Chapter 15 - Municipal Bond taxation, underwriting, and the secondary market AND Chapter 16 - Municipal Bond Rules and Regulations Flashcards
Interest on municipal bonds
Paid semi annually
Most are exempt from federal income tax due to the doctrine of reciprocal immunity applied by the supreme court
Most states exempt municipal bond interest from income tax within the state of issue
Common wealth of Puerto Rico bonds are exempt from all federal, state, and local taxes (applies to all territories of the united states)
Corporate Equivalent Yield
Municipal Yield/ (100%-investors tax rate) = taxable equivalent yield
Current yield on municipal bond
annual interest/ market price
Bonds sold at a premium and taking the loss from par
Corporate bonds- On the date of maturity when you receive the par value back you can take the full loss of the bond you purchased at a premium
Municipal bonds- You must amortize the loss from purchasing the bond at a premium each year you hold the bond
Municipal Bonds and original issue discount
If the investor buys a bond at a discount in an original offering they treat the discount as part of the interest income, not capital gains
Municipal Bonds and secondary market discount
When bonds are bought at a discount on the secondary market they are taxed at ordinary income when they are sold
Municipal bonds at a premium or discount and volatilities
Bonds trading at a discount are more volatile (they are more sensitive to interest rate changes) than bonds trading at a premium
Municipal bond swaps
The exchange of one bond for another. Usually occur at the end of the end when investors want to realize a capital loss while keeping their money in municipal bonds
Also:
Upgrade to higher rated bonds
Extend or shorten bond maturity
increase income or yield
accrued interest is NEVER a reason to do a municipal bond swap
Large Buyers of municipal bonds include
High tax bracket individuals
Commercial Banks
Insurance companies
These groups do not typically invest in municipal bonds
Charitable organizations
IRAs
pension funds
these all already have tax exempt status
The secondary market for municipal bonds
Is thin
Most bonds are bought at par and held until maturity
Blue List did and did not contain
Did: Amount of bond for sale
Name of the issuing authority
Coupon Rate
Maturity Date
Yield
Name of dealer offering the bond
Purpose of the bond
DID NOT:
The bonds quality rating
Placement Ratio
Measures the percentage of new issues that have been sold compared to those available
30 day visible supply
the amount of new issues coming to the market in the next 30 days
This is then broken down into competitive and negotiated bonds to be sold
Municipal notes are not included in the 30 day supply
Bond Buyer Index
Is made up on 20 GO bonds each with 20 year maturities
Bond Buyer Revenue Bond Index
the average of 25 revenue bonds each with 30 year maturities
Municipal market trends can be determined by using…
The 30 day visible supply
The bond buyers index
The blue list
Under writer for municipal bonds are chosen through either
Negotiated bidding- Revenue bond
Competitive bidding - GO bond issuer
Underwriters and Selling Syndicate members must agree on new issue being either
Eastern account agreement (most municipal bonds are eastern) - You are responsible for your percentage of the overall deal and also your percentage of anyone else’s left overs that they were unable to sell
Western account agreement- you take on your agreed upon percentage of the deal and that is all you are responsible for
Municipal Bond underwriters are either
Commerical banks or broker dealers who are members of FINRA or MSRB (municipal securities rulemaking board
Forming an underwriters agreement with negotiated bidding
Terms and interest rates which will be offered are negotiated directly between the issuer and the underwriter
Forming an Bid form with competitive bidding
The bond is awarded to the group that offers the lowest net interest cost
Net interest cost (NIC)
The Amount of interest that the municipality will end up paying on the bond issue
Any premium over par that is received when the bond is sold is subtracted from the interest cost to the issuer
Issuers also want to know the “True interest cost” since that considers time value of money but NIC does not
What must be included in Municipal bond notice of sale (and what does not)
Include- Date and time bid are due
The detail on the bond issue
redemption features
Interest or coupon rate
paying agent
purpose of the bond
Bond attorney that will be giving opinion
Where the bonds are to be delivered
CUSIP number
Maturity date and call features
Amount of good faith deposit required by bidders
The right to reject any and all bids
NOT-The bond rating
guarantee of debt servicing
offering yield
Bond Years
Record of tax collection
legal opinion
Bid Form
A document that is included with the notice of sale that is sent to the bidder
when executed the bond form becomes the contract
Includes coupon rate
maturities and signature of the submitting dealer
Competitive bidding roles
Issuer - determines the maturity
Underwriter - determines the spread, yield to maturity, and net interest cost
Managing underwriters in a competitive bid, before submitting a bid will
reach out to each member with a syndicate letter in which the agreement between the underwriting manager and the syndicate is described
Syndicate letter includes
The duration of the underwriting
Member’s participation or commitment
statement saying this is not a legal partnership
a vote of the syndicated members will determine the bid and offering price
A carte blanche which gives manager ability to act “ with customary authority and discretion
Priority or allocation schedule
Syndicate may violate the syndicate letter but only if it is to the benefit of the entire syndicate account
Allocation Order
Pre-sale orders
Group net account or syndicate group accounts
Designated orders
Member orders at the takedown
The take down
The syndicate member agrees to purchase the bond from the underwriter at the offering price less a discount. This discount is known as the take down and represents what the syndicate member will earn from the sale
Odd First coupon
Some times the first coupon can be longer or shorter than the standard 6 month coupon rate
Short coupon is less then 6 months
Long coupon is more then 6 months
Prospectus in municipal bonds
Municipal bonds do not call their disclosure document a prospectus, they call it an Official Statement (OS)
Official Statement
Provided by the issuer
Not required
Contained the most detailed financial information on the municipal bond
If it is provided it must be provided to all purchasers and to broker dealers upon request
If there is a preliminary OS but not an official OS it must be
Provided to a customer at the time of purchase
Then the final statement must be sent when it is available
Official statement includes
The purpose of the bond issue
redemption provisions
a description of the issues
NEVER includes a taxable equivalent yield
An entire sale of a new issue of municipal bonds to a single individual or group of accredited investors is referred to as
a private placement
Accumulation account
An account established by the sponsor of a UIT to hold bonds which will be put into the portfolio when the UTI is formally created
Accumulation account orders must be designated as such at the time of order
Earnings or debt service coverage
This reflects the number of times by which the revenues for a period exceed the debt service payable in that period
Revenue / debt service
Dated Date
The date for a new issue from which interest is accrued
Municipal Bond: The spread
Difference between syndicate cost, average offering price, and the proceeds paid to issuer
When talking about yield with Muni Bonds we are talking about…
Yield to maturity, also called the basis
Nominal yield, current yield and yield to maturity are all the same if…
the bond is trading at par
Secondary market for muni bonds are typically traded
On a principal basis, trading with the firms own inventory of bonds as opposed to purchasing between two individuals
Make money thru a mark up or mark down, not through commissions
What to consider when pricing a bond on the secondary market
The prevailing market price (not the price they paid originally for it)
The aggregate dollar amount of the transaction
The expenses of the transaction
A muni bond quote may be
Firm-
Subject to prior purchase
Subject to a subsequent price change
Nominal
Affected by interest rate moves, supply and by the market price of similar bonds
Bank Qualified Municipal Bonds
If the bank purchases an entire bond issue that is less then $10 million par value for its won portfolio then it is called a BQMB. The bank can take an 80% ta write off on the interest for the money borrowed to purchase these bonds
Market price of municipal bonds can change based on
Tax legislation
credit ratings
market conditions
Bond marketability factors
Rating and quality
Maturity - Shorter maturities are more liquid
Call features
Coupon
Block Size - $100,000 round lot. less then that is less marketable
Dollar price- all else being equal bonds at par are more marketable
Issuers name
Trading flat - have unpaid interest
Sinking funds
The blue list total is…
The par value of municipal securities offered for sale in the blue list
Visible Supply is
new offerings expected to come to market it the next 30 days
Municipal Securities Rulemaking Board (MSRB)
Created in 1975 to set rules to regulated all FIRMS in transacting in municipal securities
MSRB rules apply to
Municipal securities broker/Dealer
Bank municipal dealer department
Financial Consultants
does NOT regulate the issuer (municipality)
MSRB rules are subject to
SEC approval
MSRB rules are enforced by
Mostly SEC and FINRA( formally NASD)
Governors of the federal reserve, Comptroller of Currency, and Federal Deposit Insurance Corporation all also enforce MSRB rules
MSRB rules are not enforced by NYSE or U.S. Treasury
Gifts permitted under MSRB rules
Maximum of $100 normally
in additional:
Reminder advertising (max value $40)
Tickets to a sporting event $100
A restaurant bill for the broker and customer ($130)
Accommodations for a customer at an economic conference ($180)
When opening an account with another dealer, other then your employer
The new dealer must send notice to your employing dealer
Must act in full compliance with Dealer A written instructions
Submit Duplicate copies of confirmations to Dealer A
Prior approval from dealer A is not required to open and account or execute orders
All advertising and sales literature must be approved by..
a principal
In writing
Prior to first use
But they do not have to be files with the MSRB prior to first use
Preliminary and official statements are not sales advertising, they are considered to be disclosure documents
Reciprocal dealing
This is when a broker dealer solicits a transaction in municipal securities of a UIT in return for shares or units
This is NOT allowed
When opening a discretionary account for municipal securities, at or before settlement you must obtain
Written authorization from the client
a principals approval of the account and the initial trade
Trade reporting
Trades must be reported within 15 minutes of a trade taking place
MSRB arbitration rules
Mirror FINRA arbitration rules
Contribution limits for political candidates under MSRB
Max $250 per election, and you must be eligible to vote in that election
If violated you, and your firm, can not do business with that issuer for 2 years
Settlement for municipal securities is
Regular way - T+2
Cash trades are same day
“When, as, and if issued” trades settle on a date agreed upon by both parties but not earlier then two days after the final confirmation
Between firms they typically use “clearing house funds” and are settled in 1 day
Units for Bearer bonds
$1,000 minimum, $5,000 usual
Units for Registered bonds
$1,000 in multiples up to $100,000
What must be unreadable for a mutilated certificate
Name of issuer
Par value
Signature
Coupon Rate
Maturity Date
Seal of the issuer
Bond or Note number
Can not be rejected for missing CUSIP number
Good delivery of a bond requires
Trade to settle in T+2
Bond is not being called or has been designated as being called
Legal opinion is accompanying bond if not sold ex-legal
Bonds in demonizations of $1,000 or $5,000
All identification items are readable on the certificate
If there is a bond that is flat (has missed interest payments) and the bond is sold
The purchaser gets the bond coupons where the interest has yet to be paid
Expenses to ship a bond are paid by
the seller (postage, insurance packaging etc)
Information not needed on a bond confirmation
Quality rating
Debt service coverage
Commission per bond (total commission will be shown)
Identity of the paying agent
At of before completion of a transaction of municipal securities the agent must determine
The financial status
the tax status
investment objectives
any previous investment experience
