1 bonds 101 presentation to awwa by zions public finance

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Bonds 101

Presentation to

AWWA by

Zions Public Finance

Zions Public Finance

Our Primary Services Financial Advisory Services

Municipal Studies

Underwriting Services

Direct Purchaser Services

Additional Services Continuing Disclosure

Equipment Lease Financing

Bond Election Services

Capital Facilities Planning

Impact Fee Analysis

Special Assessment Area Administration

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1902 $2.1 billion 1927 $14 billion 1960 $66 billion 1981 $361 billion 1998 $1.3 trillion 2011 $3.7 trillion

Growth of the U.S. Municipal Market

Source: Article on Municipal Bonds by Mayraj Fahim, 20 March 2012

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1812 – First U.S. Municipal Bond

The first U.S. municipal bond was issued in 1812 by New York City as a general obligation bond to construct a canal.

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Who Borrows in the US Municipal Market?

Infrastructure

State and Local Government

State and Local Authorities

Transportation

Water and Sewer

Non-Profit Entities

Healthcare Institutions

Private Schools

Colleges and Universities

Student Loan Authorities

Museums

Private Sector Entities for Limited Purposes

Pollution Control

Industrial Development

Airports & Seaports

Housing

State and Local Housing Authorities

Housing Developers

Public Power

Public Utilities

Resource Recovery

Independent Power Projects

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Who buys bonds?

*Figures for 2013 are as of March 31, preliminary, and seasonally unadjusted. Dollar amounts are in billions of dollars. Components may not add to totals because of rounding. Source: Federal Reserve Board, Flow of Funds Accounts, Flows and Outstandings; First Quarter, 2013.

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Characteristics of Different Types of Bonds

Source: Zions Bank Public Finance

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Section 3. [Debts of counties, cities, towns and school districts not to exceed revenue—Exception.] No debt in excess of the taxes for the current year

shall be created by any county or subdivision thereof, or by any school district therein, or by any city, town or village, or any subdivision thereof in this State; unless the proposition to create such debt, shall have been submitted to a vote of such qualified electors as shall have paid a property tax therein, in the year preceding such election, and a majority of those voting thereon shall have voted in favor of incurring such debt.

January 4, 1896

Constitution of Utah Article XIV, Public Debt

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Constitution of Utah Article XIV, Public Debt

Section 3. [Certain debt of counties, cities, towns, school districts, and other political subdivisions not to exceed revenue—Exception.] No debt issued by a county, city, town, school district,

or other political subdivision of the State and directly payable from and secured by ad valorem property taxes levied by the issuer of the debt may be created in excess of the taxes for the current year unless the proposition to create the debt has been submitted to a vote of qualified voters at the time and in the manner provided by statute, and a majority of those voting thereon has voted in favor of incurring the debt.

November 6, 1999

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Illegal Municipal Debt in Utah

Debt with payments beyond one fiscal year, unless:

A majority of voters have approved it; Subject to annual appropriation; Secured by an Enterprise Fund’s

revenues;

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Participants in Issuing Municipal Bonds

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Issuer (Borrower) Selects financing team members

Approves financing terms and documents, and ultimately issues the debt instruments

Responsible for repayment of debt (unless Issuer is “conduit” issuer)

Responsible for the accuracy and completeness of the debt offering document (i.e., Official Statement, Private Placement Memorandum)

Responsible for complying with terms and covenants in financing documents

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Top 10 Utah Issuers in 2014

Utah State Board of Regents Utah County Utah Housing Corporation Utah Transit Authority Jordan School District Cache School District Intermountain Power Agency Utah Charter School Finance Authority North Davis County Sewer District Jordan Valley Water Conservancy District

$639,800,000 238,100,000 210,500,000 142,400,000 104,700,000 90,000,000 84,800,000 79,400,000 50,000,000 50,000,000

Source: Thomson Reuters

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Financial Advisor

Has a fiduciary duty to the Issuer (acts in the Issuer’s best interests) (MSRB Rule G-17 and proposed Rule G-36)

Assists Issuer in the selection of other financing team members

Advises on wide range of financial issues; may be specific to an issuance of debt, or ongoing

Quarterbacks the bond issuance process; runs the calendar; coordinates other team members

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Financial Advisor

Position of Trust

Recent SEC definition of Municipal Advisor

Strong GFOA Recommendation

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National FA Rankings - 2014

Firm Volume (000s)

1 Public Financial Management Inc. 48,517.2 2 Public Resources Advisory Group 27,663.73 First Southwest 26,763.34 Estrada Hinojosa & Co 8,748.6 5 KNN Inc., ZBPF ID, ZBPF NV, ZBPF UT 7,471.4 6 Acacia Financial Group Corp. 6,368.67 A C Advisory 5,773.08 Piper Jaffray 5,105.29 Lamont Financial Services Corp. 4,167.710 RBC Capital Markets 3,942.2

(Source: Thomson Reuters.)

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Bond Counsel Nationally recognized law firm with experience in municipal debt financing

(Red book)

Works with the Issuer and the financing team on behalf of bondholders (for whom does bond counsel work?)

Has primary responsibility for preparation of legal documents (resolutions, indentures, security documents, trust agreements, tax certificates, etc.)

Renders opinion concerning the validity of the bond issue with respect to statutory authority, constitutionally, procedural conformity and, if tax-exempt, exemption of interest from Federal and State income taxes

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Bond Counsel – Utah 2014

Firm Volume (millions)

Ballard Spahr $ 579.4 Chapman and Cutler 432.4 Orrick Herrington 84.8 Blaisdel & Church 0.0 Chamberlain & Associates 0.0

* (Source: Thomson Reuters)

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Underwriter

Investment bank (broker-dealer) hired to sell the bonds into the marketplace. Initially purchases the bonds for immediate resale

May provide input into structuring the financing and drafting the Official Statement and related documents

Directs the pre-sale marketing efforts to investors

Proposes interest rates and offering terms based on market feedback; accepts orders from investors, and may commit capital to underwrite unsold bonds

Inherent conflict with the Issuer

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Top 10 U.S. Underwriters(Market Share in 2014)

Bank of America Merrill Lynch JP Morgan Chase Citi Morgan Stanley Wells Fargo RBC Capital Markets Barclay’s Capital Raymond James Goldman Sachs & Co Stifel Nicholaus

14.1%11.9 9.8 8.7 6.8 6.3 4.8 4.0 3.9 3.5

(Source: Thompson Reuters)

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Top 5 Utah Underwriters(Par Amount in 2014)

JP Morgan RBC Capital Markets Morgan Stanley Goldman Sachs George K. Baum

$246,800,000 208,400,000 147,100,000 142,400,000 65,300,000

(Source: Thompson Reuters)

GFOA Recommended Practices

“There is a lack of understanding among many debt issuers about the appropriate roles of underwriters and financial advisers and the fiduciary relationship that each has, or does not have, with respect to state and local government issuers.”

GFOA Debt Committee Draft “Best Practices” Document Dated June 9, 2007

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GFOA Recommended Practices

“The relationship between issuer and financial advisor is one of ‘trust and confidence’ which is in the ‘nature of a fiduciary relationship’. This is in contrast to the relationship between the issuer and underwriter where the relationship is one of some common purposes but also some competing objectives, especially at the time of bond pricing.”

GFOA Debt Committee Draft “Best Practices” Document Dated June 9, 2007

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Municipal Bond Teeter Totter

Price

Interest Rate

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Underwriters An Underwriter is not necessarily your friend!

Their interests are not aligned with yours Prohibition from Financial Advisors underwriting your

bonds in a negotiated sale (Rule G-23) Underwriters may push you into a negotiated sale.

Why? Follow GFOA recommendations:

Use a Financial Advisor to look out for your interests Hire underwriters using RFPs Use Competitive Sales whenever possible Don’t use the same underwriter over and over

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Trustee/Paying Agent/Registrar

Retained by Issuer, but represents bondholders’ interests

Manages trustee-held bond funds (reserves, construction funds, etc.)

Receives interest and principal payments from Issuer/Borrower and distributes to Bondholders

Maintains the list of owners of the bonds

Holds liens and security interests and exercises remedies, for bondholders, in the event of a default

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National Trustee Rankings 2013

Firm Volume (millions)

1. Bank of New York Mellon $66,628.32. U.S. Bank 54,145.33. Wells Fargo Bank 15,646.44. Manufactures & Traders Trust 4,458.95. Huntington National Bank 4,187.7 6. California State Treasurer 2,438.6 7. Regions Bank 2,366.6 8. UMB Bank 1,734.49. BOKF, NA 1,463.710. Hancock Bank 1,362.4

(Source: Thomson Reuters)

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Counsel to the Issuer

May be internal (City Attorney, County DA, AG’s Office) or outside or general counsel; not hired specifically for bond issue

Reviews all legal documents on behalf of Issuer

May assist in drafting an Offering Statement and additional disclosure documents, and may opine as to accuracy

Issues the required local counsel’s opinion

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Underwriter’s Counsel Nationally recognized law firm representing the underwriters, with

experience in debt financing

Advises and opines on matters relating to the Offering Statement, including matters relating to disclosure under SEC regulations and other standards; may have the principal role in drafting Offering Statement

Prepares underwriting documents – Blue Sky Survey, Legal Investment Memorandum, Agreement Among Underwriters, Selling Group Agreement, and the Bond Purchase Contract

Responsible for participating in “due diligence” before the bond issue is offered to investors

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Rating Agencies

National organizations that provide rating on debt of public and private organizations

Standard & Poor’s Corporation Moody’s Investor Service, Inc. Fitch Ratings

Authoritative sources that assess a borrower’s ability to repay

Ratings have direct impact on cost of borrowing

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Bond Ratings

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Moody’s Rating Distributions

Moody’s rates 8,300 local government GO credits In June 2014 ratings ranged from Aaa to Caa3

Sector median is Aa3 Only 2% rated Baa1 or below

Source: Moody’s Investor’s Service

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Moody’s G.O Bond Rating Criteria

Source: Moody’s Investor’s Service

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Economy

Income as a % of nation Per capita and median household

figures Compare against local cost of living

indexes

Market value per capita

Rate payer concentration Percent of assessed value or total

revenue in the top 10 payers

Very Diverse <15%

Diverse 15% to 25%

Moderately Concentrated

26% to 40%

Concentrated >40%

Low ≤65%

Adequate 90%

Good 110%

Strong 130%

Very Strong

≥130%

Low $35,000

Adequate $55,000

Strong $80,000

Very Strong $100,000

Extremely Strong

+$100,000

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Rate covenants – designed to protection for the investor that the water and sewer issuer will maintain and collect rates, charges and fees sufficient to cover D/S requirements. Typically minimum levels are 1.00 X to 1.25 X

Debt service reserve fund (DSRF) – temporarily support to make D/S payments and is typically sized as the lesser of 1) 10% of principal, 2) 125% of average annual D/S, or 3) the maximum annual D/S

Additional bonds test (ABT) – prevents an issuer from using too much leverage and weakening the ability to meet D/S coverage levels

Flow of funds – Outlined in the indenture and typically the funds flow is REVENUE FUND O&M FUND BOND FUND DSRF

Credit Ratings

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• Operating Performanceo Revenue trends o Chargeso Operating margin

• Leverageo Too much debt can be a burdeno Long-term debt to capitalizationo Higher debt to capital ratios are common with older systems

upgrading aging assets or newer systems expanding capacity

• Liquidityo Annual D/S coverage at least 1Xo Max annual D/S coverageo Failure to keep covenants triggers a technical default

Credit Ratings

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Debt Profile Debt per customer is $1,500 or less Debt per capita is $500 or less Debt funding of capital projects is 50% or less 90% of more of debt is amortized in 20 years Rate covenant is 1.25x annual debt service (or

more) Additional Bonds Test is 1.25x maximum

annual debt service (or more) Cash-funded debt service reserve fund is at its

legal maximum

Strong Ratings for Water/Sewer Bonds

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Financial Profile Total debt service coverage is 2.0x or more 365 days (or more) of cash on hand Residential charges for utilities are less than

1.2% of median household income Significant percentage of revenues are

recovered through base charges (rather than volumetric charges)

Strong Ratings for Water/Sewer Bonds

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Operating Profile Number of customers is stable or growing at

less than 1% annually Top 10 customers account for less than 5% of

total revenues No single customer accounts for more than

2% of revenues Treatment capacity is greater than 40% of

demand Annual renewal of 100% or more of

depreciated assets Full compliance with regulations

Strong Ratings for Water/Sewer Bonds

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Management Extensive utility sector experience Objective, engaged, knowledgeable board Strong communication skills from

management For wholesalers – coordinated members Frequent and accurate forecasting/planning Well-developed and documented policies and

procedures

Strong Ratings for Water/Sewer Bonds

Disclosure

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Preliminary & Final Official Statement

Legal Documents– Resolutions, General and Supplemental Indentures, etc.

Continuing Disclosure

Disclosure

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Preliminary (“POS”) and Final Official Statements (“OS”)

Distributed to “Wall Street” via email and web sites

Disclosure

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Disclosure

What does the OS contain?

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Continuing Disclosure Beginning in January 1996, municipal entities issuing debt

(subject to certain exemptions) were required to comply with Rule 15c2-12, Municipal Securities Disclosure of the Securities Exchange Act of 1934

Internet web site, www.emma.msrb.org

Disclosure

Tax Exemption

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Municipal Securities are “Tax-Exempt” Investments.

Comparison of Equivalent After-Tax Returns to Investors

Taxable XYZ Company

Debentures

Tax-ExemptABC Municipality

General Obligation Bonds

9%

10

11

12

13

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4.80%

5.34

5.87

6.41

6.94

7.47

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1819 - The Roots of Tax Exemption

Hamilton Jefferson McCullough Marshall

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1819 - The Roots of Tax Exemption

McCullough –vs- Maryland

“The power to tax is the power to destroy…”

John MarshallChief Justice, US Supreme Court

Initiated the doctrine of “intergovernmental tax immunity”.

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1895 - Pollock v. Farmer’s Loan & Trust Co.

The U.S. Supreme Court held in 1895 that the federal government had no power under the U.S. Constitution to tax interest on municipal bonds.

(In 1988, the Supreme Court stated that Congress could tax interest income on municipal bonds if it so desired on the basis that tax exemption of municipal bonds is not protected by the Constitution. In South Carolina v. Baker, the Supreme Court stated that the contrary decision of the Court 1895 in the case of Pollock v. Farmers' Loan & Trust Co. had been "effectively overruled by subsequent case law.“)

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The Threat to Tax-Exemption

Most hostile threat since the 1986 Tax ActFactors include:

Deficit reduction Tax reform (simplification) Progressive argument about fairness

(Obama administration’s proposed cap of 28%)

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Federal Deficit Reduction $2 Trillion Deficit Reduction

Elimination of tax-exemption on municipal bonds helps fill 15% of a $2 trillion deficit reduction goal.

Source: Morgan Stanley, Office of Management and Budget estimates of February 2012

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The Threat to Tax-Exemption

What would be the effect on local governments? Higher borrowing rates (about 1/3) Fewer public projects (not enough revenue) Tax increases to pay for new projects?

Current Rates

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Fed Fund Rate, Inflation, and Unemployment

Sources: U.S. Federal Reserve, Bureau of Economic Analysis, U.S. Bureau of Labor StatisticsNote: PCE is total personal consumption expenditures

59Source: Municipal Market Data

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Marching Down the Yield CurveY

ield

Maturity

1 5 10 15 20

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Refinancing Analysis Factors and Metrics

NPV Savings as a % of refunded principal “3%” is the general rule (but this can be arbitrary)

How “efficient” is the ratio of savings to negative arbitrage – what is your savings compared to your negative arbitrage

How much is your savings compared to your costs of issuance to issue refunding bonds?

How many more years of bond payments do you have? How close is your bond call date?

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Zions Bank Public FinanceOne South Main Street, 18th FloorSalt Lake City, UT 84111-1904

801-844-7373

jon.bronson@zionsbank.com