the last five years; Limited tax (unvoted) general obligation refundings have also done very well in the competitive markets; Unlimited tax (voted) bonds can be sold competitively thanks to current market conditions. Page 18 9

Negotiated Sale Participants Brokers Municipal Advisor Oversight Issuer and Municipal Advisor Traders Investment Bankers Tax Exempt Page 19 Negotiated Sale GFOA Recommended Practices If conditions do not allow for a competitively bid bond sale, GFOA recommends the following practices: 1. Promote fairness in a negotiated sale by using a competitive underwriter-selection process that ensures that multiple proposals are considered. 2. Remain actively involved in each step of the negotiation and sale processes to uphold the public trust. 3. Ensure that either an employee of the issuer or an outside professional other than the issue underwriter, who is familiar with and abreast of the condition of the municipal market, is available to assist in structuring the issue, pricing, and monitoring sales activities. 4. Avoid using a firm to serve as both the financial advisor and underwriter of an issue because conflicts of interest may arise. 5. Require that financial professionals disclose the name(s) of any person or firm compensated to promote the selection of the underwriter; any existing or planned arrangements between outside professionals to share tasks, responsibilities and fees; the name(s) of any person or firm with whom the sharing is proposed; and the method used to calculate the fees to be earned. 6. Review the Agreement Among Underwriters and ensure that it governs all transactions during the underwriting period. Page 20 10

RFP Requirements Normal RFP Requirements Municipal Entity or MA conducts Particular objective identified (structuring for a particular program or project) Specified period of time (up to 6 months) Competitive (website, or 3 market participants) Mini RFP Requirements Municipal Entity or MA conducts One or more particular questions Specified period of time (up to 3 months) Sent to entire pool of prescreened participants (or at least 3) Page 21 Underwriter Selection Ranking Matrix Rating scale 4 highest; 1 lowest Topic/Firm Underwriter A Underwriter B Underwriter C Underwriter D Underwriter E Composition of distribution capabilities Uncommitted net excess capital score Experience of staff assigned Experience with Ohio school bond issues Bond structuring recommendations Average Point Total Institution salespeople 143 165 187 53 8 Retail salespeople 2,028 100,000 1,780 625 38 Uncommitted net excess capital $ 355,661,717 $ 313,339,412 $1,132,072,000 $ 164,648,000 $ 12,539,987 Page 22 11

Bond Distribution Mechanics Having multiple underwriters assigned to marketing the bonds facilitates access to greater segments of the market and creates competition among the firms for orders both factors help drive down interest rates, at NO additional cost to the District. The MA helps coordinate interaction with the bankers. Senior Managing Underwriter Branches 300 Investment Executives 2,028 $4.3 billion capacity Tax Exempt Tax Exempt Tax Exempt Co-managing Underwriter B Branches 17 Investment Executives 165/100,000 $2.27 billion capacity Co-managing Underwriter A Branches 187 Investment Executives 1,780 $12.8 billion capacity Tax Exempt Tax Exempt Single/ Sole Managing Underwriter Branches 4 Investment Executives 20 $105 million capacity Page 23 Final Underwriter Selection Rating scale 4 highest; 1 lowest Topic/Firm Underwriter A Underwriter B Underwriter C Underwriter D Underwriter E Composition of distribution capabilities 4 4 3 3 1 Uncommitted net excess capital score 3 2 4 3 1 Experience of staff assigned 4 4 4 2 3 Experience with Ohio school bond issues 4 3 4 1 3 Bond structuring recommendations 4 2 4 1 1 Average Point Total 3.8 3 3.8 2 1.8 Institution salespeople 143 165 187 53 8 Retail salespeople 2,028 100,000 1,780 625 38 Uncommitted net excess capital $ 355,661,717 $ 313,339,412 $1,132,072,000 $ 164,648,000 $ 12,539,987 Page 24 12

Pricing Period Page 25 Pricing Period Maturity Amount Total Priority Total Member Total Balance ($000's) ($000's) ($000's) ($000's) 11/01/2016 260 780 260 1040-780 11/01/2017 265 540 100 640-375 11/01/2018 295 345 100 445-150 11/01/2019 300 600 175 775-475 11/01/2020 300 600 25 625-325 11/01/2021 330 730 100 830-500 11/01/2022 335 995 100 1095-760 11/01/2023 345 680 100 780-435 11/01/2024 375 2125 375 2500-2125 11/01/2025 390 1820 0 1820-1430 11/01/2026 400 1665 0 1665-1265 11/01/2027 435 3045 0 3045-2610 11/01/2028 455 2345 0 2345-1890 11/01/2029 470 3100 220 3320-2850 11/01/2030 505 2060 0 2060-1555 11/01/2031 525 1520 0 1520-995 11/01/2032 545 2780 0 2780-2235 11/01/2033 580 580 0 580 0 11/01/2034 600 1300 0 1300-700 11/01/2035 625 2500 35 2535-1910 11/01/2040 3480 6700 300 7000-3520 11/01/2044 3480 6960 3480 10440-6960 11/01/2052 8665 24200 250 24450-15785 TOTAL: 23960 67970 5620 73590 0 Page 26 13

Pricing Results Par $23,815,000 Pricing Date 10/14/15 Final Maturity 11/1/52 TIC 3.96% Average Life 23.716 20-year Yield 3.66% Bond Buyer 20 Year Index 3.68% Total Interest Cost $22,751,333 Page 27 Pricing Comparison Count of Positive Yield Spread Lakeview 11 Comparable 7 Issuer LAKEVIEW OHIO LOC SCH DIST Comparable Transaction Underlying Credit Rating / Insurer Par Amount Bank Qualified? Underwriter Call Features Pricing Date Moody's Aa2/A1 $23,815,000 No STIFEL, NICOLAUS & CO., INC. 11/1/24 10/15/15 Moody's Aa2/A2 $13,680,000 Underwrtier X Yield to MMD on Yield Spread Yield to MMD on pricing MMD Yield Spread Year Coupon Yield Coupon Yield Yield Spread vs MMD Maturity pricing date vs MMD Maturity date Difference 2016 1.00% 0.48% 0.25% 0.23% N/A 2017 1.00% 0.82% 0.55% 0.27% 2.00% 0.97% 0.55% 0.42% 0.15% 2018 1.50% 1.07% 0.76% 0.31% 2.00% 1.21% 0.77% 0.44% 0.13% 2019 1.50% 1.26% 0.96% 0.30% 2.00% 1.43% 0.99% 0.44% 0.14% 2020 2.00% 1.55% 1.20% 0.35% 2.00% 1.71% 1.23% 0.48% 0.13% 2021 2.00% 1.76% 1.39% 0.37% 2.00% 1.93% 1.41% 0.52% 0.15% 2022 2.50% 1.97% 1.58% 0.39% 3.00% 2.16% 1.60% 0.56% 0.17% 2023 2.50% 2.22% 1.78% 0.44% 4.00% 2.40% 2.65% 1.79% 0.86% 0.42% 2024 4.00% 2.36% 1.91% 0.45% 4.00% 2.51% 3.28% 1.91% 1.37% 0.92% 2025 3.00% 2.47% 2.52% 2.02% 0.50% 5.00% 2.62% 3.28% 2.02% 1.26% 0.76% 2026 4.00% 2.64% 2.85% 2.14% 0.71% 5.00% 2.79% 2.14% 0.65% -0.06% 2027 4.00% 2.96% 3.18% 2.25% 0.93% 3.00% 3.15% 2.25% 0.90% -0.03% 2028 4.00% 3.00% 3.26% 2.35% 0.91% 3.00% 3.25% 2.35% 0.90% -0.01% 2029 3.00% 3.19% 2.44% 0.75% 3.13% 3.33% 2.44% 0.89% 0.14% 2030 4.00% 3.25% 3.50% 2.53% 0.97% 3.25% 3.45% 2.53% 0.92% -0.05% 2031 4.00% 3.32% 3.57% 2.60% 0.97% 3.38% 3.54% 2.60% 0.94% -0.03% 2032 3.25% 3.43% 2.66% 0.77% 3.38% 3.60% 2.66% 0.94% 0.17% 2033 4.00% 3.48% 3.69% 2.71% 0.98% 3.50% 3.65% 2.71% 0.94% -0.04% 2034 4.00% 3.53% 3.73% 2.76% 0.97% 3.50% 3.70% 4.43% 2.76% 1.67% 0.70% No 12/1/23 10/7/15 Page 28 14

Post-closing Procedures/Practices The Policy should provide guidance for ongoing administrative activities including: Investment of bond proceeds, Pricing Book, Primary and secondary market disclosure practices, including annual certifications as required, Arbitrage rebate monitoring and filing, Federal and state law compliance practices, and Ongoing market, rating and investor relations efforts. Page 29 Summary Recommended practices exist for executing and managing bond issues. May want to adopt a debt policy or at least know where to find best practices when the need arises. Take care in selecting a method of sale that best fits the circumstances of the debt issue at hand. Add competition to the process by requesting proposals for professional services. Be aware of post-issuance requirements and on-going debt management best practices. Stay tuned for more on SEC compliance requirements. Page 30 15

Additional Information Links GFOA Debt Management Policy Best Practices http://www.gfoa.org/debt-management-policy GFOA Debt Issuance Checklist: Considerations When Issuing Bondshttp://www.gfoa.org/sites/default/files/u2/GFOADebtIssuanceChecklistConsiderationsWhenIssuin gbonds.pdf GFOA Government Finance Review Articles: Ensuring a Successful Bond Sale http://www.gfoa.org/sites/default/files/gfr_feb_10_16.pdf Back to Basics: What Every Government Should Check Each Time It Issues Debthttp://www.gfoa.org/sites/default/files/GFR_FEB_10_30.pdf Best Practices Optimize Debt Management http://www.gfoa.org/sites/default/files/gfr_feb_13_8.pdf National Bond Lawyers/GFOA Post Issuance Compliance Checklisthttp://www.gfoa.org/sites/default/files/u2/PostIssuanceCompliance.pdf Municipal Securities Rulemaking Board www.msrb.org MSRB s Electronic Municipal Market Access system (EMMA) http://emma.msrb.org Page 31 16