Chapter 2 Study Notes Flashcards
Municipal Issues Securities Act of 33
Municipal issues are exempt from the filing provisions of the Securities Act of 1933 and are therefore not registered with the SEC. However, municipal securities are not exempt from the anti-fraud provisions of the Act.
General Obligation (GO) Bonds
A general obligation bond is secured by the full faith, credit, and taxing power of the issuer. Only issuers that possess the ability to levy and collect taxes may issue general obligation bonds. Essentially, state or local governments are able to issue general obligation bonds based on statutory or constitutional powers.
Statutory Power
A statutory power is a law that’s passed by a state or local government which allows for the sale of the security. These laws can be amended by legislative action.
Constitutional Powers
Constitutional powers to issue general obligation bonds are derived from the state constitution—a law or statute is not required to be passed first. These statutory and constitutional powers can also limit the amount of debt an issuer is able to incur.
State general obligation bonds are usually secured by
income, sales, gasoline, excise, and other taxes that are collected on the state level.
Local general obligation bonds are usually secured by
For local jurisdictions, such as counties and cities, the most common taxing power is on property. An ad valorem tax (property tax) on the assessed value of real estate is the source of funds the local government uses to support its expenses and debt (GO bonds). School taxes are also charged at the local level.
mills.
As stated, property tax is based on the assessed value of property and the tax rate levied. The tax rate is expressed in terms of mills. One mill equals 0.1% of the assessed value, which equates to a tax of $1 per thousand dollars of assessed value. If expressed as a decimal, one mill equals .001.
GO Bond
Sources of funding
In addition to the different taxes, non-tax revenue such as parking fees, park and recreational expenses, and licensing fees can be used to pay the debt service on GO bonds.
limited tax general obligation bonds
Certain governmental entities, such as school districts, have a legal limit on the tax rate that they can levy. Bonds that are issued by these entities are referred to as limited tax general obligation bonds.
Unlimited tax bonds
Unlimited tax bonds are issued by government units that have no legal limitation on their power to tax.
When evaluating the risk of default for a general obligation bond, analysts will look at factors such as:
* The overall economic health of the community including changes in property values, its largest employers, average income, and demographic factors * The tax burden and source of payments * The budgetary structure and financial condition of the issuer * Existing debt using such measures as debt per capita and overlapping debt (described later)
Analyzing General Obligation Bonds Demographics
The population comprising the issuing municipality is an important indicator of a bond’s quality. Since many general obligation bonds are dependent on property tax revenues, a growing population is a sign of economic strength, whereas a declining population may signal a deterioration in the tax base, and therefore a weak economy. (Although a city may lose population to its suburbs, it may still retain its economic strength as a place of employment.)
Analyzing General Obligation Bonds Geography
Geography (where a bond is issued) plays an important role in analyzing GO bonds. If an area of the country (e.g., the industrial northeast) is experiencing negative population trends, that is a factor that might cause concern for the agency that’s providing the rating of a bond
Analyzing General Obligation Bonds Nature of the Issuer’s Debt
Examining the fiscal responsibility of the issuer’s past attitudes towards debt will be an indicator of the issuer’s present, and possibly future, ability to engage in fiscally sound behavior. Important indicators are whether the issuer has maintained a balanced budget over the last five years and how well the issuer has maintained fund reserves.
Analyzing General Obligation Bonds debt trend
If a community uses debt to support the growth of its suburbs (by building roads and schools needed to support that growth), debt is not necessarily bad. Conversely, issuing debt to finance budget deficits or to increase spending in a weak local economy might be an indication of unwise fiscal policy.
Analyzing General Obligation Bonds schedule of debt repayment.
Another aspect in the analysis of the debt is the schedule of debt repayment. A serial bond issue (where maturities are staggered) will provide greater flexibility to meet debt requirements than a term issue (one maturity date), because serial maturities can be organized to coincide with expected revenues.
Analyzing General Obligation Bonds Future financing
Issuers that borrow now to finance school improvements or new water systems for expected increases in the future, might be better off than the municipality that waits until it’s too late to support an over-burdened infrastructure.
Analyzing General Obligation Bonds Fiscal Responsibility
The soundness of the budget process is critical because it shows how well the particular governmental entity is managing its fiscal affairs. Fiscal responsibility, such as balancing the budget, creating rainy-day funds for use in business cycle downturns when fewer tax receipts are collected, a string of budget surpluses over five years, and reducing expenditures by monitoring the conditions on which services are provided, are issues to consider when analyzing GO bonds.
Analyzing General Obligation Bonds Financial Condition
A strong financial condition depends on sound budgetary practices. How well public officials manage in times of economic and financial stress is particularly important to the credit quality of an issuer. A sound financial condition means that the governmental entity is able to meet all of its obligations to creditors, employees, taxpayers, suppliers, and others, as they come due. Measuring the financial resources that are necessary to make payments determines the financial condition.
Analyzing General Obligation Bonds Unfunded Pension Liabilities
Another factor to examine is the municipality’s pension fund. The existence of unfunded pension liabilities (the money available is less than the amount that’s required to pay projected pensions) will have a negative impact on the quality of the issuer’s debt.
Analyzing General Obligation Bonds Tax Issues
A community’s tax limitations must be examined in addition to budget considerations. Attempts to limit a municipality’s taxing power will positively influence general obligation bonds, as projected revenues will service the already-issued debt; fiscal responsibility is imposed and the creditworthiness of the issuer is enhanced.
Analyzing General Obligation Bonds Tax Red Flags
Since most general obligation issues are secured by property taxes, the tax collection record of the community is an essential component of quality analysis. A poor collection record might be a red flag indicating an inefficient local government which results in bonds with low credit ratings. Another red flag or negative trend that impacts an issuer’s credit is whether property taxes were increasing in the face of a declining population, if there was an increasing tax burden on the community in comparison to other regions, or if general obligation debt was increasing and property values remained stagnant.
Analyzing General Obligation Bonds litigation
If a community is involved in a lawsuit, any liability that a municipality is obligated to pay will place a large financial burden on the community. This litigation might negatively affect the community’s ability to pay the debt service on outstanding bonds and will be a relevant factor to consider when analyzing the issue.
Analyzing General Obligation Bonds real estate valuation
Tracking trends in real estate valuation provides a good indication of a community’s health. Analysts concentrate more on the market value of real estate rather than the assessed value. Estimating the revenues available to a general obligation bond involves the community’s full evaluation, percentage of assessed value that’s taxable, and the tax rate (millage rate).
The Debt Statement Components
* Direct Debt * Net Direct Debt: * Overlapping Debt: * Total Bonded Debt:
Direct Debt
All the debt (bonds and notes) issued by the municipality.
Net Direct Debt:
The direct debt (all issues) minus any self-supporting debt, such as revenue issues and note issues. In general, the net direct debt is only the general obligation debt (bonds supported by taxes).
Overlapping Debt:
Debt of a political entity, such as a county or school district, where its tax base overlaps the tax base of another political entity, such as a city or town within a county or school district.
Total Bonded Debt:
The sum of both the long- and short-term debt of a municipality, plus its applicable share of overlapping debt.
coterminous
When examining the debt of a city, if a city and school district lie within the same boundaries, they are considered to be coterminous and the school district’s debt must be shown as overlapping debt.
ratio of annual debt service to tax and other income
An analyst could also use the ratio of annual debt service to tax and other income to assess the quality of a GO issue. A high ratio indicates a decreasing margin of safety to repay principal and interest. If the debt service increases and tax and other income remain stagnant or decreases, there are fewer funds available to pay the debt service.
Revenue Bonds
Revenue bonds are issued for either projects or enterprise financing in which a bond issuer pledges to bondholders the revenues that are generated by the financed project.
Issuers of revenue bonds
an be authorized political entities, such as state or local governments, or an authority (such as the Port Authority of New York and New Jersey), or a commission that’s created to issue bonds and build and operate a project.
Revenue vs. GO Bonds Issuance
Revenue bonds can be issued when voter approval for general obligation bonds cannot be obtained. Revenue bonds can also be used to finance capital projects when statutory or constitutional debt limitations prevent a municipality from issuing general obligation bonds.
Types of Revenue Bonds
* Housing Revenue Bonds * Utility Revenue Bonds *Health Care Revenue Bonds * Transportation Bonds * Industrial Development Revenue Bonds (IDB) and Pollution Control Revenue (PCR) Bonds * Special Tax Bonds *Special Assessment Bonds * Moral Obligation Bonds * Education Bonds * Lease Rental Bonds * Certificates of Participation (COPs) * Taxable Municipal Bonds * Build America Bonds (BABs) * Double-Barreled * Advance Refunded Municipal Bonds * Escrowed-to-Maturity Bonds * parity Bonds
A Tax Credit Bond
A Tax Credit Bond allows the bondholder to receive a credit against their federal income tax in lieu of an interest payment
Direct Pay Bonds
Direct Pay Bonds were issued by municipalities to raise capital for all the traditional purposes except for refundings, private activity bonds, and 501(c)(3) borrowers. The Treasury will reimburse 35% of the interest paid on the bonds to the issuer, which helps to defray the costs of borrowing.
Build America Bonds (BABs) Issuer Filing
Despite the fact that Build America Bonds are taxable, they were issued by municipal governments and subject to MSRB rules. Broker-dealers that were involved in the underwriting of these bonds were required to provide official statements (MSRB Rule G-32) and all sales activities had to be supervised by a Municipal Securities Principal.
501(c)(3) Organization Revenue Bonds
Under IRS guidelines, a 501(c)(3) organization is a not-for-profit entity such as an educational, charitable, or religious entity. The beneficiary is a 501(c)(3) organization such as a not-for-profit Cornell University. It’s important to remember that the payments and credit strength of these bonds are based on the 501(c)(3) borrower , not the issuer.
Housing Revenue Bonds
These bonds are issued by state or local housing finance agencies to help fund single family or multifamily housing, typically for low or moderate income families. In some cases, the proceeds of the bond offering are loaned to real estate developers to construct property. In other situations, the money raised through the offering is used to support the mortgage markets.
Utility Revenue Bonds
These bonds are used to finance gas, water and sewer, and electric power systems that are owned by a governmental unit. The bonds are normally backed by the user fees being charged to customers. When assessing the credit risk, environmental factors and the growth rate of the area served by the utility are important.