PART 2: UNDERSTANDING MUNICIPAL FINANCE (35% OF EXAM) Flashcards
2.1
2.1 ISSUER PARTICIPANT
Broker
Any person engaged in the business of effecting securities transactions for the accounts of others
Agency Transactions
Transaction by brokers; called this because the broker is acting as an agent between a buyer and seller
How are Brokers usually paid?
commission or transactions
Dealer
any person engaged in the business of buying and selling securities for its own account (not including security-based swaps)
Principal Transactions
Transactions by Dealers
How do Dealers make money?
Make money through the difference between what they bought the security for and what they sell it for (called the spread) and on markups and markdowns on principal transactions
Person
A natural person, company, government, political subdivision or agency, or instrumentality of a government
Broker-Dealer
Perform functions of both brokers and dealers
Is a Broker-Dealer a person, company, or both?
Can be a person but usually a company
Is a commercial bank usually considered a Broker-Dealer?
No
What type of transactions (agency or principal) do Broker-Dealers perform?
Agency
Municipal Securities
Securities issued by city, state, or county governments or an entity derived from local government (e.g., school, water bureau)
Where are municipal securities usually sold?
In public, over the county market
Municipal Entity
Any agency, authority, state, or local government; any plan, program, or pool of assets sponsored or established by the state, agency, authority, or local government; any other issuer of municipal securities
Does the definition of Municipal Entity include public pension funds, LGIPs, and other state and local government entities or funds?
Yes
Does the definition of Municipal Entity include participant-directed investment programs or plans (e.g., 529s, 403b, and 457 plans)?
Yes
Obligated Person
Any person committed by contract or other arrangement to support the payment of all or part of the obligations associated with an offering of municipal securities.
Does the definition of an obligated person include an issuer of municipal securities (which could be an individual but is usually an entity)?
Yes
Bank Dealer
A municipal securities dealer that is a bank or separately identifiable department of a bank engaged in municipal securities activities with respect to municipal securities
What activities does a Bank Dealer include?
Underwriting, trading, or sales
Financial advisory or consultant services for issuers
Processing or clearance activities
Research or investment advice
Any other activities that involve communication with public investors in muni securities
Maintenance of records
Does a Bank Dealer include those that buy or sell muni securities for their own account but not as part of a regular business?
No
Does a Bank Dealer include banks that only act as agents?
No (unless they have a separately identifiable department)
Would Big Bank need to register as a municipal securities dealer based on the example below?
Big Bank 1 is a commercial bank that sells 529 plans to its customers. It operates as an agent of 529 plans but not as an underwriter. It does not engage in any other muni securities activities and does not trade for its own account.
No
Would Medium Bank need to register as a municipal securities dealer based on the example below?
Medium Bank is the primary distributor of a 529 plan. It does not engage in any other municipal securities activities. They are the underwriter of a 529 plan.
Yes, since they are an underwriter of a 529 plan
Would Lucky Sports and Games need to register as a municipal securities dealer based on the example below?
Lucky Sports and Games is a sporting goods chain that invests its extra income in municipal securities.
No, because it is trading in municipal securities for investment purposes and the retailer is not presenting itself as a municipal securities dealer
Municipal Securities Broker’s Broker
A muni securities dealer that buys and sells muni securities on behalf of other dealers; only perform agency transactions (not dealer transactions)
Would Small Bank need to register as a municipal securities dealer based on the example below?
Small Bank underwrites new issues or municipal securities.
Yes, because it is engaging in municipal securities activities and using its own funds to underwrite the new issue
Municipal Advisor
Any person that provides advice to, or on behalf of, municipal entities or an obligated person
Four activities of a Municipal Advisor
-Providing advice about muni financial products
-Providing advice about the issuance of muni securities
-Soliciting muni entities to invest in financial products
-Soliciting muni entities to issue muni securities
Includes any advice regarding the investment of proceeds from a muni issuance
Professionals involved in a Negotiated Municipal Bond Financing Transaction
-State and Local Governments (Taxpayers)
-Underwriter(s)
-Municipal Advisor(s)
-Underwriter’s Counsel
-Bond Counsel-
-Underwriting Syndicate Members
-Selling Group Members
-Other Counsel
-Feasibility Consultant
-Auditor
-Trustee
-Credit Enhancer
-Rating Agencies
-Disclosure Counsel
Who is on the financing team in an Initial Municipal Bond Offering? /
Types of Municipal Advisor Professionals
-Financial Advisors
-Pricing Consultants
-Investment Advisers
-Swap Advisors
-Pension Fund Advisors
-Financial Feasibility Consultants
-Appraisers
-Market Consultants
-Rate Consultants
-Solicitors
Municipal Advisor
A person or entity (with certain exceptions) that:
-provides advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues,
OR
-solicits a municipal entity, for compensation, on behalf of an unaffiliated municipal securities dealer, municipal advisor, or investment adviser to engage such party in connection with municipal financial products, the issuance of municipal securities, or investment advisory services.
Role of municipal advisors in Initial Bond Offering
- Acts in a fiduciary capacity for the state or local government
- Develops requests for proposals and qualifications for underwriters, bond or disclosure counsel, credit enhancement facilities, investment products
- Assists in developing the plan of finance and related transaction timetable
- Identifies and analyzes financing solutions and alternatives for funding capital improvement plan
- Advises on the method of sale, taking into account market conditions and near-term activity in the municipal market
- Assists in preparation of any rating agency strategies and presentations
- Coordinates internal/external accountants, feasibility consultants and escrow agents
- Assists with the selection of underwriters, underwriter compensation issues, syndicate structure and bond allocations
- Assists with negotiated sales, including advice regarding retail order periods and institutional marketing, analysis of comparable bonds and secondary market data
- Assists with competitive bond sales, including preparation of notice of sale and preliminary official statement, bid verification, true interest cost (TIC) calculations and reconciliations/verifications of bidding platform calculations, preparation of notice of sale, obtaining CUSIP numbers
- Prepares preliminary cash flows/preliminary refunding analysis
- Analyzes whether to use SLGS, open markets and/or agency securities for purposes of investment of bond proceeds
- Manages the escrow bids or reviewing SLGS applications for structuring advance refunding escrow
- Assists in procuring printers, verification agents, etc.
- Verifies cash flow calculations
- Plans and coordinates bond closings
- Prepares any requires post-sale reports of bond sales
- Evaluates market conditions and pricing performance of senior manager and co-managers’ distribution of bonds
Financial Advisor
(1) With respect to a new issue of municipal securities, commonly refers to an individual or firm that advises the issuer or other obligated person on matters pertinent to the issue, such as structure, timing, marketing, fairness of pricing, terms and bond ratings.
-May be employed to provide advice on subjects unrelated to a new issue of municipal securities, such as advising on cash flow and investment matters in connection with outstanding municipal securities.
(2) An investment professional who advises customers on the purchase and sale of securities
Pricing Consultants
A consultant who provides a fairness letter to an issuer or its agent, regarding the fairness of the pricing of a new issue of municipal securities
Fairness Letter
A letter or opinion prepared by a financial advisor, pricing advisor, or similarly qualified person opining on the fairness of the price paid by the underwriters to the issuer in connection with a new issue of municipal securities or paid by purchasers of assets. Also refers to similar letters delivered by an investment banker, financial advisor or similarly qualified person regarding the fairness of the price being paid by an issuer or conduit borrow for assets being purchased with bond proceeds or for the pricing terms of swap agreements or other arrangements entered into by an issuer.
Investment Advisers (GIC; investment of municipal bond proceeds)
Any person or group that makes investment recommendations or conducts securities analysis in return for a fee, whether through direct management of client assets or via written publications
Guaranteed Investment Contract (GIC)
An investment secured by a contract with a financial institution that guarantees a fixed rate of return and a fixed maturity
-Typically issued by insurance companies and marketed to institutions that qualify for favorable tax status under federal laws
-Corporations and individuals pay money in exchange for a contact that “promises” them the return of their principal at maturity plus an investment yield in line with prevailing money market rates at the inception of the contract (1)
Investment of Municipal Bond Proceeds
- Bond proceeds often deposited in various funds (construction, debt service, capitalized interest, debt service funds)
-Often these funds are invested until needed
-Investment strategies depend on fund and federal/state statutes governing the types of instruments permitted to be used for the investments, the arbitrage yield permitted for the fund, requirements for rating agencies and/or credit enhancement objectives - Investment of bond proceeds should include an evaluation of investment alternatives including: (2)
-Individual securities or portfolio of securities - generally limited to direct obligations of the US Treasury, obligations of federal agencies that are directly or indirectly guaranteed by the US, and debt obligations of other entities that are of exceedingly high credit quality and relatively short duration
-Investment agreements - contract providing the lending of the issuer funds to a financial institution, which agrees to repay the funds with interest under predetermined specifications
-Mutual or pooled investment funds, including money market funds - include commercial, for-profit mutual funds and public sector, not-for-profit pools which both attempt to leverage economies of scale in professional management, purchasing power, transaction costs, credit risk diversification, and liquidity requirements to improve upon what a smaller or less experienced investor could accomplish through purchases of individual securities - Dodd Frank Act & SEC Municipal Advisor Rule, brokers may be considered municipal advisors if they provide advice on investments of bond proceeds to governments
-Providing advice = make a recommendation to governmental clients to buy a particular security
-More information on these rules on link
Swap Advisors
An advisor to a municipal entity or borrower in connection with the entity’s or borrower’s consideration of entering into an interest rate swap transaction.
Swap Dealer
Any person acting for or on behalf of a Swap Dealer including an “associated person,” as defined in the Commodity Exchange Act.
Associated Person of a Swap Dealer
A person who is associated with a Swap Dealer as a partner, officer, employee, or agent (or any person occupying a similar status or performing similar functions), in any capacity that involves (i) the solicitation or acceptance of swaps (other than in a clerical or ministerial capacity) or (ii) the supervision of any person or persons so engaged.
What must a Swap Dealer that recommends a swap or trading strategy involving a swap to a counterparty do?
a. Undertake reasonable diligence to understand the potential risks and rewards associated with the recommended swap or trading strategy involving the swap
b. Have a reasonable basis to believe that the recommended swap or trading strategy involving a swap is suitable for the counterparty. To establish a reasonable basis for a recommendation, a Swap Dealer must have or obtain information about the counterparty, including the counterparty’s investment profile, trading objectives and ability to absorb potential losses associated with the recommended swap or trading strategy involving a swap.
What two things does a Swap Dealer “acting as an advisor” do to comply with its duty?
- Makes a reasonable effort to obtain necessary information
- Acts in good faith and makes full and fair disclosure of all material facts and conflicts of interest with respect to the recommended swap
A Swap Dealer employs reasonable care that any recommendation made to a Special Entity designed to further the Special Entity’s stated objectives.
N/A
A Swap Dealer will not “act as an advisor” to a Special Entity if what happens/doesn’t happen?
The Swap Dealer does not express an opinion as to whether the Special Entity should enter into a recommended swap or trading strategy involving a swap that is tailored to the particular needs or characteristics of the Special Entity.
-The Special Entity represents in writing that (A) the Special Entity will not rely on recommendations provided by the Swap Dealer and (B) the Special Entity will rely on advice from a qualified independent representative
-The Swap Dealer discloses to the Special Entity that it is not undertaking to act in the best interests of Special Entity
Pension Funds
A fund established by an employer to facilitate and organize the investment of employee’s retirement funds contributed by the employer and employees. A common asset pool meant to generate stable growth over the long term, and provide pensions for employees when they reach the end of their working years.
Pension Fund Advisors
Can be called ‘institutional investment consultants’ – provide investment advice to public and private companies, foundations, and endowments looking for help with managing their money, or the money in their employees’ retirement funds. These advisors use pension expertise to give advice.
Financial Feasibility Consultants
An expert that prepares a feasibility study.
Provide an opinion on the economic feasibility of a facility, enterprise, or lending program to be undertaken with the proceed of an issue
*Feasibility study is most often associated with the issuance of revenue bonds
*Feasibility study assesses the economic viability of the project and
*Analyzes the market or demand for the project
*Reviews historical revenues and expenditures for comparable facilities
*Makes forecasts or projects of financial performance
*Details of the physical operating economic and engineering aspects of the project
*Estimates construction costs, completion dates and drawdown schedules
*Estimates revenues that will be generated for the purpose of servicing the debt
Feasibility Study
A report/study detailing the economic practicability of and the need for a proposed program, service or project. Frequently analyzes the market demand for the program, project or service being considered, historical revenues and expenditures for the same or comparable facilities, and, based upon assumptions, makes forecasts or projections of financial performance or other operating statistics. This study may include a user or other rate analysis to provide an estimate of revenues that will be generated for the purpose of substantiating that debt service can be met form pledged revenues. Also may provide details of the physical, operating, economic or engineering aspects of the proposed project, including estimates of or assumptions regarding construction costs, completion dates, and drawdown schedules.
Feasibility Consultant
Writes the feasibility report prepared for revenue bond sales (such as airport and water and sewer revenue bond offerings) and included in official statements.
-Report may evaluate the economic viability, the adequacy of revenues generated by a capital project or program to pay debt. The report generally describes historic and projected demand for the services, economic trends, user base, user fees, and rates that generate revenues pledged to cover debt service.
Appraisers
Practitioner who has the knowledge and expertise necessary to estimate the value of an asset, or the likelihood of an event occurring, and the cost of such an occurrence. Ideally, an appraiser should act independently of the buying and selling parties in a transaction in order to arrive at the fair value of an asset without bias.
Market Consultants and Rate Consultants
*Provide specialized expertise in helping issuers design a plan to place a new issue of municipal securities successfully in the marketplace
*Market Consultants
*Specialize in analyzing and evaluating current business prospects and the receptiveness of the market overall to the new issue
*Rate Consultants
*Help ensure that user charges and revenue for new municipal facilities are appropriate for the location and usage of the facility will effectively service the debt
*If issuer faces a problem in repayment of the bonds such as shortfall in revenues the advisor gets involved in resolving the problem or proposing a workout
*Pricing Consultants
*Determine the appropriateness of the interest rates and other terms of the underwrites offer to buy the bonds
*A pricing consultant generally provides a fairness letter to an issuer explaining its evaluation of the pricing that will be paid by the underwriters of the ultimate purchasers of the issues
Name two Solicitors
- Third-party marketers
- Placement agent
Third-Party Marketers
N/A
Placement Agent
- (1) a municipal securities dealer acting as agent who places a new issue of municipal securities directly with investors on behalf of the issuer
- (2) an entity that may be registered as a broker-dealer, investment adviser and/or municipal advisor that solicits municipal entities to invest assets of the municipal entity with investment professionals, such as asset managers
- Private placements are sold by negotiation and involve the sale by a placement agent directly to institutional or private investors rather than through an offering to the general investing public.
Issuer Participants
-State Governments and Instrumentalities:
-State and State Treasurers
-State agencies and authorities
-State Conduit Issuers
-Municipal Entities and Instrumentalities:
-501(c)(3) Organizations; Obligated Persons (e.g., health care entities, private colleges)
-Quasi-governmental agencies (Joint powers agencies, inter-local agencies)
-Multi-state agencies
Three State Governments and Instrumentalities that are Issuer Parcipants
- State and state treasurers
- State agencies and authorities
- State Conduit Issuers
State Conduit Issuers
An issuer of municipal securities that issues securities on behalf of another entity
The gov unit acts as a conduit issuer and the third party entity is the conduit borrower.
Conduit Financing
The issuance of municipal securities by a governmental unit to finance a project to be used primarily by a third party, which may be a for-profit entity engaged in private enterprise, a 501(c)(3) organization, or another governmental entity (referred to as a conduit borrower). The conduit borrower is liable for making debt service payments on the bonds. Industrial development bonds, multi-family housing revenue bonds and qualified 501(c)(3) bonds are common types of conduit financing.
Benefits of Conduit Financing
Investors in conduit bonds generally enjoy higher yields than GO bonds, with the same tax-free interest income.
Risks: higher returns come with a higher degree of risk.
Risks of Conduit Financing
Higher returns come with a higher degree of risk. These bonds are not backed by full faith and credit of issuing agency. Investors should remember that when issuing these bonds, they are investing in the project, not the issuer.
Conduit Borrower
A borrower of bond proceeds in a conduit financing.
Conduit Revenue Bond is an obligation issued by a governmental unit but payable solely from the loan repayments received by the gov issuer under the loan agreement with the borrower
*Loan repayments are made from revenues received from the project that was built with the bond proceeds
*Conduit Bonds are frequently issues to support the following projects:
*Educational facilities
*Health facilities
*Multi fam housing projects
*Economic development bonds that fund
*Small manufacturing plants - also called Industrial Development Bonds (IDBs)
*Facilities for pollution control or abatement, solid waste disposal also called Pollution Control Revenue Bonds
*Other facilities such as airport or port facilities, water furnishing facilities , mass commuting facilities, and facilities for local furnishing of electricity or gas
*These issues are primarily used to provide below market interest rate financing for industrial development and related projects for private enterprises.
*Use is tightly regulated
*Other less frequently issued conduit bonds include
*Bonds for solid waste projects
*Non educational 501©(3) nonprofit corporation projects such as museums and research facilities and for certain energy facilities
*Many types of governmental agencies can issue conduit revenue bonds including
*State financing authorities
*Chartered cities
*Counties
*Joint power authorities
*Local housing and industrial development authorities
*The borrowers under a conduit bond issue of a municipal entity are known as obligated persons.
*They have some or all of the obligation for payment of debt service
*Ex - not for profit college would be a obligated person if they received proceeds from an offering of securities by a government agency
Municipal Entities and Instrumentalities (Issuer Participants)
A state, political subdivision of a state, or municipal corporate instrumentality of a state, including (a) any agency, authority, or instrumentality of the state, political subdivision, or municipal corporate instrumentality; (b) any plan, program, or pool of assets sponsored or established by the state, political subdivision, or municipal corporate instrumentality or any agency, authority, or instrumentality thereof; and (c) any other issuer of municipal securities.
Traditionally, tax-exempt bonds were issued by state and local governmental units for traditional government functions. However, certain private organizations may also avail themselves of the benefits of conduit tax-exempt financing through state and local government units
N/A
501(c)(3) Organizations
An organization recognized by the Internal Revenue Service as a not-for-profit organization operated for charitable or other exempt purposes and not for private interests. Subject to certain IRS rules and regulations, these organizations can borrow funds to finance projects on a tax-exempt basis through a governmental unit (referred to as a conduit issuer).
501(c)(3) Bonds
Private activity bonds issued to finance a facility owned and utilized by a 501(c)(3) organization. Not subject to the federal alternative minimum tax.
Principal advantage of municipal bond financing for 501(c)(3) organizations are:
-low interest rates
-attractiveness of the debt to lenders and investors
501(c)(3) Bond Restrictions
no more than 5% of the proceeds may be applied to private business use
Private Activity Bonds
A municipal security of which the proceeds are used by one or more private entities. A municipal security is considered a private activity bond if it meets two sets of conditions: (1) if more than 10 percent of the proceeds of the issue are used for any private business use and the payment of the principal of or interest on more than 10 percent of the proceeds of such issue is secured by or payable from property used for a private business use (2) if the amount of proceeds of the issue used to make loans to non-governmental borrowers exceeds the lesser of 5 percent of the proceeds or $5 million (the “private loan financing test”)
501(c)(3) examples
-Not-for-profit colleges and universities
-Hospitals
-Museums
-Retirement committees
Obligated Persons
Any person (including the issuer) legally committed to support payment of all or part of an issue of municipal securities, other than certain unrelated providers of credit or liquidity enhancement.
Obligated Persons - Exchange Act Section 15B(e)(10) definition
Any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund, or account of such person, committed by contract or other arrangement to support the payment of all or part of the obligations on the municipal securities to be sold in an offering of municipal securities,
When does a private entity become an obligated person?
Not until it begins the process of applying to, or negotiating with, a municipal entity to issue conduit bonds on its behalf.
Quasi-governmental agencies (Joint powers agencies, inter-local agencies)
Supported by the government but managed privately
Joint Power Agreements
Bring together existing agencies in cooperative arrangements
-Or may be used to create new separate institutions
-Might be renewed annually, or revoked by either agency if the arrangement is not beneficial
Joint Powers Agency
Partnership or collaboration between similar agencies across separate local or state governments. These are formed to manage common goals or problems that cross local and state borders. (Example: one might be formed to manage a large transit project spanning multiple urban areas or one could be formed to manage water or utility projects that supply significant portions of a state).
Joint Power Agencies are permitted to exercise any powers and authorities conferred to individual agencies and may operate within a single state or together with other state agencies.
Multi State Agencies
are often created between two or several state to regulate shared resources or utilities
Inter-local Agency
May be formed for the mutual benefit of two or more local areas
-School districts may unite to form interlocal purchasing agreements or services for greater discounts on supplies etc.
-Voter approval is generally not required for agency or authority bond issues that support public infrastructure projects
State and local gov also establish special district or special purpose districts to address specific needs of residents within that district
*These districts are organized for a common purpose and the many functions they supports include
*Airports, highways, mass transit, parking facilities, fire protection, ambulance services, lib, parks, cemeteries, irrigation, waste, environmental and conservations services.
*School districts are generally excluded from the def of special districts
*May be created by legislative actions, court action or public referendum
*Often formed to provide service delivery to properties in a specific location
*Often cross the lines of towns and villages but less frequently cross city or county lines
Non-Issuer Participants
-Bond/Issuer Counsel
-Disclosure Counsel
-Tax Counsel
-Underwriter’s Counsel
-General/Issuer’s Counsel
-Trustee’s Counsel
-Other Counsel
-Product Counsel (for structured products)
-Swap Counsel
Bond/Issuer Counsel
An attorney or law firm retained, typically by the issuer, to give the traditional bond counsel opinion. Such opinion customarily opines that the bonds have been validly issued and, if tax exemption is intended, that the bonds are tax-exempt bonds. The opinion also may address related matters, such as state or local tax exemption and the enforceability of certain security provisions. Typically, bond counsel prepares, reviews, and advises the issue regarding: authorizing resolutions, bond contracts, official statements, validation proceedings, and litigation.
What does Bond/Issuer Counsel do?
-Drafts bond resolution, indenture, loan agreement and/or other bond financing documents
-Reviews applicable law to confirm the issuer’s authority to issue bonds and its conformity with other legal requirements
-Affirms issuer’s authorization of the bond offering
-Discloses and examines litigation that may jeopardize the validity of the bond issue
-Interprets arbitrage regulations and tax law
-Attests to the validity and enforceability of the bonds
-Provides guidance in structuring issues related to tax law
-Confirms tax-exempt status
-Drafts tax certificate
Disclosure Counsel
An attorney or law firm retained by the issuer to provide advice on disclosure obligations and to prepare the official statement and/or continuing disclosure agreement.
Tax Counsel
A lawyer or law firm employed to give an opinion that the interest on tax-exempt bonds qualifies for exclusion from gross income of the bondholders thereof for federal income tax purposes.
Underwriter’s Counsel
An attorney or law firm retained to represent the interests of an underwriter in connection with the purchase of a new issue of municipal securities. The duties of underwriter’s counsel may include review of the issuer’s bond resolution and documentation on behalf of the underwriter, review of the accuracy and adequacy of disclosure in the official statement; preparation of the agreement among underwriters, purchase contract and/or official statement; assisting the underwriter in meeting the underwriter’s due diligence obligation; and delivery of a 10b-5 opinion.
Also prepares the bond purchase agreement/contract – pursuant to which the debt is sold to the underwriter.
10b-5 Opinion
A letter of counsel, sometimes referred to as a due diligence opinion, generally based upon an investigation of specified facts and addressing the accuracy and completeness of the official statement. A due diligence opinion addressed to an underwriter by underwriter’s counsel customarily states that, based on certain specified inquiries, nothing has come to such counsel’s attention indicating that the official statement contains any misstatements of material facts or any material omissions. An opinion by counsel to an issuer or conduit borrower may use similar or different language to address the adequacy and accuracy of the disclosure made.
Four roles of underwriter’s counsel in initial bond offering
- Drafts bond purchase agreement, blue sky memorandum, and agreement among underwriters
- Advises underwriters regarding their legal positions with respect to the issue
- Advises underwriters on state and federal securities laws
- Assists underwriters in undertaking due diligence review and provides legal opinion that, based on such review, official statement does not contain misleading information or omit material information
Trustee’s Counsel
-Acts in a fiduciary role for the benefit of bondholders in enforcing the terms of the trust indenture
-Transmits principal and interest payments from an issuer of municipal securities to the bondholders
-Holds and invests moneys held in a construction fund, reserve fund or other funds that serve as security for payment of debt service on the bonds
-Maintains records on behalf of the issuer that identify the registered owners of the bonds and related matters
-Represents the interests of bondholders in the event of a default
General/Issuer’s Counsel
Handle issuer’s normal legal work, including litigation, contracts, and labor matters. These individuals are sometimes full-time municipal employees and sometimes they are attorneys in private practice with the municipality being just one of their clients. Typically, they do not have any expertise in the law of debt issuance.
Product Counsel (for structured products)
Structured products are typically comprised of: a fixed income note and derivative product
A structured product is typically built around a fixed income instrument and a derivative product. The note pays a specified rate of interest to the investor at defined intervals. The derivative component establishes the amount of payment at maturity.
Other Counsel
Other counsel in the bond issuance process may include special tax counsel, bank counsel, and borrower’s counsel. Such special counsel may be necessary for specific issues that are more complex or have particular characteristics calling for such participation.
Swap Counsel
Consists of Swap Advisor and Insurer
Non-Issuer Participants: Market Intermediaries
-Broker-Dealers and Dealer Banks
-Underwriters
-Traders
-Placement Agents
-Market Makers
-Leaser Marketers
-Solicitors for Investments
Broker-Dealers
A general term for a securities firm that is engaged in both buying and selling securities for customers and/for its own account
Dealer Banks
A commercial bank authorized to buy and sell government debt securities including federal and municipal bonds. This debt is usually issued to fund large government projects such as road and bridge construction. These banks are registered with the MSRB
Traders
Dealers often have traders responsible for knowing all about a group of bonds and quoting a price to buy or sell them, or “making a market” for bonds.
Underwriters
A municipal securities dealer that purchases a new issue of municipal securities from the issuer for resale in a primary offering. The underwriter may acquire the securities either by negotiation with the issuer or by award on the basis of competitive bidding.
What is the role of underwriters in Initial Bond Offering?
- Has an “arm’s-length” relationship with the municipal government
- Provides proceeds at closing and obtains funds from investors
- Manages the affairs of any underwriting syndicate formed in connection with a new issue
- In a negotiated offering: works with state/local government and municipal advisor to design the plan of finance, develops the bond structure, assists in determining timing to sell bonds based on market conditions, assists in preparing any rating agency strategy and presentation, “runs numbers” providing quantitative analysis of financing structure, manages the pricing process, executes pre-sale marketing, solicits price views from syndicate members, which provides preliminary pricing indicators among underwriters and customers about the offering range of a new issue, prepares distribution analysis, works with the state or local government to determine how orders are filled from the bond pricing order period, and executes the bond purchase agreement with the municipal government on behalf of the syndicate
Placement Agents
(1) a municipal securities dealer acting as agent who places a new issue of municipal securities directly with investors on behalf of the issuer
(2) an entity that may be registered as a broker-dealer, investment adviser and/or municipal advisor that solicits municipal entities to invest assets of the municipal entity with investment professionals, such as asset managers
Differ from underwriters in that they do not actually purchase bonds from the issuer, rather they arrange the bond sale to a third party for a fee
Solicitors for Investments
A third-party solicitor that seeks business on behalf of an investment adviser from a municipal pension fund or a local government investment pool must register as a municipal advisor.
Market Makers
Broker-dealers, bond dealers in over-the-counter markets that tend to be large investment banks (though hedge funds and high-frequency traders are also broker-dealers), serve as market makers
-Market maker – an entity that is willing to quote a price to buy or sell a security at any time – even if the market maker does not have another buyer lined up
-They make money on the difference between the bid and ask prices they display (bid-ask spread)
These individual play an important role in bond markets, since they provide liquidity (the ability to buy or sell a security quickly without having to take a penalty in terms of price).
-Without a market where investors can sell their bonds before their maturity date, investors would be hesitant to tie up large amounts of money in bonds for an extended period of time. This would reduce the overall amount of money available to borrow in the bond market, which in turn would make borrowing more expensive.
Market makers in stocks never leave the ‘playing field’, but since bonds do not trade on exchanges with set rules, market makers can leave the market at any time, which can cause liquidity to disappear. This happened during the financial crisis, when markets for mortgage-backed securities-bonds backed by mortgages across the country- dried up very quickly.
Lease Marketers
Marketing bonds (3)
1. Major advantage of negotiated sale: time can be devoted to presale marketing
2. Salespeople can concentrate more on a negotiated issue in which their firm is a senior or co-manager than on a competitive sale because they are certain that there will be an underwriting and that there will be bonds to sell. The salespeople thus work with public finance bankers in the early stages of a deal to develop a marketing plan for the bonds. Investors are sent a preliminary official statement.
Credit Enhancers/Liquidity Providers
-Bond Insurer
-Credit Enhancers
-Letter of Credit Banks
-Standby purchasers for variable rate obligations
-Guarantors
-Rating Agencies
Bond Insurer
An insurance company or consortium of insurance companies that issues bond insurance policies to guarantee the payment of principal of and/or interest on bonds
Bond Insurance
A guarantee by a bond issuer of the payment of the principal of and interest on municipal bonds as they become due should the issuer or obligated person fail to make required payments. Bond insurance typically is acquired in conjunction with a new issue of municipal securities, although insurance also is available for outstanding bonds trading in the secondary market. In the case of insurance obtained at the time of issuance, the issuer of the policy typically is provided extensive rights under the bond contract to control remedies in the event of a default
Typically payments will be made as originally scheduled, and the principal will not be accelerated and insurance typically covers the full maturity range of the bonds (3)
Role of municipal bond insurance in the market is threefold
(1) to reduce interest costs to issuers
(2) to provide a high level of security to investors
(3) to furnish improved secondary-market liquidity and price support
Credit Enhancers
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
Issuer may choose to obtain if they have a lower rating from a credit rating agency
Enhancement in the form of: Letter of Credit, issued by a bank, Bond Insurance Policy issued by a specialty insurance company
Letter of Credit Banks
i. A irrevocable commitment, usually made by a commercial bank, to honor demands for payment of a debt upon compliance with conditions and/or the occurrence of certain events specified under the terms of the letter of credit and any associated reimbursement agreement. A letter of credit is frequently used to provide credit and liquidity support for variable rate demand obligations and other types of securities. Bank letters of credit are sometimes used as additional sources of security for issues of municipal notes, commercial paper or bonds, with the bank issuing the letter of credit committing to pay principal of and interest on the securities in the event that the issuer is unable to do so.
ii. Typically written for a much shorter period of time than bond insurance. Issues with bank letters of credit will receive the bank’s rating.
iii. “LOC’s used to increase market access for an issuer that may have difficulty in selling its bonds due to a perceived weakness in its ability to meet its obligations. LOC generally issued by a commercial bank and represents a contract between the issuing bank and the bond trustee. Under the letter, the bank irrevocably agrees to pay to the trustee on demand monies in an amount necessary to cover all payments due on the bonds. As with all contracts, the specific terms are negotiated and can vary with each bond sale. Within the context of the municipal market, however, terms and conditions tend to be standardized, especially as far as the investor is concerned.” (3)
iv. “LOC’s are used for two purposes: to enhance credit and to enhance liquidity. To enhance credit, the bank issuing the LOC irrevocably pledges to provide funds to meet debt service payments in the event that the pledges to provide funds to meet debt service payments in the event that the bond issuer cannot do so. The terms of the LOC empower the bond trustee to draw on the letter of credit directly if the bond issuer fails to make deposits sufficient to provide for timely payment of interest or principal or both. Thus, the letter of credit is used to protect investors from a default.” (3)
v. To increase liquidity: “The bank issuing the letter of credit agrees to advance any funds necessary to purchase bonds tendered by investors. The bank, in effect, provides for extraordinary demands for cash if a substantial number of bonds are tendered.” (3)
Standby purchasers for variable rate obligations
i. Variable Rate Demand Obligations (VRDO): long-term, tax-exempt bonds whose interest rates generally reset on a daily, weekly, or monthly basis. Typically issued with long-dated maturities and are purchased by investors at par in $100,000 increments. If investors want to redeem their Variable Rate Obligation, they put the bond back to an investment dealer at par plus any accrued interest.
ii. The credibility of the put feature rests on the fact that virtually all Variable Rate Obligations are structured to include a contractual source of liquidity support, which comes in the form of either a letter of credit or a standby bond purchase agreement usually provided by a large multinational financial institution.
iii. Under the standby bond purchase agreement, the bond is insured by an investment grade insurance provider. If the bond cannot be remarketed, the SBPA provider is obligated to buy the bonds as long as the insurer maintains its investment grade rating. The result is that the issuer takes on the credit rating of the insurer, who guarantees to pay principal and interest if the issuer defaults
1. Liquidity risk - standby bond purchase agreements can be terminated by the issuing bank if the credit ratings of the monoline insurer (insurance company that provides guarantees to issuers, often in the form of credit wraps, that enhance the credit of the issuer.)
2. The standard language generally states that the liquidity provider (the bank issuing the standby purchase agreement) is no longer obligated to provide liquidity if any of the following occurs:
a. Insurer declares insolvency or inability to pay its debt
b. Insurer is downgraded below investment grade or the rating is suspended by all three credit agencies
c. Insurer defaults on principal or interest payments covered under the insurance policy
d. Bond is declared taxable by the IRS
e. Insurance policy is ruled invalid by a court or government authority
3. Credit risk – also associated with standby purchase agreements
Rating Agencies
Assess the credit quality of the bonds, assigns a rating to the bond issue, and updates ratings periodically while debt is outstanding
Guarantors
Financial guarantors are monoline insurance companies that issue insurance policies designed to provide credit enhancements to debt instruments. Specifically, they unconditionally and irrevocably pledge to make timely payment of principal and interest when due in the event of defaults by insured obligors.
Moody’s Rating Agency (rating municipal bonds since 1909)
- nine basic rating categories for long-term obligation; applies numerical modifiers 1,2,3 on Aa to Caa (BBG)
- Aaa – best quality, smallest investment risk (high grade bond)
- Aa – high quality, margins of protection not as large (high grade bond)
- A – security of principal and interest adequate, but elements suggest susceptibility (upper medium grade)
- Baa – lack outstanding investment characteristics; neither highly protected nor poorly secured (medium grade obligations)
- ABOVE THIS, INVESTMENT GRADE
- Ba – speculative elements, uncertainty of position
- B – generally lack characteristics of desirable investment (small assurance of payments being made)
- Caa – poor standing, may be in default
- Ca – speculative to a high degree, often in default or shortcomings
- C – lowest rated, poor prospects of ever attaining investment standing
3 Major Rating Agencies
-Moody’s
-Standard & Poor’s
-Fitch
Who pays the fee for the rating service?
The Issuer
What is the rating service fee based on?
-Issue size
-Issue type
-Issue complexity
Absence of Rating
Many non-rated municipal bonds are from smaller, higher quality issues, there are many other non-rated bonds that represent riskier investments offering higher returns to commensurate with their risk. Non-rated municipal bonds can be an excellent way for investors to earn higher tax-exempt income, if the risk/return profile is appropriate.
Standard & Poor’s Rating Agency (rating municipal bonds since 1940)
- or – ratings from AA to CCC may be modigied to show relative standing within rating categories
- AAA – highest rating, ability to meet financial commitments is extremely strong
- AA – ability to meet financial obligations is very strong
- A – more susceptible to changes; ability to meet financial obligations still strong
- BBB – adequate protection parameters, adverse economic conditions could be problematic
- ABOVE THIS LINE, INVESTMENT GRADE
- BB – more speculative
- B – more vulnerable to nonpayment
- CCC – currently vulnerable to nonpayment
- CC – currently highly vulnerable to nonpayment
- C – bankruptcy has been filed, still paying on obligation
- D – default
Fitch’s Rating Agency (rating bonds since 1913)
- or – modifiers to AA to CCC
- AAA – lowest expectation of credit risk
- AA – very high credit quality, low expectation of credit risk
- A – high credit quality, low expectation of credit risk (more vulnerable to changes)
- BBB – good credit quality, currently low expectation of credit risk
- ABOVE THIS LINE, INVESTMENT GRADE
- BB – speculative, possibility of credit risk
- B – highly speculative, significant credit risk is present, limited safety margin
- CCC, CC, C – high default risk
- DDD, DD, D – default
Underlying Ratings
In the case of a security for which credit enhancement has been obtained, the rating assigned by a rating agency to such security, on a stand-alone basis, without regard to credit enhancement.
Involves same analytical review as regular issue rating, these ratings offer financial flexibility and potential cost savings for public sector entities such as municipalities and state governments.
Are revenue bonds or general obligation bonds more likely to be non-rated?
Revenue bonds are non-rated more than GO bonds.
Revenue bonds are backed by the income stream of the project the bonds finance, rather than the full faith and taxing power of the municipality.
2 main reasons for issuing without credit rating
- Some issues are of higher quality but the rating is foregone because the size or placement of the issue makes it uneconomical to pay for the rating
- Many non-rated bonds would not meet the rating criteria of the rating agencies, or if rated, would fall below investment grade (below BBB)
Why are most non-rated bonds that are smaller in size and/or possess non-investment grade characteristics generally less liquidity for these bonds than for rated bond issues.
Investors in these bonds often buy and hold, and do not try to sell the bonds before maturity, thus minimizing the market activity in these bonds
Higher quality non-rated bonds are often priced to yield returns that are comparable to rated bonds. However, for riskier non-rated bonds, the reward for accepting the credit and liquidity risk is usually a higher yield.
N/A
Swap Advisors
An individual or entity that provides advisory services with experience in the area of derivative transactions for issuers of debt. A Swap Advisor’s fiduciary duty in a transaction must strictly be only to the Governmental Entity.
What is the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Index?
It is a 7-day high-grade market index comprised of tax-exempt Variable Rate Demand Obligations (VRDOs) with certain characteristics.
Who are the players in a municipal SWAP/initial bond issue?
-Issuer Participants
-Non-Issuer Participants (legal and market intermediaries)
-Investors
-Trustees, paying agents, and registrars
-Verification Agents
-Other Service Providers (e.g., Depository Trust & Clearing Corp, CUSIP Service Bureau)
Who are the issuer participants in a municipal SWAP/initial bond offering?
Issuer Participants
-501(c)(3) organizations
-Obligated persons (e.g., health care entities, private colleges)
Who are the non-issuer participants - legal in a Municipal SWAP/initial bond offering?
Bond Counsel
Who are the non-issuer participants - market intermediaries in a Municipal SWAP/initial bond offering
Underwriters
Three classes of investors that dominate the municipal marketplace
- households - consist of individuals acting directly or through investment counsels
- household proxies - i.e., bond funds such as managed closed-ended funds, open-ended mutual funds, money market funds, bank personal trusts, and unit investment trusts
- institutions - particularly commercial banks and property & casualty insurance companies
What is the principal characteristic of all buyers of municipal bonds?
They are in a sufficiently high tax bracket that they can benefit from the tax exemption
What type of investors are in a Municipal SWAP/initial bond offering?
-Retail Investors
-Direct Institutional Investors
-Mutual Funds and ETFs
-Public Entities
Who are the largest holders of municipal securities, owning approximately 40 percent of outstanding bonds directly?
Retail Investors
Retail Investor
an individual investor who buys and sells securities for their personal account, and not for another company or organization
What are the four major factors that define the fluctuating activity of Retail Investors in the market?
- The absolute level or interest rates
- The relationship of municipal yields to those of taxable securities
- Competing returns in the equities markets
- Income tax rates
When do individuals usually purchase the greatest volume of municipal securities?
When municipal rates are near their highest levels.
Retail investors are generally the last investor category in the business cycle to buy bonds
Who are Direct Institutional Investors?
Entities that pool together funds on behalf of others, and invest those funds in a variety of different financial instruments and asset classes.
Three types of Direct Institutional Investors
- Banks
- Insurance Companies
- Corporations
Direct Institutional Investors are generally considered to be more proficient at investing due to the assumed professional nature of operations and greater access to companies and managements because of size.
Four advantages of Direct Institutional Investors
- Lower risk than faced by non-institutional investors owing to a broad and diversified investment portfolio
- Active involvement and influence in corporate governance
- Ability to influence a company’s solvency (capability to meet financial obligations)
- Influencing the conduct and capital requirements of listed companies
Historically, what factors have influenced the interest of banks in purchasing municipal bonds?
-level of loan demand
-overall bank profitability
-attractiveness of municipal bonds vs. alternative investments
-level of interest expense deductions
What term length of bonds do banks prefer?
Short and medium term because they are better matches for the maturities of the banks’ liabilities
Insurance Companies as investors
- Include property and casualty insurers and life insurance companies; take in premiums to protect policy holders from various types of risk. These premiums are then invested by the insurance companies to provide a source of future claims and a profit.
- “Investment objectives and high tax rates have encouraged companies in the property and casualty insurance industry to invest in municipal bonds. Considerable volatility in the investment activity of insurance companies is due to the cyclical nature of profits within the industry. The level of purchases depends mostly on their taxable profits. As profitability levels rise, insurers accelerate their purchases of tax-exempt securities.
- The Tax Reform Act of 1986 altered the investment implications of tax-exempt bonds for property and casualty companies with the imposition of an alternative minimum income tax as well as changes in the calculation of loss reserves. However, changes in the way in which insurers’ income is calculated may tend to increase their taxable income, thereby generating greater demand for municipal bonds in some cases.
- Casualty insurers have typically favored long-term maturities for their municipal bond portfolios. They have been interested principally in producing the highest yield possible, given adequate credit quality, and long-term municipal bonds produce the highest returns. Many casualty insurers prefer revenue bonds to GO securities to produce higher returns on their investments. However, portfolio managers are always looking for opportunities along the yield curve and among sectors to maximize their performance
Why do corporations invest in municipal bonds?
Successful companies that are tax aware will attempt to minimize their liability, and will often invest in municipal bonds as the interest income on municipal bonds is exempt from federal (and potentially state) income taxes
Why should corporate operating portfolios consider tax-exempt bonds?
- credit - high quality municipal bonds typically have lower default rates
- tax-efficient - attractive after tax yields
- total return- enhanced after-tax total return
Mutual Funds and ETFs as Investors
i. Benefits:
ii. Bond funds give the portfolio the opportunity to earn income, unlike money market funds (which focus on protecting your cash) and stock funds (which aim for long-term growth)
iii. Bond funds add stability to the portfolio by balancing out risks associated with stock funds
iv. Bond funds spread out the portfolio’s exposure to risk through diversification
v. Mutual funds have professional managers and municipal analysts that perform the essential credit research and security selection processes that would be time-consuming and impractical for most individuals to do on their own
vi. Mutual funds provide liquidity by allowing investors to easily sell all or a portion of their shares at the day’s closing market price, often without the transaction costs associated with individual bonds.
vii. Drawbacks:
viii. Do not have fixed coupons or maturity dates like individual bonds
ix. Less certainty about future income
x. Possibility of taxable capital gain distributions
What is a Government-Sponsored Enterprise (GSE)?
-A financial services corporation created by the United States Congress; privately held corporations with public purposes created by the US Congress to reduce the cost of capital for certain borrowing sectors of the economy.
Trustee
A financial institution with trust powers, designated by the issuer or borrower, that acts, pursuant to a bond contract, in a fiduciary capacity for the benefit of the bondholders in enforcing the terms of the bond contract. In many cases, the trustee also acts as custodian, paying agent, registrar and/or transfer agent for the bonds
What is a Trustee responsible for?
Carrying out the administrative functions that are required under the bond documents.
Trustee Functions
Include:
-establishing the accounts and holding the funds relating to the debt issue
-authenticating the bonds
-maintaining a list of holders of the bonds
-paying principal and interest on the debt
-representing the interests of the bondholders in the event of default
What 7 things should an issuer expect a Trustee to do?
- Ensure that the compliance requirements and covenant restrictions are met
- Invoice debt service and collect revenues or payments for payment to the bondholders
- Ensure that the security interests in assets and property granted to bondholders for their benefit are preserved
- Ensure that bond proceeds are invested per the terms and conditions of the Indenture or Trust Agreement
- Ensure that the required calculations and other operationally oriented tasks required in the administration of the issue are done timely and correctly
- Administer project/construction funds including the documentation requirements relating to the disbursement of funds for project costs
- Ensure the proper operation of the funds and accounts established in the financing documents and that the “waterfall” of revenue or payments through those funds and accounts occurs as envisioned
What is a Paying Agent?
The entity responsible for transmitting payments of interest and principal from an issuer of municipal securities to the bondholders. Usually a corporate trust department of a bank or trust company, but may be the treasurer or some other officer of the issuer or another governmental entity. Also, may provide other services for the issuer such as reconciliation of the securities and interest paid, destruction of paid securities, and similar services.
What is a Registrar?
The person or entity responsible for maintaining records on behalf of the issuer that identify the owners of a registered bond issue. The trustee can also act as a registrar.
What does a Verification Agent do?
Verifies cash flow sufficiency to the call date of the escrow securities to pay principal and interest on refunded bonds.
What does an Escrow Agent do?
Serves as custodian of funds and holds securities to pay debt service on refunded bonds. They verify that the proceeds of the escrow accounts combined with the future interest on those accounts will match the funds needed to pay off previous bonds and their interest.
What is the Depository Trust and Clearing Corporation (DTCC)?
A registered clearing agency and holding company that through its subsidiaries provides book entry, clearance, and settlement for various types of securities, including municipal securities.
Depository
A registered clearing agency that provides immobilization, safekeeping and book-entry and settlement services to its participants.
Depository Trust Company
A depository that is a subsidiary of DTCC.
What does CUSIP stand for?
Committee on Uniform Securities Identification Procedures
CUSIP Number
An identification number assigned by the CUSIP Service Bureau to each maturity of an issue intended to facilitate the identification and clearance of securities. In some cases, separate CUSIP numbers may be assigned to different portions of a maturity that bear different interest rates or where differences exist in terms of the securities of such maturity that may impair the fungibility (interchangeability of financial instruments having effectively identical features) of the securities within the maturity.
Municipal Issuers are unique because of the tax exempt status of the debt they issue
Main type of municipal issuers are
*States, counties, cities, and school districts.
*Agencies, authorities, and other special districts
State Government
*Each state in the U.S establishes a budget and collects revenues from income and sales taxes
*The treasurer of the state is the watchdog for these funds
*State Treasurers responsibilities
*Manage the cash flows of all state accounts
*Invest the states cash in short term, interest bearing accounts for liquidity
*Issuing and managing the states debt
*Issuing and managing certificates of participation for the funding of projects for state agencies, local gov, and schools
*Administering state financial programs such as sate 529 savings programs for college programs and pension plans
*Most state Govs. Maintain two budgets
*Operating budget - to fund current expenses
*EE salaries, payment for services, and int payments on debt
*Capital budget - to finance infrastructure investments
Short Term Notes such as revenue anticipation notes or tax anticipations notes are often issues to finance current spending and the paid off with upcoming revenue collections
*They are backed by upcoming revenue collections or upcoming tax collections.
*Short term debt is rarely carried over into the next fiscal year
*States objective in issue debt is to lock in the lowest possible cost with the least risk
Within state government are agencies and authorities that are established by legislation or executive order
*May be funded by the state gov or authorized to issue bonds to finance the services and public projects they oversee
Local Issuing Authorities
*Local agencies and governments do not have the authority to issue general obligation bonds that are backed by the full taxing authority of the state.
GFOA
oProvides recommendations for issuers in hiring a municipal advisor
oRecommended a financial advisor be retained prior to the undertaking of a debt financing unless the issuer has sufficient expertise and access to the bond market
oIssuers should carefully assess the selected municipal advisor to ensure expertise in the following
*Determining the best type of financing for the government
*Selecting other finance professionals
*Planning the bond sale
*Successfully selling and closing the bonds
oIssuers should choose municipal advisor on the basis of merit through a competitive process using a request for proposal (RFP) or a request for qualifications (RFQ) process
RFP (Request for Proposal) content
oAllows the issuer to compare the qualifications of the responders and select the most qualified firm based on scope of service and evaluation criteria.
oShould include the following components
*Clear and concise description of the scope of work, length of the contract and indicate whether joint proposals with other firms are acceptable
*Clarity on whether the issuer can select more than one municipal advisoror may choose to form a advisory team
*A requirement that all fee structures be presented in a standard format
-Also should request a description of any conditions that may impact the fee proposal and explicitly request clarification of which costs are included in the fee proposal and which costs are to be reimbursed
*A requirement that the proposer provide at least here references from other public sector clients for which similar services were performed
*Description for the RFP review process and an explanation of how proposal will be evaluated
The 3 principal types of advisors that must be registered with the SEC and MSRB
-Financial Advisors
-Investment Advisors
-Third Party Marketers and Solicitors
Financial Advisors
provide advice to municipal entities regarding the issuance of municipal securities and the use of municipal financial products, and may include broker dealers and municipal securities dealers already registered with the SEC
Financial Advisors
-Typically retained by issuers to advise and assist in formulating and or executing a debt financing plan to accomplish the issuers public purpose.
*May be a consulting firm, an investment banking firm or a commercial bank
-Independent Financial Advisors
*Means they typically do not engage in the underwriting or trading of municipal securities
Investment Advisors
provide advice to municipal entities on the investment of public monies, including the proceeds from the municipal securities issuances.
Investment Advisors
*Issuers frequently retain a municipal advisor to assist them in investing bond proceeds, municipal escrow funds, and other funds of the municipality that were raised from prior bond issues.
*These advisors also assist in the investment managements of public monies including general and special funds of state and local gov public pension plans and other funds dedicated to public programs such as public transportation, police and fire protections, public health and education
*In acting as investment advisors these professionals provide issuers with
*Cash management and bank consulting services
*Investment policy advice and performance monitoring
*Analysis of recent credit events & headlines affecting the market
*Advice concerning guaranteed investment contracts (GICs)
*Guaranteed investment accounts, or GICs, are offered by insurance companies and other financial institutions. They pay a fixed rate that is slightly higher than money market funds and have a fixed maturity. They are considered safe investments and are a suitable investment option for the investment of municipal proceeds, including escrow accounts.
*Portfolio management and recommendations
*Derivative strategies for maximizing returns
*Municipal advisors that develop expertise in derivatives are known as swap advisors
*Swaps and derivatives are used by issuers to provide protective hedging and additional income for municipal portfolios
*Swap advisors provide a review and analysis of swap alternatives and swap market conditions, provide about rates and structure and provide derivative contracts.
Third Party Marketers and Solicitors
market and represent the value of advisory services to issuers and seek business on behalf of a broker dealer municipal securities dealer, municipal advisor or investment advisor
Third Party Marketers and Solicitors
*Include parties or entities that act on behalf of firms to increase their business or sales activity
*Solicitors are compensated to communicate with municipal entities or obligated persons in the establishment of engagements in which MA’s provide guidance regarding
*Municipal finance products
*Issuance of municipal securities
*Investment advisory services to or on behalf of a municipal entity
*Solicitors must register as MA’s under the Dodd Frank Act
*But limited exemptions are available for solicitations regarding underwriting activities on behalf of registered broker dealers or for investment advisory services as provided by investments advisors registered under the investment company act of 1940
*Solicitor advisors do not have a fiduciary duty as their clients are MA’s rather than entities or obligated persons
*Included in this category of MA’s
*Are placement agents - which act on behalf of issuers in private placements of municipal securities
*These issues are generally place with institutional investors.
*Do not take financial risk for the bonds or purchase them for their inventory
KNOPMAN NOTE - Financial advisors provide advice regarding the issuance process while investment advisors provide advice on the investment of funds
2.4 DUTIES OF NON-SOLICTOR MUNICIPAL ADVISORS
*Rule G-42 describes certain standards of conduct that apply to municipal advisors
-Critical to this rule area an advisors duty of care and loyalty
*When dealing with an obligated person, all municipal advisory activities are subject to a duty of care
-Duty requires that MA’s possess the knowledge and expertise needed to provide the client with informed advice
*When dealing with municipal entity clients all MA activities are subject to a duty of loyalty and care .
-Duty of loyalty adds to the standard of care of acting in the clients best interest without regard to the interest of the advisor financial or otherwise.
*G-42 differentiates between advice and recommendations
-Recommendation is a call to actions that involves a specified municipal financial product or the issuing the a security and must meet the MSRBs suitability standard.
*Underwriters are not subject to the fiduciary standard that applies to MA’s.
-However they are still required by other securities laws to act fairly in dealing with all market participants
*Not all municipal advice includes a recommendation
*When making recommendations the determination of whether a product or service is suitable must be based on numerous factors
-Clients financial situation, objections tax status risk tolerance and liquidity needs
-Clients experience with municipal securities transactions
-Financial capacity to withstand changes in the market
*The facts that the MSRB considers essential to knowing a client include those required to
-Effectively service the municipal advisory relationship with the client
-Act in accordance with any special direction from client
-Understand the authority of each person acting behalf of the client
*In making suitable recommendations the municipal advisor must inform the client of
-Potential risks and benefits as evaluated by the advisor
-The basis upon which the MA reasonably believes the recommended municipal securities transaction or financial project is or is not suitable for the client
-Whether the MA has been investigated or considered reasonably feasible alternatives to the recommended municipal securities that could meet client objectives
*A MA must evidence each of its MA relationships with a dated written document that must be created delivered to the entity or obligated person prior to upon or promptly after the establishment of the MA relationship
-Document must include
*The form and basis of any direct or indirect compensation
*Information about any criminal actions, investigations, terminations, liens, civil actions, complaints etc.
-Advisory firm must also provide detailed information specifying where the client may electronically access the MA most recent form MA and Form MA-1
*Scope of the MA activities to be performed and any limitations on the scope of the engagement
*Date, triggering event or means from the termination of the MA relationship or if none a statement that says that
*Any terms relating to withdrawal from the MA relationship
-Customer signature is not required on this document, a signed contract is not required to proceed.
Disclosure of Conflicts of interest
*Written full and fair disclosure must be made of all material conflicts of interest to obligated persons or municipal entities.
*These include
-Any affiliates of the MA firm currently offering advice or services to or on behalf of the client
-Any payments made by the MA, directly or indirectly to obtain or retain an engagement to perform MA activities for the client.
-Any payments received by the MA from a third party to enlist the MA recommendation to the client of the third parties service
-Any fee splitting arrangements involving the MA and a provider of investments or services to the client
-Any conflicts of interests arising from compensation for MA activities to be performed contingent on the size or closing of any transaction
*If no conflicts of interest exist the MA must provide a written statement to the client that states that
*Also at this time the advisor must disclose any legal or disciplinary event
-If a conflicts of interest cannot be mitigated or resolved a MA cannot provide advisory services
*MA firms can engage in principal transactions with clients if they are also registered broker dealer or municipal dealers transacting business in brokerage accounts and are acting in the best interest of the client
-Any sale or purchase of municipal securities in a principal transaction cannot be related to securities on which the client has provided or is providing advice or that were underwritten by the firm
*Does not apply when dealing with an obligated person
-Prior to or not later than the completion of the transaction the MA must disclose its capacity and obtain the consent of the municipal entity client
-Written confirmation must include a plain English statement
-The MA disclosed to the client prior to the execution of the transaction that the MA may be acting in a principal capacity in the transaction
-The municipal entity client authorized the transaction
-The MA sold the security to or bought the security from the municipal entity client for its own account.
2.5 LEGAL PROFESSIONALS
Bond Counsel
*Is an attorney or law firm that is retained by the issuer to give legal advice and assist In document prep for the new issue
*Bond counsels responsibilities include
*Draft the bond resolution, indenture, loan agreement, and or other bond financing documents
*Reviewing applicable laws to confirm the issuers authority to issue the bonds
*Disclosing any litigation or other roadblocks that may jeopardize the validity of the issue
*And confirm the tax exempt status of the issue
*Prepares a legal opinion to communicate this information
*A copy of the legal opinion must accompany delivery of all municipal bonds and is classified as one of two types
-Approving or unqualified opinion - the bond counsel has no reservations about the issuers authority to borrow, the nature of the bond, or the tax exemption
-Qualified Opinion - the bond counsel has determined that there are some outstanding questions related to the issuer.
*An unqualified legal opinion is preferred for marketability of the new issue because it indicates that there are no potential concerns and that the issue is eligible for tax favored interest treatment
-Preferred as it indicates the issuance has no legal hurdles
*Other Legal Professionals
-In addition to the firm that serves as bond counsel one or more bond lawyers will serve on the finance team. They are usually from other firms
-Disclosure Counsel
-Borrowers Counsel
-Product Counsel
-Tax Counsel
-Underwriters Counsel
-General Issuers Counsel
-Trustees Counsel
Disclosure Counsel
The attorney or law firm retained by the issuer to provide advice on issuer disclosure obligations and documents
-The counsel may prepare the draft official state, the bond purchase contract for negotiated underwritings, the official notice of sale for competitive sales, the continuing disclosure agreement and any blue sky memoranda
*Disclosure counsel may render a 10b-5 opinion to the underwriters which attests
*To the official statements truthfulness and verifies the statement is not deceptive and includes all material information
*In doing this work the counsel represents the issuer not the underwriter
*The disclosure counsel is paid by the issuer from the proceeds of the issuance.
Borrowers Counsel
-Refers to firms with expertise In conduit financing techniques or private activity bonds.
*Represent 501 c 3 nonprofit entities, private colleges, housing and healthcare facilities and advise them on securing tax exempt financing through governmental issuers
*Represent clients in securing property tax abatement, sales and use tax exemption, tax credits and other economic incentives and benefits available through governmental issuers
*Borrowers counsel regularly works with bond counsel and underwriter on behalf of borrowers as part of the financing team
Product Counsel
-Another form of specailized counsel in the public finance market
*Innovative concept that involves repackaging municipal bonds into tax exempt instruments with characteristics different from the bonds as originally stated
*Need unique expertise in securities laws and related tax laws
*Municipalities also use swaps and other hedging instruments for risk management and rely on counsel to provide expertise in securities and tax laws
*Product counsel can represent issuers, underwriters, swap counterparties, and providers of saps and other hedging instruments
Tax Counsel
-Is retained by the issuers, underwriters, financial advisor, and investors to address the increasing complexity for tax regulations in municipal finance
*Counsel focuses on questions relating to the eligibility of projects for tax exempt financing, private business use analysis, arbitrage issues, assisting nonprofit organizations, cities, and states with tax credits that may be available
Underwriters Counsel
-Retained by underwriters to represent their interests in negotiated offerings
*Normally no underwriters counsel is retained in a competitive sale
*Negotiates terms on underwriters behalf
*Assist underwriters in drafting bond purchase agreements, blue sky memoranda and agreements amount underwriters
*Advise underwriters regarding their legal positions
*Retained to provide or review legal opinion regarding tax exempt status
*Review the OS
General Issuers Counsel
*Employed by the municipality
*Handles there normal legal work
*Litigations, contracts, labor matters etc
*May be full time employees of the municipality or may be attorneys in private practice with the municipality as one of their clients
*Role overall is to help get the deal done in a way that supports their clients best interests
Trustees Counsel
*Acts on behalf of the trustee which protects the interest of the bondholder in enforcing the terms of the trust indenture
*Reviews the indenture to ensure the trustee is represented properly
*Also represents the trustee in any matters regarding the execution of its fiduciary responsibilities
*Maintaining funds as security for payments to the bondholders
*Transmitting principal and interest payments from the issuer to the bondholders and maintaining records on behalf of the issuers
*The trustee may also be called the paying agent or registrar
Bond Counsel is responsible for preparing the legal opinion while the disclosure counsel prepares the issuer disclosure documents such as the official statement
Underwriters - Securities Dealers
*Purchase newly issued securities from the issuer and resell the securities to investors
*Underwriters assists municipalities
*By providing expertise to help the issuer determine the best and most cost effective strategy
*Preparing necessary documents to ensure all investor regulatory disclosure requirements are met
*Ensuring all gov regulations have been followed in the raising of any capital
*Finding investors through client relationships that will lend money to the issuer by purchasing the bond - most important
*In their role as underwriters, broker dealers may provide advice about the structure and sale of that issue only without registration as a MA
Secondary Market Participants
*After the initial sale is done through the underwriting and primary market process trading for the remaining life of the security continues in the secondary market
-Generally occurs in the over the counter marketplace
*Decentralized dealer to dealer marketplace includes more than 2000 municipal securities firms which must be registered with the MSRB to participate
-Secondary market for municipal securities includes securities firms that trade on behalf of customers and also amount themselves in the interdealer market
Market Makers
*Act like wholesales for certain municipal issues,
-In this role they stand ready to buy or sell securities on a regular basis at a publicly quoted price
*Take a position on both sides of the market
-Assume risk of having to buy securities from a seller without having a buyer or having to find the security for a buyer without holding it in inventory
-Market maker profits on the difference between the bid and asked price (Spread)
-Without them transactions could not be executed and the over the counter markets could not function
Traders
*Traders are employed by municipal securities firms and other financial institutions such as banks, pension funds, hedge funds or private equity firms
*Trading desk servers two types of business
-Buy side handles the portfolio management and investment needs of asset management companies and institutional investors such as mutual funds insurance companies and pension funds
-Sell side manages the inventory, trading, and arbitrage business of the investment bank or broker dealer.
*Traders are responsible for the purchase and sale of municipal bonds, evaluating market conditions and volatility and ensuring that customers receive the best rates possible
-Turn over the inventory of securities as profitably as possible
Principal Trade
*Broker dealer or bank acts as the customers counterparty, trading with the customer from its own inventory
*An investor may purchase a bond the firm already owns out of the firms inventory or the broker dealer, bank or investor for resale to its customer
*Firm makes a profit through a mark up
-In which the security is resold at a high price to the customer
*If the firm buys the security from a customer, the compensation is a mark down and securities are bought at a lower price from the customer
*Firms that engage in both principal transactions and MA businesses with clients must ensure all disclosure and consent requirements are met
Agency Trade
*The broker dealer or bank is an intermediary between the buyer and seller and does not take ownership of the securities
*Much less common in the municipal securities market than the corporate securities market
-Because of the high number of unique municipal issues
A municipal bond dealer effecting a transaction with a customer whether a principal or agent is required by the MSRB rules to trade at a fair price
2.8 INVESTORS AS MUNICIPAL MARKET PARTICIPANTS
Institutional Investors
Organizations or entities like banks, insurance companies, registered investment advisor, retirement funds, hedge funds, mutual funds and exchange traded funds
* Considered sophisticated and make large investments
Individual or retail investors directly or indirectly hold more than 75% of the outstanding principal amount of municipal securities
MSRB rule that requires suitable recommendations applies to retail customers but not institutional customers
*Before the enactment of the Tax Reform act of 1986 (TRA), commercial banks were the primary holders of municipal securities because they were allowed to deducts 8% of the interest expense associated with acquiring tax exempt securities
-The TRA significantly reduced the tax benefits to banks for purchasing tax exempt municipal securities
National Municipal Bond Funds and ETFs
Invest primarily in the bonds of various municipal issuers in the United States, these funds seek to provide investors with interest income free from federal tax
State Municipal Bond Funds and ETFs
Invest primarily in municipal bonds issued by a particular state to provide its residents with income that is tax exempt at federal and state levels
Suitability of Recommendations
Sophisticated municipal market professionals (SMMPs)
Defined by the msrb as institutional customers that
*A dealer has reasonable basis to believe are capable of evaluating investment risks and market value independently, both with regard to individual transactions and the market overall
*Are confident in exercising their own judgement in evaluating recommendations of securities from a dealer
Tax Exempt Monty Market Funds
-Invest in short term municipal securities and must have avg maturities of 90 days or less
-Offer liquidity and preservation of capital and income that is free from deferral and in some cases’ state and local tax
An issuer customarily selects one or more commercial banks or trust companies to perform these functions.
2.9 TRUSTEES, PAYING AGENTS, REGISTRARS
*Requirement for development of an investor profile prior to recommending a transactions does not apply to SMMPs
*Recommendations to SMMPs are also exempt from requirements for customer specific suitability determination
Trustee acts as a fiduciary in protecting the interests of the bond holders
Bond trustees, paying agents and registrars act on behalf of bondholder and issuers in admin duties relating to the bond issue
Trustee
Fiscal agent to perform certain duties including the establishment of accounts for bond proceeds and revenues and the holding of funds and securities on behalf of the entities they represent
Other Trustee Duties
Placement Agents
Types of market intermediaries that assist issuers in private placement of municipal securities
*Deal primarily with institutions in these placements
Market Intermediaries (Placement Agents, Leaser Marketers, Verification Agents)
*Link the issuer of the municipal securities to the final buyer
*Also called distribution intermediaries
-These market participants play a critical role in the packaging , promotion, trading, marketing and reselling of the municipal security
Lease Marketers
*Some municipalities rely on lease financing to acquire equipment and real property
-State and local gov, authorities, agencies, school districts and nonprofit corps can use leagues to improve cash flow
Verification Agents
*Are hired by the municipalities to ensure sufficiency of funds and to perform the following services
-Verification of sufficient cash flow for payments
-Verification that the yield on the escrow purchased with the proceeds of an advance refunding does not exceed the yield on the refunding bonds
-Verification of the mathematical accuracy of escrow reports relating to the purchase of securities place in escrow to support debt service including the verification of existing escrows
*Often coordinates with the issuer, underwriter, FA and any other party to ensure the valuation information concerning the refunded bonds and escrow investments are accurate and properly reported
Depository Trust and Clearing Corporation (DTCC)
*Is an organization that makes the process of book entry ownership and paperless exchange of securities between investors possible
*Established 1999
*DTCC provides
*Clearance, settlement, custodial and information services for many types of securities, including municipal bonds and gov securities
*Application process is required to obtain DTCC book entry delivery settlement and custody service
*To determine eligibility is handled on behalf of the issuer by the lead underwriter or FA
CUSIP (Committee on Uniform Securities Identification Procedures)
-Number so the security can be easily identified
-9 digit alpha numeric code
