Ch. 8 Municipal Bonds Flashcards
What are General Obligation (GO) Bonds?
- They fund Non-Revenue producing facilities
-Not self-supporting
-Issued to build or support projects like schools, libraries, police, fire, etc. - Backed by the Full Faith and Credit (Taxing Power) of the Municipality
-The taxes of the people living in the municipality back the bonds
-Taxpayers have a right to vote on the project
-Property AND Sales Taxes - Require Vote Approval
-Taxpayers have the right to vote on the project b/c backed by their tax $$$
Factors that can impact a GO Bond’s marketability
Characteristics of the issuer
Factors affecting the issuer’s ability to pay
Municipal debt ratios
Quality rating
Maturity
Call Feature
Interest (coupon) rate
Block Size
Dollar Price
Issuer’s name (reputation)
Liquidity of the bond
Credit and liquidity support
Denominations
Sinking Fund
Credit Enhancement
Re: marketability of GO Bonds, what is Quality Rating?
Three main credit rating agencies are Standard & Poor’s, Moody’s and Fitch
The higher the credit rating the safer the bond and the more marketable it is
Re: marketability of GO Bonds, what is Maturity?
The shorter the maturity, the more marketable the bond issue
Re: marketability of GO Bonds, what is Call Features?
Callable bonds are less marketable than non-callable bonds
Re: marketability of GO Bonds, what is Interest (coupon) rate?
Bonds with higher coupon (interest) rates are more marketable
Re: marketability of GO Bonds, what is Block Size
The larger the block size, the more marketable the bond usually is.
Re: marketability of GO Bonds, what is Dollar Price
The lower the dollar price, the more marketable the bond is
Re: marketability of GO Bonds, what is Issuer’s name
Reputation
Bonds are more marketable when the issuer has a good reputation for paying off its bonds on time
If they have a national “name” that also help w/ marketability
Re: marketability of GO Bonds, what is Liquidity
The ability to sell the bond in the secondary market
The more liquidity, the easier it would be to sell in the secondary market
Re: marketability of GO Bonds, what is Credit and liquidity support
when Muni’s are issued w/ credit and Liquidity Support, they have a bank issued leter of credit commiting to payment of principal and interest in the even that the municipal issuer is unable to do so.
Adds a layer of safety (lower yield)
Re: marketability of GO Bonds, what is Denominations
Frequently of $5,000 but can be as low as $1,000 and as high as $100,000.
How affordable is it for investors. ($100,000 would be hard to sell)
Re: marketability of GO Bonds, what is Sinking Fund?
If the issuer has put money aside to pay the bonds off at maturity, the bonds are more marketable because the default risk is lower.
Re: marketability of GO Bonds, what is Credit Enhancement?
Uses credit from another entity to provie additional scurity to a bond issue.
bond insurance, bank leters of credit, government guarantees, etc
more desirable to investors but produce lower yields.
SEC is requiring issuers of muni bonds to update the MSRB when…
Material changes take place that could afect the marketability of their municipal securities.
Any materical changes must be disclosed w/in 10 biz days
Info will be made available to investors & industry professionals on the MSRB’s EMMA website
What are material changes that must be disclosed w/in 10 biz days?
Principal & interest payment
delinquencies on the securities being offered
unscheduled draws on debt service reserves
unscheduled draws on credit enhancements
substitution of credit or liquidity providers
defeasances,
ratings changes
tender offers
bankruptcy,
adverse tax opinions that might make the issue taxable
non-payment related defaults
bond calls
When considering a GO Muni bond, how do you deal with debt?
- Consider the municipality’s name (reputation)
- Look at credit history
- Look at current debt
When analyzing a GO muni bond looking at current debt, consider 1, 2, 3
- Net Overall Debt
- Net Direct Debt
- Overlapping Debt
What is Net Overall Debt
Debt that the muni owes directly plus the portion of overlapping debt that the muni is responsible for
What is Net Direct Debt?
The debt the Muni obtained on its own
Comes from both GO bonds and short term muni notes
Revenue bonds are NOT included
What is Overlapping Debt?
Occurs when several authorities in a geographic area have the ability to tax the same residents.
What is Debt Per Capita
Take the debt (overall, direct, or overlapping) and divide it by the number of people in the municipality.
The lower the number, the better!
How are property values connected to GO Muni Bonds?
Ad Valorem taxes (property taxes) are based on assessed property values.
The higher the assessed property value, the higher the ad valorem taxes (property taxes), the more taxes collected and the easier it is for the municipality to pay off its debt
Ad Valorem taxes are based on _____ or ______ of a dollar.
mills or thousandths of a dollar ($0.001)
How is Population of a municipality connected to GO Muni Bonds?
The more people who live there and pay taxes, the better for investors.
Population trend is important too - they want people to be moving into a municipality, not out of a municipality.
Easier for investors to recoup their principal and interest.
What is a Tax Base?
The # of people living in the municipality,
the Assessed property values
the Average income
Larger tax bases are ideal to support municipal GO Bonds
What are Sales Per Capita
Sales tax also supports GO Muni Bonds
the amount of goods the average person buys is important
What are Traffic Finds and Licensing Fees? (re: GO Muni bonds)
Help pay for the municipality’s debt
Because Muni GO bonds are backed by the huge taxing power of a municipality…
they have higher ratings and lower yields than revenue bonds. B/c investors are not taking as much risk, they don’t get as much reward.
What are Qualified Bonds?
Interest expenses associated w/ purchasing securities are deductible from taxes.
When municipal bonds are puchased ON MARGIN, they _____ tax deductible
Are NOT
What is a Bank Qualified Bond?
If the muni bonds are bank qualified, commercial banks can purchase the muni bonds on margin and deduct 80 PERCENT of the MARGIN INTERST EXPENSE ON THEIR TAXES while still receiving TAX-FREE INTEREST from the municipal bond.
Not available to retail investors
When are Revenue Bonds issued by a municipality?
To fund municipal facilities that will generate enough income to support the bonds
Raise money for certain utilities, toll roads, airports, hospitals, student loans, etc.
Do NOT need voter approval
Require a FEASIBILITY STUDY (Does this make sense?)
What is an Industrial Development Bond? (IDB)
Municipal Bond (The riskiest muni bond)
Finance the construction of facilities for corporations that move into that municipality.
Issued by municipalities
BACKED BY LEASE PAYMENTS MADE BY A CORPORATION
Because a corporation is backing the bonds, the credit rating of the bonds is derived from the credit rating of the corporation.
B/c benefits a corporation and not the mni, the interest income may not be federally tax-free to investors subject to the Alternative Minimum Tax (AMT)
What does a feasibility study include?
Estimates of revenues that the facility could generate
economic aspects of the project
operating aspects of the project
engineering
Consider When Analyzing if a Revenue Bond is appropriate for your client…
- Evaluate the safety
- Specifics of the security
- Does it have a credit enhancement (insurance)
- Does it have Call Features?
Revenue Bonds involve ______
Covenants
What is a Bond Covenant?
Promises that protect investors by holding the issuer legally accountable
Types of Bond Covenants
Rate Covenant
Maintenance Covenant
Insurance Covenant
What is a “Rate Covenant”?
Promises that the muni will Charge sufficient fees to people using the facility to be able to pay expenses and the debt service (principal and interest on the bonds)
What is a Maintenance Covenant?
Promises that the Municipality will adequately take care of the facility and ay equipment so the facility continues to earn revenue
What is an Insurance Covenant?
Promises that the municipality will adequately insure the facility.
Covenant Equals…
Revenue Bonds
Municipalities must provide ____ and are subject to _____ for all of their revenue bond issues.
financial reports
outside audits
What is the Additional Bonds Covenant? (Additional Bonds Test)
IF the Municipality is going to issue more bonds backed by the same project, it must prove that the revenues will be sufficient to cover all the bonds.
The indenture on the initial Bonds can be either ____ or ____
Open ended or closed ended
What does it mean when the indenture on the initial bond is open ended?
Additional bonds will have equal claims to the assets
What does it mean when the indenture on the initial bond is closed ended?
Additional bonds will NOT have equal claims to the assets. Any other bond issued will be subordinate to the original issue.
Revenue Bonds are backed by _____.
Credit enhancements
(GO bonds are, too)
What is a credit enancement?
Pays the investors in the event that the issuer defaults
Because revenue bonds are backed by a revenue producing facility, most revenue bond issuers also carry…
Catastrophe insurance
What does a catastrophe clause state?
If a facility is destroyed due to a catastrophic event such as a flood, hurricane or tornado or the like, the municipality will use the insurance that it purchased to call the bonds and pay back bondholders.
What is the “Flow of Funds”?
Exclusive to Revenue Bonds
Tells you what a municipality does with the money collected from the revenue-producing facility that’s backing the bonds.
Typically, the “flow of funds” is as follows…
- Operation and maintenance
- Debt service fund
- Debt service Reserve Fund (one year’s debt service)
- Reserve Maintenance Fund
- Renewal and replacement fund
- Surplus Fund
What is debt service?
principal of maturing or redeemed bonds and interest on the remaining outstanding bonds
What is a Net Revenue Pledge?
Net Revenues (gross revenues minus operation and maintenance) are used to pay the debt service
What is a Gross Revenue Pledge?
Gross Revenue Pledge is when the municipality pays the debt service BEFORE paying operations and maintenance
What is the debt service coverage ratio?
An indication of the aility of a municipal issuer to meet the debt service payments onits bonds.
Higher DSCR, the more likely the issuer is to be able to meet interest and principal payments on time
net OR gross revenues DSCR = ------------------------------------
principal + interest
The SEC requires that the UW of municipal bonds enter into an agreement to provide required information to the …
The info required includes…
MSRB
annual financial information (ops data, financial statements)
Event notices
- principal & interest payment delinquencies
- bond calls
- tender offers
- ratings changes
- unscheduled draws on debt service reserves
- bankruptcy
- appointment of a successor trustee
- defeasances
must submit disclosures on or before the date specified in the CONTINUING DISCLOSURE AGREEMENT or provide a notice of a failure to do so via the EMMA website
Muni Bond issuers are exempt from providing continuing disclosure if..
…the entire issue is less than $1 million
OR
The bonds are sold to no more than 35 unaccredited investors and sold in units of no less than $100,000
OR
the bonds are sold in denominations of $100,000 or more and mature in 9 months or less from initial issuance
OR
if the bonds were issued prior to July 1995
Municipalities issuing revenue bonds or IDRs typically choose which method of selecting an underwriter?
Negotiated Offering
Municipal issuers of GO bonds typically choose which method of selecting and underwriter?
Competitive Offering
How does a Municipality looking to issue GO bonds proceed w/ selecting a UW?
- Issuer posts a NOTICE OF SALE (an ad) in the Daily Bond Buyer - Accepting Bids!
- Interested UWs submit a GOOD FAITH DEPOSIT and their bids to the issuer
- The winner of the bid = lowest cost to taxpayers
- Lowest Cost is due to
- issuing the bond w/ a lower coupon rate and/or
- agreeing to pay more to purchase the bonds - UW determines the coupon rate & selling price
What does the Notice of Sale contain?
- All bidding info about new muni issues
- when and where to submit bids
- amount of good faith deposit
- Whether to expect a NIC (Net Interest Cost) basis or a TIC (True interest cost) basis
- Amount of bonds to be issued
- Maturity
How is the coupon rate determined by the UW?
- issuer credit history
- outstanding debt amount
- issue size
- tax base
How would a private placement work for a municipal bond issuer?
It would be a PRIMARY OFFERING
A Placement Agent sells the new securities directly to the public on an agency (commission) basis
The Placement Agent does NOT purchase the securities. He/she just sells them directly for the mini issuer.
Due to resale restrictions of securities sold via private offerings, a PRIVATE PLACEMENT LETTER is often required outlining the rules.
What is an Advance Refunding?
When a Muni issues new bonds (the refunding issue) to pay off outstanding bonds (the refunded issue).
The Refunded Issue (outstanding bonds) must remain outstanding for more than 90 days after the issuance of the refunding issue (new bonds) for tax law purposes.
The $ received from the sale of the refunding issueis invested in US Treasury securities and the principal and interest earned is used to pay principal and interest on the refunded issue.
What is Crossover Refunding?
A method of advance refunding
The revenue stream which was originally pledged to pay the debt service on the refunded bonds continue to be used to pay the principal and interest on those bonds until they mature or are called.
Once this happens, those pledged revenues crosover and are used to pay principal and interest on the refunding isue and escrowed securities are used to pay the refuned bonds.
When both the refunded and refunding bonds are BOTHOUTSTANDING, the debt service on the refudning bonds is paid from the interest earnings on the money invested by the muni from the sale of the refunding issue.
Rules have changed to make it so that the refunding issue cannot be issued as tax-free bonds.
Thus, there will be no advantage to munis to advance refund their bonds because they’d have to pay interest on the refunding bonds that is much higher than on tax-free bonds
What is a direct exchange of securities?
exchanging the called or matured bonds to the new issue of bonds
Why would an issuer offer a Direct Exchange of securities?
An issuer may offer a direct exchange of bonds to their existing bondholders vs. selling new securities b/c this will help keep costs lower for the issuer.
They won’t have to market the new securities, pay UWs, or pay the costs of transferring $ or securities.
Why would pre-refunded bonds be Escrowed To Maturity?
This means that the proceeds of sale from the new issue of bonds is held in an escrow account.
This escrowed money is invested in securities w/ a high credit rating such as US Treasury securities defeasance).
The interest and principal received in the escrow account will be used to make principal and interest payments to the bondholders.
What are the ways a municipal bond can be called?
Par or premium
Optional
Mandatory
Partial or in-whole call
Sinking Fund
Extraordinary Calls
Make Whole Calls
What is a Par or Premium call feature on a municipal bond?
Call features on a bond mean prepayment provisions
PAR: Typically, bonds are called or redeemed at PAR or an accreted value in the case of original issue discount bonds or Zero-coupon bonds, plus accrued interest up to the redemption date
PREMIUM: In some cases, bonds may be called or redeemed above par or accreted value plus accrued interest up to the redemption date
What is an Optional Call Feature on a municipal bond?
Gives HOLDERS the right to option or redeem their bonds on or after a specified date determined by the issuer.
Typically the date is set at least 10 years out from issue
What is a Mandatory Call Feature on a municipal bond?
Occur on a scheduled basis or as a sinking fund
Scheduled basis: in specific amounts or in amounts then on deposit in the sinking fund
Sinking fund call: based on when a certain amount of money is available in the sinking fund
What is a Partial or In-Whole Call Feature on a municipal bond?
In-Whole Call: all callable bonds of that issue must be redeemed
Partial call: A portion of callable bonds of that issue must be redeemed
Depends on the terms w/in the bond contract
What is a Sinking Fund Call Feature on a municipal bond?
Issuer puts money aside to pay off the bonds at some future date
Once there is enough money in the “sinking fund” to redeem the bonds, there will be a mandatory sinking-fund call
What is an Extraordinary Call on a municipal bond?
Mandatory or optional
Redemptions due to an extraordinary event such as the loss of a revenue producing facility backing the bonds.
What is a Make Whole Call on a municipal bond?
Allows issuers to pay off the debt securities early but at a higher expense.
Issuer must make a lump sum payment based on the NET PRESENT VALUE of future interest payments that would be due on the bonds that will not be paid due to the bonds being called.
Rarely issued. High cost for the municipality
Callable bonds are _____ for the investor because…
Riskier
They aren’t sure how long they’re going to be able to hold their bonds
Issuers usually call their callable bonds when ______ so that they can…
fall
issue new bonds with a lower coupon rate and save $$$
Benefits of a callable bond…
The risks of a callable bond
For investors: higher coupon payment BUT may bot be able to keep the bond as long as wanted. May have to reinvest at a lower rate when called.
For Issuers: Won’t be stuck paying super high interest rates compared to future current market prices / rates BUT will make a higher coupon payment than on non-callable bonds
What are puttable municipal bonds
Rare. Put more power in the hands of the investor but at the cost of a lower interest rate.
Put options give the investors the right to require the issuer to purchase their bonds usually at par value at certain specified times prior to the maturity date.
Typically variable-rate securities
What are Special Tax Bonds (Municipal)?
Secured by one or more taxes OTHER than ad valorem taxes.
May be backed by sales taxes on fuel, tobacco, alcohold, business licenses, etc.
What are Special Assessment Bonds?
Special District Bonds?
Issued to find construction of sidewalks, streets, sewers, etc.
Backed by taxes ONLY on the properties that BENEFIT from the improvements.
What are Double Barreled bonds?
A combination of Revenue and GO bonds
Issued to find revenue producing facilities (toll bridges, water and sewer facilities…_ but if the revenues taken in aren’t enough to pay off the debt, tax revenues make up the deficiency.
What are Lease Revenue Bonds?
Lease Rental Bonds?+
