imta institute 2019 - eiu
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IMTA INSTITUTE 2019 Debt Policy
ANDREW KIM DIRECTOR, PUBLIC FINANCE
PMA SECURITIES, LLC
November 20, 2019
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DEBT MANAGEMENT POLICIES
Purpose of a Debt Management Policy
• Create tools to reconcile capital needs with available resources
• Establishes some basic parameters and principles
• Educate stakeholders
• Board-approved policies provide protection against political expediency
Key Components of a Debt Management Policy
Through the Issuance Process
I. Scope and Purpose
II. Uses of Debt
III. Types of Debt Permitted
IV. Debt and Debt Repayment Structure
V. Debt Issuance Practices
Post-Issuance
VII. Ongoing Post-Issuance Administrative Activities
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I. SCOPE AND PURPOSE
Debt management policies typically start with a statement of purpose to explain the overall objective of adoption and debt management policy.
Example
“The purpose of this policy is to establish a framework for debt management to work in conjunction with the Capital Improvement Program Development. These guidelines will enhance the quality of decisions, rationalize the decision making process, identify objectives for staff, and demonstrate a commitment to long-term planning.
This Policy will be a positive factor in the municipal market’s assessment of the City’s credit quality. The City’s financial condition and credit ratings should always be the primary considerations when considering the issuance of debt. It should be recognized that these guidelines are not immutable; changing circumstances require flexibility and revision. Anticipation of every future contingency is unrealistic. When adjustments are necessary, the reasons for such policy changes need to be well documented if the City wishes to demonstrate to the credit markets and its citizens that its commitment to sound debt management principles is unchanged.”
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II. USES OF DEBT
The Debt policy should consider when it is appropriate to use debt and when it is not appropriate; however, this policy does not exist in isolation. Other Policies intrinsic to Debt Management include:
• Capital Improvement Planning
• Economic Development
• Fund Balance Policy
• Long-term Financial Planning, etc.
Capital and Equipment
• When is it appropriate to use debt for capital projects?
• When is it appropriate to use debt for equipment?
• When is it appropriate to use other funding sources?
– Operating Levy (PAY GO)
– General Fund balance
– Equipment Replacement fund balances
Economic Development Initiatives
• When is it appropriate to use debt for economic development initiatives?
– Capital Projects vs. Developer Incentive “Gap” Payments
• When should interfund loans be used to provide temporary financing?
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III. TYPES OF DEBT PERMITTED (IL)
General Obligation (GO)
• Unlimited GO Bonds
• Limited GO Bonds
Direct Revenue Bonds
• Typically utilities (Water, Sewer, Electric, Stormwater), but could include other revenues (TIF Revenues)
Alternate Revenue Bonds
• Typically utilities (Water, Sewer, Electric, Stormwater), but could include other revenues (TIF Revenues)
• In addition to one of these revenue streams, the municipality pledges its GO credit
Special Assessment Bonds
• Secured by a special assessment against the property
Other Financing Options
• Anticipation Notes
• Tax Securitization Bonds
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IV. DEBT LIMITATIONS
Debt limitations exist for both:
• Amount of Debt
• Debt Service Requirements
Sources of these limits include:
• Limits imposed by Law (for non-Home Rule units of government)
– Statutory Debt Limit: 8.625% of municipality’s EAV
– Non-referendum Debt Limit: 0.5% of municipality’s EAV
• Limits imposed by Contract
– Revenue Debt – Additional Bonds Test for new debt to be issued “on a parity”with existing debt
– Revenue Debt – Debt Service Coverage requirements
• Limits imposed by Rating Agency reaction
– Increases to Debt or Debt Service can affect financial ratios that are correlated with a given rating
• Limits imposed by Policymakers
– Stricter limits intended to promote fiscal discipline
– Can be modified as circumstances change
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EXAMPLE DEBT AND DEBT SERVICE LIMITS
Example No. 1
Direct Debt to Equalized Value
• Guideline: 1.0% to 3.0% limit
• 75% of Guideline: 2.5%
Direct Debt per Capita
• Guideline: $500 to $1,000 per capita
• 75% of Guideline: $875 per capita
Debt Service Expenditures as a % of General Fund Expenditures
• Guideline: 5% to 10%
• 75% of Guideline: 8.75%
Impact on Credit Rating
• The Village will seek to maintain or improve its current bond rating and will specifically discuss with the Board any proposal which might cause that rating to be lowered
Example No. 2
The City should not exceed credit industry benchmarks where applicable. Therefore, the following factors should be considered in developing debt issuance plans:
Ratio of Net Bond Debt to Estimated Full Value
• The formula for this is Net Bonded Debt, which is the total outstanding debt divided by the current Estimated Full Value as determined by the most recent EAV
Net Bonded Debt per Capita
• The formula for this is Net Bonded Debt divided by the current population as determined by most recent census information available
Ratio of Annual Debt Service to General Governmental Expenditures
• The formula for this is annual debt service expenditures divided by General Government expenditures
Below are example debt and debt service limitation policies from medium-sized Illinois municipalities.
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V. DEBT ISSUANCE PRACTICES
Per the GFOA, a Debt Management Policy should include guidance on the issuance process including:
• Selection and use of professional service providers, including an independent financial advisor, to assist with determining the method of sale and the selection of other financing team members.
– Disclosure Counsel for assistance with preparing and documenting the Official Statement?
• Criteria for determining the sale method (competitive, negotiated, private placement) and investment of proceeds.
• Use of comparative bond pricing services or market indices as a benchmark in negotiated transactions, as well as to evaluate final bond pricing results.
• Criteria for issuance of advance refunding and current refunding bonds. (no more Tax-Exempt Advance Refundings post Tax Cut and Jobs Act of 2017, effective 12/31/17)
• Use of credit ratings, minimum bond ratings, determination of the number of ratings, and selection of rating services.
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EXAMPLE DEBT ISSUANCE PRACTICES
Example No. 2 Structure of Debt Issuances The duration of a debt issue shall not exceed the economic or useful life of the improvement or asset that the issue is financing. The City shall design the financing schedule and repayment of debt so as to take best advantage of market conditions and, as practical, to recapture or maximize its credit capacity for future use, and moderate the impact to the taxpayer. Method of Sale Indebtedness to be issued by the City will be offered through the competitive bidding process except as expressly approved by the Mayor and City Council. If it is proposed that debt not be issued through competitive bidding, such request will state the compelling reasons why the competitive bidding process is not deemed suitable for the particular issuance of debt.
Below are example debt issuance practice policies from medium-sized Illinois municipalities.
Competitive Sale - Underwriter is not known ahead of time.
• Financial Advisor conducts an open bid and the Bonds are awarded to the Underwriter with the lowest average rate
Negotiated Sale - Underwriter is selected ahead of time by the issuer.
• A formal selection process can be facilitated by a Financial Advisor or the issuer can proceed by itself
Example No. 1
Professional Team To provide assistance in debt issuance, the Village will select a financial advisor and/or investment banker and bond counsel on a competitive basis; these advisors will be retained for several years to provide continuity and allow them to develop an understanding of the Village’s needs.
Method of Sale The Village will generally conduct financing on a competitive basis; however, a negotiated financing may be used where market volatility or the use of an unusual or complex financing or security structure causes a concern with regard to marketability.
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VI. POST-ISSUANCE COMPLIANCE
After the Debt is issued there are required ongoing administrative activities.
Investment of Bond Proceeds
• IRS: Arbitrage Rebate and Yield Restriction
MSRB Disclosure Requirements
• SEC Rule 15c2-12
• Annual Report preparation and posting on EMMA website (usually within 180 to 210 days of FYE)
• Material Events Disclosure (within 10 business days)
Record Retention
• IRS: Life of the Bonds (or life of the refunding bonds) + 3 years
Private Business Use Monitoring
• IRS: If the financed facility has any management contracts, leases or sub-leases
Consider adopting a separate Post-Issuance Compliance Policy to formally designate team members and their ongoing post-issuance responsibilities.
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Investment of Bond Proceeds
Arbitrage Rebate and Yield Restriction compliance are two restrictions after issuance.
• Arbitrage Rebate
– Issuers must rebate certain excess earnings on proceeds of tax-exempt bonds to the federal government.
– There are two notable exceptions that allow issuers to keep any positive arbitrage.
1. Small Issuer Exception
– $5 million or less of Tax Exempt debt issued in a calendar year for municipalities.
2. Spending Test
– 6-month, 18-month, or 24-month spending exceptions.
– Perform calculations no later than 5-year anniversary, and if needed make payment within 60 days.
• Yield Restriction
– Prohibits investments that earn a rate higher than the arbitrage yield (i.e., borrowing rate).
– For a new project, Yield Restriction would typically apply to any unspent bond proceeds remaining after the standard three-year Temporary Period expires.
VI. POST-ISSUANCE - INVESTMENTS
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VI. POST-ISSUANCE - DISCLOSURE
MSRB Disclosure Requirements – Material Events
The Continuing Disclosure Undertakings for municipal securities issued on or after February 27, 2019, and subject to Securities and Exchange Commission Rule 15c2-12 (the “Rule”), must include two additional reportable events:
1. The incurrence of a financial obligation of the obligated person, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the obligated person, any of which affect security holders, if material
2. A default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation of the obligated person, any of which reflect financial difficulties
The above two reportable events are in addition to the 14 enumerated reportable events under the Rule.
IMTA INSTITUTE 2019 Capital Improvement Plans
STEPHEN ADAMS DIRECTOR, PUBLIC FINANCE
PMA SECURITIES, LLC
November 20, 2019
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CAPITAL IMPROVEMENT PLAN
• Definition - A Capital Improvement Plan (“CIP”) is a short range plan that identifies capital projects and major equipment purchases. The CIP provides a schedule of when these projects or purchases will occur. It also should identify options for the financing of the project or purchase.
– Short Range – usually between 3 and 10 years but varies by community
– The CIP not only lists the projects and purchases but ranks them in order of importance
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CIP – STEPS TO FORMULATING
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1. Allows for a systematic evaluation of all potential projects at the same
time
2. Assures the most important projects receive funding
3. Provides the ability to stabilize debt and consolidate projects to reduce
borrowing costs
4. Serves as a public relations and economic development tool
5. Focus on preserving infrastructure while ensuring the efficient use of
public funds
6. Integrates budgeting for the project as well as the operational needs
once the project has been completed
7. An opportunity to foster cooperation among departments and an ability
to inform other units of government of the priorities of the municipality
8. Improves project planning and timing sequence
9. Assures the most appropriate method of funding is selected
* Source: GFOA Website: https://www.gfoa.org/capital-improvement-planning-budgeting-resource-center
CIP - BENEFITS
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CIP – IMPORTANT ELEMENTS
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1. Can be time-intensive for all parties involved
2. Fiscal Restraints • Revenue Sources
• Funding Options
• Return on Investment
• Up front costs even if long-term savings
3. Project justification
4. Project prioritization
CIP - CHALLENGES
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DOCUMENTATION
1.What went well?
2.What went poorly?
3.What can be done better?
4.What did we learn?
5.Are there any actions for follow up?
CIP - EVALUATION
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TRUE OR FALSE????
CIP – QUIZ QUESTION #1
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TRUE OR FALSE????
CIP – QUIZ QUESTION #2
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TRUE OR FALSE????
CIP – QUIZ QUESTION #3
IMTA INSTITUTE 2019 Selecting Service Providers
ANDREW KIM DIRECTOR, PUBLIC FINANCE
PMA SECURITIES, LLC
November 20, 2019
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PARTICIPANTS ON A BOND TRANSACTION
ISSUER
Bond Counsel
Disclosure Counsel
Local Counsel
Bond Insurance Company
Escrow Agent
Bond Registrar/
Paying Agent
Rating Agency
Underwriter
Municipal Advisor
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THE LAWYERS – BOND COUNSEL
• Almost all municipal bonds are accompanied by a bond opinion of bond counsel who assists/represents not only the issuer, but the legal interests of the bondholders.
• The bond opinion addresses the main legal issues, whether:
1. The bonds constitute legal, valid and binding obligations of the issuer; and
2. Interest on the bonds is exempt from federal (and in some cases state) income taxation under applicable tax laws.
• In rendering the bond opinion, bond counsel:
1. Undertakes a review and examination of all applicable laws authorizing the issuance of bonds;
2. Ascertains that all required procedural steps have been completed to assure proper authorization and issuance of the bonds; and
3. Determines that all federal (and in some cases state) tax laws governing the issuance of the bonds have been complied with.
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THE LAWYERS – BOND COUNSEL (CONTINUED)
• Bond counsel assembles all relevant documentation into a transcript, which serves as a permanent record and reference of the steps taken to issue the bonds and of the underlying payment and security arrangements.
• A list of bond counsel firms can be found in the Bond Buyer’s Municipal Marketplace or Red Book.
• Other attorneys that may participate in the bond issuance include corporate counsel for the issuer, disclosure counsel and underwriter’s counsel for a broker dealer.
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MUNICIPAL ADVISORS AND OTHER ISSUER CONSULTANTS
• Issuers often seek the advice of a municipal advisor. Municipal advisors perform a variety of tasks, including:
1. Analyzing the financing needs and options of the issuer;
2. Helping the issuer in selecting a broker dealer and other financing professionals;
3. Advising on the issuer’s debt plans relating to its capital needs;
4. Structuring the bond issue;
5. Organizing the issuance of the bonds;
6. Working with rating agencies and credit enhancers;
7. Preparing the disclosure document for the bond sale; and
8. In a negotiated sale, negotiating with the purchaser of the bonds on the interest rates for the bonds.
• Issuers do not have to hire a municipal advisor, but the GFOA “recommends that the issuer hire a municipal advisor prior to the undertaking of a debt financing unless the issuer has sufficient in-house expertise and access to current bond market information”.
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• PMA’s public finance team was interested in determining whether there was a discernable difference in the fees paid by issuers for negotiated sales with a financial advisor (FA) involved versus without
• Using publicly available information on Bloomberg and www.emma.msrb.org, we recorded the underwriting spread and total costs of issuance data for Illinois community college bonds issued on a negotiated basis from 2009 through June 2019
BACKGROUND
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ALL NEGOTIATED IL COMMUNITY COLLEGE ISSUES
UNDERWRITING SPREAD AS A % OF PAR
• The issues highlighted in green involved an FA
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
0 1 2 3 4 5 6 7 8
Un
der
wri
tin
g Sp
read
as
% o
f P
ar
UW Spread for all Negotiated CC Issues
UW Spread (% of Par) UW Spread (% of Par) with FA Linear (UW Spread (% of Par)) Linear (UW Spread (% of Par) with FA)
Aaa/AAA Aa1/AA+ Aa2/AA Aa3/AA- A1/A+ A2/A A3/A- NR
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ALL NEGOTIATED IL COMMUNITY COLLEGE ISSUES
TOTAL COSTS OF ISSUANCE AS A % OF PAR
• The issues highlighted in green involved an FA
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
0 1 2 3 4 5 6 7 8
Tota
l Co
sts
of
Issu
ance
as
% o
f P
ar
Total COI for all Negotiated CC Issues
Total COI (% of Par) Total COI (% of Par) with FA Linear (Total COI (% of Par)) Linear (Total COI (% of Par) with FA)
Aaa/AAA Aa1/AA+ Aa2/AA Aa3/AA- A1/A+ A2/A A3/A- NR
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“FLIPPING” CASE STUDY
WERE YOUR BONDS SOLD AT THE LOWEST POSSIBLE YIELD?
• Par amount of bonds issued by the school district: $11,000,000
• Underwriter’s compensation: $330,850 (3.0077% of par)
• Secondary trade data on EMMA1 reveals immediate “flipping”
• The use of secondary trades may allow for a lower cost of funds under certain circumstances which PMA monitors as municipal advisor
• However, if an underwriter regularly relies upon a flipping strategy to place bonds with investors, it likely results in a higher cost to the issuer when better alternatives are available.
1EMMA is a service of the Municipal Securities Rulemaking Board, which protects investors, state and local governments, and the public interest. www.msrb.org
Underwriter first trades the bonds to another broker-dealer
at the list price
Then 12 minutes later the second dealer sells the bonds to a customer at a lower yield / higher price. The use of the second dealer to find the investor may have cost the
issuer 0.733% or $12,974
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RATING AGENCIES AND CREDIT ENHANCERS
• Especially after the Great Recession and with certain recent municipal bond
defaults, bond ratings are playing a more prominent role in the municipal bond market. A rating is almost obligatory for the sale of any major bond issue in the public market.
• A bond rating is an alphabetical and/or numeric symbol used to give relative indications of credit quality of a bond issue.
• Issuers prepare rating agency presentations, with the help of their municipal advisor and their broker dealer (negotiated sale).
• Rating agencies also review their ratings periodically and analyze the issuer’s current financial and operational information.
• Credit enhancement denotes the credit of a stronger, more highly rated entity (such as a bond insurer), that is used to strengthen or enhance the credit of a lower-rated issuer. Many bond insurers have left the market, but recently the use is growing for issues rated in the “A” or lower categories.
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BROKER DEALERS
• Broker dealers typically purchase the bonds from the issuer, unless there is a direct purchase of the bonds such as by a local bank. Bonds are usually purchased through a competitive or negotiated sale.
• In a competitive sale, a bid for the bonds is submitted to the issuer at a specific date and time. Broker dealers will sometimes bid on bonds as a syndicate of two or more broker dealer firms. The bidder with the lowest true interest cost is selected on the sale date to serve as the broker dealer.
• In a negotiated sale, one or more broker dealers are selected at the beginning of a bond issue, often through a RFP process. The broker dealer, along with the municipal advisor, assists the issuer in coordinating and managing the bond issue.
• Broker dealers have personnel that serve in a variety of roles: public finance bankers, underwriters, traders, sales people, and operations people.
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OTHER PARTICIPANTS
• Commercial Banks – Can serve as the direct purchaser of bonds (usually shorter
term bonds), as bond registrar, paying agent, trustee or escrow agent; as a liquidity or letter of credit provider.
• CUSIP Service Bureau – Assigns unique numbers to municipal bonds.
• DTC – Most bonds are registered in the name of Cede and Co. and held in book-entry form through the Depositary Trust Company.
• Regulators – the SEC is responsible for administering federal securities law. FINRA and MSRB develop rules and set standards regulating broker dealers and municipal advisors.
• Derivative Specialists – SWAP providers, related remarketing agents, etc. In a bond issue with a derivative component, the issuer should be sure that it is getting qualified help from a consultant that is solely representing the issuer’s interests in the transaction.
IMTA INSTITUTE 2019 Method of Sale
STEPHEN ADAMS DIRECTOR, PUBLIC FINANCE
PMA SECURITIES, LLC
November 20, 2019
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SALE TYPE
PUBLIC OFFERING DIRECT PLACEMENT
• The Issuer and financial advisor prepare an official statement
• Underwriter that will resell the bonds to investors selected via a competitive or negotiated sale
• Issuer obtains a bond rating
• Requires disclosure counsel to review the official statement
• Will likely have a lower interest rate, but will have higher costs of issuance
• No official statement, rating, underwriter or
disclosure counsel is required • A term sheet is sent out to banks and other local
units of government that will provide a proposal to purchase the bonds directly
• The interest rate is typically higher than a public offering but may result in a lower overall financing cost since some costs of issuance are avoided
• This process has typically proven to be effective for relatively smaller bond issues paid off with a shorter amortization
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TYPES OF PUBLIC OFFERINGS
NEGOTIATED SALE COMPETITIVE SALE
• The Issuer preselects a broker-dealer as underwriter
• The underwriter’s fee is negotiated by the Issuer in consultation with the Financial Advisor during the pre-selection process
• This firm sells the bonds to investors
• The Issuer engages a municipal advisor to
manage the bond issuance process
• Underwriter selected via a competitive sale in which multiple bids are received to purchase the bonds
• The winning bidder sells the bonds to investors
• The bidder with the lowest true interest cost is selected
• The underwriter’s fee is included in the bid and taken into account in the calculation of the true interest cost
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CHOOSING THE METHOD OF SALE
A competitive sale is appropriate when: A negotiated sale is appropriate when:
• Issuer has a strong underlying credit rating at least in the “A” category
• General obligation bonds or full faith obligations (e.g. alternate revenue bonds or debt certificates)
• Structure does not include special features that would require extensive explanation to the market
• Issuer is frequently in the market and/or issue size is conducive to attracting investors
• Issuer has a credit rating lower than “A”
• Debt structure is complicated
• Issuer wants input in how bonds are allocated among underwriting firms and/or the types of investors to be reached
• Other factors exist that the issuer, in consultation with its municipal advisor, believes favor the use of a negotiated sale process
Source: Selecting and Managing the Method of Sale of Bonds (February 2014), Government Finance Officers Association (Best Practice). See the following webpage: http://www.gfoa.org/selecting-and-managing-method-sale-bonds
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• Competitive vs. Negotiated Sale – One of the biggest financing decisions that an issuer will navigate is whether to
bring an issue to the market as a competitive or negotiated sale.
– The best approach for the sale must be chosen to meet financing goals and
specific needs.
– If the issuer has in-house expertise, defined as dedicated debt management staff
whose responsibilities include daily management of a debt portfolio, this analysis
and selection could be made by the issuer's staff.
– However, in the more common situation where an issuer does not have sufficient
in-house expertise, this analysis and selection should be undertaken with the
advice of a municipal advisor.*
*Source: GFOA Best Practices Website: https://www.gfoa.org/selecting-and-managing-method-sale-bonds
METHOD OF SALE – COMPETITIVE VS. NEGOTIATED SALES
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• Impact of Tax Cut and Jobs Act of 2017 – In the wake of the 2017 tax legislation, the conversation regarding
method of sale may be particularly critical.
– The legislation included various provisions that have impacted the
municipal market, influencing both the supply (elimination of tax-exempt
advance refundings) and demand of municipal bonds.
– Provision impacting municipal bond demand • Reduction in the corporate tax rate from 35% to 21%
• Reduced the incentive for institutional investors to purchase municipal bonds
• In response, there has been a stronger reliance on direct and indirect retail investors
during a sale of municipal bonds
METHOD OF SALE – IMPACT OF TAX LEGISLATION
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COMPETITIVE SALE - MUNIAUCTION
Sample MuniAuction Sale Results
The following table represents the results of the bidding on a $14.21 million MuniAuction sale for
Woodstock CUSD No. 200 which is rated “AA” by S&P. The District received 14 bids from six different
bidders.
Auction Date Type Start End Time Now
Status
Wed., Nov 14, 2018 AON 10:45:00 am 11:02:52 am 11:09:25 am EST Over Connected to server
$14,210,000*
Community Unit School District Number 200 (Woodstock), McHenry County,
Illinois
General Obligation Limited Refunding School Bonds, Series 2018
Source: MuniAuction
Bidder Firm TIC Time Gross
Interest
+ Discount/
(Premium) Total Interest Bid No.
Cumulative
Improvement
1st KEYB-RB KeyBanc 3.131272% 11:00:52 am $4,400,444.44 (1,451,396.55) $2,949,047.89 2 0.034191%
2nd UMBB-SM UMB Bank 3.135090% 11:01:52 am $4,400,444.44 (1,448,219.20) $2,952,225.24 5 0.064050%
3rd JPMO-BA JP Morgan 3.142731% 11:02:18 am $4,400,444.44 (1,441,863.25) $2,958,581.19 2 0.001973%
4th RWBA-DK Robert Baird 3.193349% 10:58:01 am $4,400,444.44 (1,399,851.90) $3,000,592.54 1 -
5th RAYM-RS Raymond James 3.202459% 11:00:29 am $4,400,444.44 (1,392,307.65) $3,008,136.79 3 0.051599%
6th HUTC-JV Hutchinson 3.250029% 10:58:56 am $4,400,444.44 (1,353,000.00) $3,047,444.44 1 -
Total Bids: 14
*Preliminary, subject to change
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COMPETITIVE SALE - PARITY
Sample Parity Sale Results
The following table represents the results of the bidding on a $5.7 million Parity sale for Itasca School
District 10, which is rated “Aa1” by Moody’s. The district received bids from six different bidders.
Source: Parity
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NEGOTIATED SALE
Unlike a competitive sale, bond pricing in a negotiated sale requires a much greater degree of issuer and financial advisor involvement. GFOA’s Best Practices recommend the following*: 1. Communication of specific goals and expectations to the underwriter 2. Management of underwriting fees 3. Formulate proper pre-marketing effort 4. Analyze market for timing purposes 5. Evaluate structural features such as optional redemption (call features) and how they may
impact the overall interest impact of an issue 6. Evaluation of recent comparable issues as related to the pre-pricing scale 7. Constant contact during the sales process to evaluate the potential for a pricing
adjustment based on market demand 8. Post issuance summary with results
*Source: GFOA Best Practices Website: https://www.gfoa.org/pricing-bonds-negotiated-sale
IMTA INSTITUTE 2019 Debt Types
The Right Debt Instruments
ANDREW KIM DIRECTOR, PUBLIC FINANCE
PMA SECURITIES, LLC
STEPHEN ADAMS DIRECTOR, PUBLIC FINANCE
PMA SECURITIES, LLC
November 20, 2019
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• Form of Debt – Allows a municipality to make debt service payments over time to
spread out the liability over the expected useful life of whatever is being financed
– Also allows for the municipality to not increase taxes or spend down reserves all at once for a project
• Bonds can be used for – – Capital Projects
– Working Capital
– Refinancing Other Debt
WHAT IS A BOND?
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• Home rule municipalities have no debt limit
• Non-home rule municipalities
– Overall debt limit, 8.625% of EAV • Includes general obligation bonds, debt certificates and financing
leases
• Does not include tax anticipation warrants, revenue bonds, special assessment bonds and alternate bonds (unless full faith and credit tax is extended for payment)
– Overall debt limit for other units of government (school districts, park districts, library districts, etc.) vary depending on the type of government.
DEBT LIMIT
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• Bonds issued backed by the full faith and credit of a municipality – Pledges the ad valorem taxing ability of the municipality
• Authority – Home Rule – Typically issue G.O. Bonds and then can pay from any
source, do not require referendum, do not require Bond Issue Notification Act (“BINA”) hearing
– Non-Home Rule – Can issue G.O. Bonds after referendum approval (please see exceptions to this rule on the following slide), BINA hearing required
TYPES OF BONDS – GENERAL OBLIGATION (G.O.)
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– Non-Home Rule Referendum Exceptions
• Refunding Bonds
• Tort Judgement Bonds
• Working Cash Fund Bonds
• Bonds used to pay pollution abating costs mandated under the Environmental Protection Act
• Bonds issued for acquisition, construction or improvement to water or wastewater treatment facilities mandated by a compliance order issued by the USEPA or the Illinois Pollution Control Board
• Bonds issued, separately or in aggregate, that do not exceed 0.05% (one-half percent) of the EAV of the municipality
TYPES OF BONDS – GENERAL OBLIGATION (G.O.)
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• Bonds backed solely by a specific revenue stream related to the
project being financed.
– Water/Sewer Systems
– Sporting Facilities
– Parking
– Transportation
• There must be a statutory grant of power to operate the revenue
producing entity
• Revenue bonds do not count against the statutory debt limit of a
municipality
• Referendum approval is not required but subject to back door
referendum provisions
• BINA hearing is not required
TYPES OF BONDS – REVENUE
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• Also known as “double barrel” bonds
– Pledge of revenues
– Back up pledge of the full faith and credit of the municipal entity
• Pledged revenue source required to show 1.25x coverage over debt
service*
– Ex. Debt Service is $100 – audit needs to show the revenue producing unit
generated a minimum of $125
*1.10x coverage requirement if the pledged revenue source is:
– some amount of federal or state funds have been received by the municipality during each of
the previous fiscal years preceding the issuance of ARS bonds or
– Revenues are to be received from another governmental unit under an intergovernmental
agreement
TYPES OF BONDS – ALTERNATE REVENUE SOURCE (ARS)
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• ARS bonds do not count against the statutory debt limit of a
municipality unless the entity levies for the payment of even a
portion of the debt service
• Referendum approval is not required but subject to back door
referendum provisions
• BINA hearing is required
TYPES OF BONDS – ALTERNATE REVENUE SOURCE (ARS) CON’T
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• Leases
• Debt Certificates
– Paid out of general or operating funds
– Typically price approximately 0.10% - 0.15% higher than GO Bonds
– No petition period or hearing required
– Maximum 20-year final maturity
• Limited Bonds – PTELL entities
• Promissory Notes
• Special Service Area Bonds
• Tax Increment Finance Bonds
• Tax Securitization Bonds
– Particularly valuable for lesser-rated credits
– Requires extensive legal provisions due to establishment of separate Special
Purpose Entity (SPE), also known as a Municipal Finance Corporation
– Significantly improves a municipality’s ability to access capital market through an
SPE rating that may be up to six notches higher than the municipality’s GO rating
TYPES OF BONDS – OTHER TYPES
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TYPES OF BONDS – SUMMARY CHART
IMTA INSTITUTE 2019 Debt Service Funds
ANDREW KIM DIRECTOR, PUBLIC FINANCE
PMA SECURITIES, LLC
November 20, 2019
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DEBT SERVICE FUNDS
• Municipalities utilize debt service funds to account for the accumulation of resources in anticipation of debt service payments
• Excess dollars in Debt Service Funds – Most municipalities do not collect 100% of their extended levies
– Most Illinois counties, therefore, permit a unit of government to extend an amount that is typically 1% - 5% (or perhaps even more) higher than a municipality’s actual Bond & Interest levy
– This may cause a municipality’s Debt Service Fund to become over funded
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DEBT SERVICE FUNDS
• For non-Home Rule units of government, those Debt Service Fund dollars must be used for debt service purposes
– Can execute a Debt Service Fund clean-out by issuing 30-day General Obligation Bonds, and
– Use funds on hand in Debt Service Fund to make debt service payment
– Some legal opinions in Illinois believe that Home Rule units of government do not need to pursue this route and can simply transfer funds in the Debt Service Fund into other operating funds; however, there is no legal consensus on this
• Are dollars in the Debt Service Fund yield restricted? – Some legal opinions believe that all dollars in a Debt Service Fund are yield restricted
– Other legal opinions believe that only those dollars that are not used for debt service payments need to be yield restricted
– ALSO, interest earnings within a Debt Service Fund can be transferred out so long as the interest earnings have not been pledged to pay debt service on a bond issue
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DEBT SERVICE RESERVE FUNDS
• A reserve fund is used to pay debt service if pledged revenues are insufficient to satisfy the debt service requirements – May be required per terms of the contract
– Must be funded at the onset of the bond issue
• Three Prong Test – Lesser of: – 10% of Par Amount
• May apply to Issue Price if Issue Price differs from Par Amount by more than de minimis (2%) amount
• Applies to original amount of issue and does not change over life of the bond issue as principal is paid off
– Maximum Annual Debt Service (MADS)
– 125% of Average Annual Debt Service
• Size and investment of DSRF generally is subject to arbitrage regulations
IMTA INSTITUTE 2019 Rating Agencies
STEPHEN ADAMS DIRECTOR, PUBLIC FINANCE
PMA SECURITIES, LLC
November 20, 2019
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• What is a rating agency?
– A private institution whose main function is to evaluate the economic well-being of a municipality and the ability to pay back debt
• What is the purpose of a rating?
– Potential investors have confidence in the higher the rating of a municipality the less of a perceived risk of default they are
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Moody's S&P Fitch Kroll
Aaa AAA AAA AAA Extremely strong capacity to meet financial obligations.
Aa1 AA+ AA+ AA+
Aa2 AA AA AA Very strong capacity to meet obligations.
Aa3 AA- AA- AA-
A1 A+ A+ A+
A2 A A A Strong financial capacity but susceptible to adversity.
A3 A- A- A-
Baa1 BBB+ BBB+ BBB+
Baa2 BBB BBB BBB
Baa3 BBB- BBB- BBB-
Ba1 BB+ BB+ BB+
Ba2 BB BB BB Non-Investment Grade Speculative
Ba3 BB- BB- BB-
B1 B+ B+ B+
B2 B B B Highly Speculative
B3 B- B- B-
Caa CCC+ CCC+
Ca CCC CCC CCC Extremely Speculative
C CCC- CCC-
DDD CC
DD C
D D D Default
Adequate financial capacity but adverse conditions will
lead to weakness.
Investment Grade
Non-Investment Grade
CREDIT RATING SCALES AND DEFINITIONS
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G.O. RATING METHODOLOGY - MOODY’S
Moody’s released a G.O. rating methodology in January 2014 (updated Dec. 2016). There are a number of adjustments to the “simple” scorecard shown below.
Factor Sub-factor
Broad Rating Factors Weighting Rating Sub-factors Weighting
I. Economy/Tax Base 30% Tax Base Size (Equalized Value) 10%
Equalized Value Per Capita 10%
Wealth (median family income) 10%
II. Finances 30% Fund Balance (% of Operating Revenues) 10%
Fund Balance Trend (5-year change) 5%
Cash Balance (% of Operating Revenues) 10%
Cash Balance Trend (5-year change) 5%
III. Management 20% Institutional Framework 10%
Operating History 10%
IV. Debt/Pensions 20% Debt to Equalized Value 5%
Debt to Revenue 5%
Moody's ANPL* (3-yr avg.) to Equalized Value 5%
Moody's ANPL* (3-yr avg.) to Revenue 5%
* Adjusted Net Pension Liability
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G.O. RATING METHODOLOGY – S&P
S&P released a GO rating methodology in September 2013.
There are a number of adjustments to the “simple” scorecard shown below.
S&P’s Management score includes a Financial Management Assessment (FMA), which assesses the policies and practices of a local government (not individual managerial quality, organizational efficiency, or any other performance indicators).
Factor III. Management
Broad Rating Factors Weighting Financial Management Assessment
I. Institutional Framework* 10% Revenue/Expenditure Assumptions
II. Economy 30% Budget Amendment/Updates
III. Management 20% Long Term Financial Planning
IV. Liquidity 10% Capital Improvement Plan
V. Budgetary Performance 10% Investment Policy and Reporting
VI. Budgetary Flexibility 10% Debt Management Policy
VII. Debt & Contingent Liabilities 10% Reserve (Fund Balance) Policy
* Illinois municipalities that are home rule receive a “2” (Strong)Illinois municipalities that are non-home rule, but subject to PTELL also receive a “2” (Strong)Illinois municipalities that are non-home rule, and not subject to PTELL receive a “3” (Adequate)
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S&P RATING SCORECARD
The above scorecard is a baseline analysis that utilizes a scoring methodology as set forth by S&P Global Ratings and is an indicator only. It consists of several key quantitative elements used in credit analysis; however, it is neither a rating calculator nor does it consider all factors that affect the rating outcome.
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• Does the issuer have… – A fund balance policy? – A debt policy? – A capital improvement plan with needs and funding
sources identified that is updated annually? – Long range financial projections?
• How often does the administration provide a report on investment holdings to the governing body (at least quarterly is suggested)?
• How often does the administration report on intra-year trends in revenues and expenditures?
• Is the budget amended and for what reasons?
STEPS TO ADDRESS WELL
BEFORE THE NEXT RATING REVIEW
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• Educate the governing board on pension related liabilities and the consequences of deferring tough decisions (see State of Illinois and the City of Chicago)
– Establish policies and procedures
• If pension/OPEB liabilities are increasing, create a credible plan to address the
liabilities especially if trends are worsening
• Make additional contributions to reduce net pension liabilities – Utilize excess fund balances – Borrow tax exempt for capital expenditures in lieu of using funds on hand to
pay capital expenditures
• Both rating agencies give credit to governments that begin to prefund OPEB
liabilities
HOW TO ADDRESS LONG-TERM
BENEFIT LIABILITIES IN THE NEAR TERM?
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• Describe the development that is taking place
• Talk to the assessor(s) about expected EAV trends
• Know the status of significant property tax appeals (PTAB)
• Understand your OPEB and pension liabilities and have a credible management plan
• Disclose direct-purchase debt (avoid onerous covenants like acceleration)
• Be ready to explain revenue raising flexibility – Know what untapped revenue sources are in $$
– Discuss willingness and history of raising revenues
• Be prepared to address prior deficits and causes
• Be prepared to provide year-to-date budget-to-actual numbers
WHAT INFORMATION TO KNOW
FOR THE RATING REVIEW NOT IN THE CAFR OR OS?
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• Provides a rating agency with an opportunity to make credit ratings do not become “stale” – Accountability to the investor community – Regulations and policy require at least a “Passive” review
annually
• Frequency of “Active” surveillance may vary, but it is
happening much more often than before
• The issuer is provided a list of questions – It’s important to be responsive – Typically given a couple weeks to prepare for the call
WHAT IS A SURVEILLANCE CALL?
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• Treat the surveillance call like a rating presentation for a bond sale – Take time to prepare detailed responses to each
question
• Talk the analyst through your written responses
• Consult with your financial advisor as soon as you
receive the email or phone call requesting the surveillance call
SURVEILLANCE CALL BEST PRACTICES
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• Has the issuer done everything communicated the during the last rating review? – Review the most recent rating report – Be prepared to address differences
• What circumstances have changed since the last
rating review?
• Has anything made it difficult to achieve what was anticipated during the last rating review?
SURVEILLANCE CALL CONSIDERATIONS
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