Contenu connexe Similaire à Bonds and Basics-Lauren Lowe-TN Economic Development Finance Course (20) Plus de University of Tennessee-Center for Industrial Services-Economic Development (20) Bonds and Basics-Lauren Lowe-TN Economic Development Finance Course1. Council of Development Finance Agencies
Bonds and Basics
February 20, 2014
530 Oak Court Drive, Suite 160
Memphis, TN 38117
P: 901-682-8356
F: 901-682-8386
www.pfm.com
© 2014 Public Financial Management, Inc.
2. Bond Topics
Bond Basics
The Players
Structuring Features/Considerations
The Process
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4. What is a Bond?
Debt investment in which an investor loans money to an entity (corporate or
governmental as the issuer) that borrows the funds for a defined period of time at a
fixed (typically) interest rate.
Bonds are used by companies, municipalities, states and U.S. and foreign
governments to finance a variety of projects and activities.
Bonds are commonly referred to as fixed-income securities.
The indebted entity (issuer) issues a bond that states the interest rate (coupon) that
will be paid and when the loaned funds (bond principal) are to be returned (maturity
date).
Interest on bonds is usually paid every six months (semi-annually).
Main categories of bonds are corporate bonds, municipal bonds, and U.S. Treasury
bonds, notes and bills, which are collectively referred to as simply “Treasuries.”
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5. General Municipal Bond Purposes
New Money Bonds
Issued to fund capital projects: roads, bridges, stadiums, schools, power
plants, etc.
Refunding Bonds
Issued to pay off existing debt(bonds or notes). The old debt service
payments are replaced with new debt service payments.
Create debt service savings by issuing new bonds at a lower interest rate.
“High to Low”
Remove restrictive requirements of an indenture (which sets the
parameters for which they can issue bonds and requirements for funding
them) on outstanding bonds
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6. General Bond Terminology
Principal or Par
Amount
• Amount of the Bond Issue or the indebtedness
Maturity Date
• Repayment Date of Bond Issue
Coupon Rate
• Interest rate paid annually on the Bond Issue
• Usually expressed as a percentage of Par Amount
Price
• Amount an investor will invest in consideration of future
receipt of principal and interest payments
Yield
• Income return on an investment
• Usually expressed annually as a percentage of Par Amount
Annuity of Interest
Price
© 2014 Public Financial Management, Inc.
Principal
Maturity
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7. Terminology Reference – Example Series
CITY OF HYPOTHETICAL, TENNESSEE
Par
Amount
Maturity
Date
Principal
Amount
$26,495,000 GENERAL OBLIGATION BONDS, EXAMPLE SERIES
Due
March 1
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
© 2014 Public Financial Management, Inc.
Principal
Amount
$1,770,000
1,770,000
1,770,000
1,765,000
1,770,000
1,765,000
1,765,000
1,765,000
1,765,000
1,765,000
1,765,000
1,765,000
1,765,000
1,765,000
1,765,000
Coupon
Rate
Rate
Yeld
3.000%
4.000%
4.000%
4.000%
1.500%
2.000%
3.000%
3.000%
4.000%
4.000%
2.500%
3.000%
3.000%
4.000%
4.000%
0.350%
0.380%
0.500%
0.680%
1.000%
1.250%
1.550%
1.850%
2.160%
2.310%
2.500%
2.800%
3.100%
3.130%
3.250%
CUSIP No.
654 123 7Q6
654 123 7R4
654 123 7S2
654 123 7T0
654 123 7U7
654 123 7V5
654 123 7W3
654 123 7X1
654 123 7Y9
654 123 7Z6
654 123 8A0
654 123 8B8
654 123 8C6
654 123 8D4
654 123 8E2
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8. Types of Bond Sales
•
Public Offering – Bond(s) sold by an underwriter through a public sale
Competitive Sales: An Issuer procures bids from a variety of Underwriters on the
obligations they are planning to issue and select one bid (i.e., the lowest costing
bid).
Negotiated Solicitation: An Issuer selects an Underwriter or a group of
underwriting firms and works with the selected Underwriter(s) to price
obligations through negotiation with the Underwriter(s) and Investors.
•
Privately Placement - Bond(s) purchased directly from the Issuer.
Negotiating a price for their obligations directly with the Investor(s).
Usually more expensive as the universe of potential investors is reduced.
Factors such as security type and transaction size typically help determine the best
method of sale to utilize.
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10. Participants to the Transaction Team
Swap
Advisor
Escrow
Agent
Financial
Advisor
Bond/Tax
Counsel
Registrar/
Paying Agent/
Trustee
Underwriter
Counsel
Issuer
Trustee
Counsel
Every issue
Underwriter /
Lender
Financial/
Feasibility
Consultant
Verification
Agent /
Accountant
Rating
Agencies
Credit
Enhancers
Moody’s
S&P
Fitch
As needed
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11. Issuer & Their Counsels
•
Issuer – Issuing body with the authority to issue bonds.
City/County/State and their Agencies
Can serve as the conduit between the developer/private company and the
bondholder/investor
•
Bond Counsel – Every bond issue must be reviewed by a lawyer or law firm known
as bond counsel.
The legal opinion is an authorization of the debt and covers two main issues:
It ensures that the bonds are legal, valid and binding obligations of the
issuer
It verifies the tax status of the debt; that is, interest on the bonds is exempt
from federal income taxes (as well as state and local taxes in some cases).
•
Other Counsels –may include special tax counsel, disclosure counsel, and issuer's
counsel. Such special counsel may be necessary for specific issues that are more
complex and diverse than standard offerings.
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12. Advisors/Consultants
•
Financial Advisor – Advises the Issuer through the bond issue process with a specific
role as to provide advice on structuring the debt, obtaining a rating and pricing
negotiations.
•
Swap Advisor – Advises the Issuer on structuring and procuring any interest rate
swaps (derivatives) on both a competitive and a negotiated.
•
Feasibility Consultant – Evaluates and analyzes the potential of a proposed project
which is based on extensive investigation and research to support the process of
decision making.
•
Engineering Consultant – Provides consulting related to the construction and
operations of the financing project; typically specializes in infrastructure development
in energy, water, telecommunications, and environmental markets.
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13. Underwriter/Underwriter Counsel
•
Underwriter – Securities dealer who helps government entities bring bond issues to
market. The key role it plays is to buy the bonds from the issuer and then resell them
to investors. In doing so it assumes a financial risk and thus expects to make a profit
on the transaction.
•
Underwriter Counsel – Represents the underwriters in a negotiated issue. Performs a
due diligence review of the issuer. In other words, underwriter's counsel ensures that
the issuer's financial condition and plans and other matters that are important for an
investor to know are accurately disclosed.
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14. Trustee/Paying/Escrow/Verification Agents
•
Trustee – Financial institution with trust powers that is given fiduciary powers by a
bond issuer to enforce the terms of a bond indenture. An indenture is a contract
between a bond issuer and a bond holder. A trustee sees that bond interest payments
are made as scheduled, and protects the interests of the bondholders if the issuer
defaults.
•
Paying Agent – Agent who accepts payments from the issuer of a security and then
distributes the payments to the holders of the security
•
Trustee/Paying Agent Counsel – Counsel to such entities and assists in monitoring
bond documents and any amendments to documents
Refunding Bond Specific
•
Escrow Agent – Serves as custodian of funds and holds securities to pay debt service
on refunded bonds
•
Verification Agent – Verifies cash flow sufficiency to the call date of the escrow
securities to pay principal and interest on refunded bonds
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15. Rating Agencies/Credit Enhancement
Rating Agencies (Moody’s, Standard & Poor’s and Fitch) rate municipal bond issuers
on a scale in order to rank or categorize the credit worthiness and proximity to default
of an Issuer and their obligations.
While many sophisticated investors do their own credit research, ratings play a critical
role in the minds of most market participants and are perceived by the market as a
guide of an Issuer’s credit worthiness.
Ultimately, credit ratings play a significant role in broadening the investor base for an
issuer and usually having a strong rating enhances an Issuer’s access to Investors,
helping to lower their cost of capital.
Investment Grade Rating Scales
Moody's
Aaa
Aa1
Aa2
Aa3
A1
A2
A3
Baa1
Baa2
Baa3
S&P/Fitch
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
Credit Enhancement – Supports an issuer’s credit in exchange for a fee or a premium,
in the form of enhancement such as bond insurance or a letter of credit
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17. Common Bond Security Structures
General Obligation Bonds
Full Faith and Credit Pledge
All legally Available Revenues
Taxing Power
Not Subject to Appropriation
Appropriation (Lease) Bonds
Special Obligation Pledge
All legally Available Revenues
No Taxing Power
Subject to Appropriation
Revenue Bonds
Revenue Pledge
Specifically Defined Revenue Source
No Property Taxing Power
Covenants to Ensure Revenue Sufficiency
Not Subject to Appropriation
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18. Tax-Exempt, AMT, and Taxable Bonds
Governmental
Bonds
Alternative Minimum Tax
(Tax–Exempt)
(AMT)
Private Activity
Bonds
(Taxable)
Lowest cost
Slightly higher cost
Interest is federally taxexempt
Interest is included in gross
Interest is subject to the
income for federal income
federal alternative minimum
tax purposes
tax
Projects are deemed taxable
Private Activity Projects –
if they do not provide a
outside the realm of pure
significant benefit to the
governmental functions
general public
Issued by State and Local
governments
Finance projects owned,
operated, or used by a
government for its own
purposes
Highest cost
• Airports
• Not for profit 501(c)(3)
• Housing Agencies
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19. Tax-Exempt Bonds – Historical Interest Rates
Benefit of Tax-Exempt Bonds
Cost of financing is generally lower for issuers
Theoretical rate: ≈67% of Taxable Rate
Interest paid to bondholders is not includable in their gross income for federal income tax
purposes.
7
AAA 30 Yr Tax‐Exempt
6
AAA 30 Yr Taxable
Interest Rate (%)
5
4
3
2
AAA 30 Yr AAA 30 Yr
Tax‐Exempt Taxable
Max
5.08
5.72
Min
2.47
3.29
Average
3.74
4.48
Current
3.81
4.37
1
0
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20. Fixed Rate vs. Variable Rate
Fixed Rate
Fixed Rate Bond
12
Interest
10
Dollars ($000)
The rates (coupons) are set on the day of
the pricing and do not change
The issuer will pay the exact same interest
payments (usually twice a year) for as long
as they own the bonds
Fixed interest cost and amortization
facilitate budgetary certainty and
administration
Principal
8
6
4
2
0
2004
2005
2006
2007
2008 2009
Year
2010
2011
2012
2013
Variable Rate
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Variable Rate Bond
12
10
Dollars ($000)
The interest rates are reset to different
coupons at predetermined points
throughout the year
The Issuer’s interest payments will vary for
the life of the bonds based on market
conditions
Having a portion of an issuer’s capital
structure as variable rate debt creates a
better match and a natural hedge between
short-term assets and liabilities
Interest
Principal
8
6
4
2
0
2004
2005
2006
2007
2008
2009
Year
2010
2011
2012
2013
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21. Interest Rate Swaps (derivatives)
Interest Rate Caps – an agreement which insures the interest rate will not exceed a
predetermined rate (the “strike rate”) for a predetermined period of time (e.g. 3 years,
5 years, etc.).
Interest Rate Swap - the Borrower exchanges their variable rate payment obligation
with a third party for a fixed payment obligation for a specified period of time.
At the end of that time, the Swap can either be extended or the bonds will revert to
the variable-rate mode.
Fixed Swap Rate
Issuer
Swap Counterparty
Variable Swap Rate
Variable Bond Rate
Bondholders
© 2014 Public Financial Management, Inc.
Ancillary Fees:
• Remarketing Fees
• Letter of Credit
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23. Call Options
Call Options
Call is exercised only at the option of the issuer not the investor
Calls typically exercised to achieve savings or restructure debt
Issuers typically issues Bonds with a 10 year call option or refinancing opportunity
Mandatory Call
Call must be exercised on specified date/during specified timeline
May be required by law
May be required by legal structure of transaction
Extraordinary Call
Call exercised upon occurrence of certain events
May be optional
Redemption Prices for Call Vary
Par
Premium
Make-whole
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24. Bond Pricing Mechanics
Price is often quoted as a percentage of face value. A bond priced at 101, for example, will
be worth 101% of the face value of the bond. This is known as a premium. Similarly, a
bond priced at 95 will be worth only 95% of the face value of bond. This is known as a
discount. The types of bonds are outlined below:
Par Bonds
Coupon Rate is equal to Yield; investor pays the stated price, or “Par”
Discount Bonds
Coupon Rate is less than Yield; investor pays less than the stated price, or “discount”
Premium Bonds
Coupon Rate is greater than Yield; investor pays more than stated price, or “premium”
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25. Credit Ratings and Cost of Borrowing —
Credit Spreads
400
350
Basis Points
300
250
200
150
150
100
80
50
23
0
AA
A
Baa/BBB
*Ten Year Maturity
MMD = Municipal Market Data Index
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27. Tao of Municipal Bond Modeling
Refunding
Escrow(s)
Other
Construction
Elements
Fund
of Size
Size
Capitalized
Costs of
Issuance
Interest
Bond
Underwriter’s
Insurance
Discount
Debt Service
Reserve Fund
Bond
Structure
Structure
Yield
Debt
Structure
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28. Bond Sale Process
Negotiated Bond Sale Process
Financing Team Selected:
Bond Counsel, Financial Advisor, Underwriter and Underwriter’s
Counsel
Applications/Request made to necessary
parities
Certain types of bonds require special authorizations and/or
allocations made to local and state level governments
Initial and Authorizing Resolution
(20 day wait period on New Money Bonds)
Resolutions presented to local government body
(City Council, Board of Mayor and Alderman)
Bond Structuring
Financing Team evaluates security structure, interest rates, terms,
call features, swaps, etc.
Seek Credit Rating and/or Credit
Enhancement
2-3 week process to coordinate with creditors
Offering Document Distribution
(Preliminary Official Statement)
Document describing the bond structure, credit , flow of funds to
the investor community
Bond Marketing to Investors
Typically 1 week - Underwriter markets the bonds to potential
investors
Bond pricing
Negotiations with Underwriter and investors
Finalize Offering Document
(Official Statement)
Finalize Offering Document (Official Statement)
Closing
Funds received
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29. Post Issuance Compliance Requirements
Continuing Disclosure
Issuer covenants to provide ongoing disclosure of both routine financial
information on an annual basis and periodic notification upon certain
events, e.g., defeasance of bonds
Arbitrage Rebate (if tax-exempt or AMT)
Issuer may be required to rebate investment earnings in excess of the bond
yield to the federal government every five years
Rating Maintenance
Issuer is required to provide ongoing updates to the rating agencies
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