2 Understanding Municipal Finance 2.2 Bond Proceeds Investment Strategies & Municipal Fund Securities Flashcards
Excrow
-A fund established to hold funds pledged and to be used solely for a designated purpose, typically to pay debt service on an outstanding issue in an advance refunding.
-It is important to create a refunding escrow that is efficient and will optimize savings
An escrow is efficient if escrow securities mature or pay interest when debt service payments of the refunded escrow are due – the lower the cost of the escrow (assuming all legal and permitted investment guidelines are met) the more efficient the escrow.
Where can issuers purchase escrow securities?
- Open Market
- State or Local Government Securities (SLGS)
- A special series of U.S. Treasury securities
- Other permitted investments, and/or use a hybrid structure.
Regarding escrow - Issuers may consider implementing an economic defeasance, as opposed to the standard legal defeasance.
Regarding escrow
Among the issues that should be considered with regard to each type of instrument are the following:
SLGS can be structured to comply with the federal tax law limits on investment return on escrow securities and eliminate any inefficiency in the escrow.
Open market securities may have a higher return but may not mature or pay interest on the date when debt payments are due.
Other permitted investments may provide even higher yields, resulting in greater savings, but often do not allow issuers to meet the requirements for a legal defeasance.
Regarding escrow - Issuers may be required to increase the issue size or blend higher- and lower-yielding securities to comply with yield-restriction requirements and generate sufficient revenues. Such inefficiency may be eliminated by future escrow substitutions. Additionally, forward supply agreements, guaranteed investment contracts, or float contracts also may be considered to minimize escrow inefficiencies. However, issuers need to be concerned with potential counterparty risk, with these investment instruments.
Treasury
Debt obligations of the United States Government sold by the Treasury Department in the form of bills, notes and bonds (as well as SLGS sold to issuers of municipal securities) backed by the full faith and credit of the United States Government
Three types of Treasury
- Bills
- Notes
- Bonds
Bills
Short-term obligations that mature in one year or less and are sold on the basis of a rate of discount.
Notes
Obligations that mature between one year and ten years.
Bonds
Long-term obligations that mature in ten years or more
Federal Agencies
A term for securities issued by a federal agency or certain federally chartered entities (often referred to as government-sponsored enterprises or GSEs). Agency securities typically are not guaranteed by the federal government, particularly those of GSEs. Agency securities also are generally exempt from the registration and prospectus requirements of the Securities Act of 1933. Securities of the following entities are generally considered agency securities although the terms of a bond contract or escrow deposit agreement may further limit what are considered to be agency securities for purposes of that contract or agreement: Federal Agricultural Mortgage Corporation (Farmer Mac); Federal Farm Credit Banks Funding Corporation (FFCB or Farm Credit); Federal Home Loan Bank System (FHLB or Home Loan); Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac); Federal Housing Administration (FHA); Federal National Mortgage Association (FNMA or Fannie Mae); Government National Mortgage Association (GNMA or Ginnie Mae); and Tennessee Valley Authority (TVA).
Two types of Investment Contracts
- Guaranteed Investment Contracts (GICs)
- Forward Delivery Agreement
Guaranteed Investment Contracts (GICs)
An investment, secured by a contract with a financial institution, that guarantees a fixed rate of return and a fixed maturity.
Forward Delivery Agreement
A contract (variously known as a forward contract, forward delivery agreement or forward purchase contract) wherein the buyer and seller agree to settle their respective obligations at some specified future date based upon the current market price at the time the contract is executed. A forward may be used for any number of purposes. For example, a forward may provide for the delivery of specific types of securities on specified future dates at fixed yields for the purpose of optimizing the investment of a debt service reserve fund. A forward may provide for an issuer to issue and an underwriter to purchase an issue of bonds on a specified date in the future for the purpose of effecting a refunding of an outstanding issue that cannot be advance refunded.
Three types of Money Market Instruments
- Certificates of Deposit
- Commercial Paper
- Investment of bond proceeds (investment suitability, investment policy of issuer, liquidity and spending schedules; indenture requirements)
Certificates of Deposit
A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are generally issued by commercial banks and are insured by the FDIC. The term of a CD generally ranges from one month to five years.
Commercial Paper
An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing market interest rates.
Local government investment pools (LGIP)
An investment pool established by a state or local governmental entity or instrumentality that serves as a vehicle for investing public funds of participating governmental units. Participants purchase shares or units in the pool (often formed as a trust) and assets are invested in a manner consistent with the portfolio’s stated investment objectives. The investment advisor invests in a manner consistent with the cash management needs of the governmental unit participants.
529 college savings plans
A program, sometimes referred to as a “college savings plan,” established by a state as a “qualified tuition program” pursuant to Section 529 of the Internal Revenue Code. Under a 529 college savings plan, a person may make contributions to an account established for the purpose of meeting the qualified higher education expenses of the designated beneficiary of the account. Contributions generally are used to acquire shares or units in a state trust, with trust assets invested in a manner consistent with the trust’s stated investment objectives. Shares or units typically constitute municipal fund securities. Under current federal tax law, earnings from a 529 college savings plan used for qualified higher education expenses of the designated beneficiary are excluded from gross income for federal income tax purposes.
