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A B C s of Issuing Debt

A B C s of Issuing Debt. Ron Queen CGFM , CPA. General Information. Carver Mead, PhD. ''It's easy to have a complicated idea. It's very, very hard to have a simple idea.'' - Carver Mead, PhD – prophet, a genius and one of the founding fathers of information technology. Debt Policies.

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A B C s of Issuing Debt

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  1. ABCs of Issuing Debt Ron Queen CGFM, CPA

  2. General Information

  3. Carver Mead, PhD • ''It's easy to have a complicated idea. It's very, very hard to have a simple idea.'' - Carver Mead, PhD – prophet, a genius and one of the founding fathers of information technology

  4. Debt Policies Debt Management Policies are written guidelines and restrictions that affect the amount and type of debt issued by a government, the issuance process, and the management of a debt portfolio. A debt management policy improves the quality of decisions, provides justification for the structure of debt issuance, identifies policy goals, and demonstrates a commitment to long-term financial planning, including a multi-year capital plan. Adherence to a debt management policy signals to rating agencies and the capital markets that a government is well managed and should meet its obligations in a timely manner. • Source: GFOA Recommended Practices – Debt Management Policy

  5. Debt Financing • Bonds • Notes & Interfund Loans • Capital Leases • Loan Agreements

  6. Definitions • Bond – A certificate or evidence of debt on which the issuing governmental body promises to pay the bondholders a specified amount of interest for a specified length of time, and to repay the loan based on a predetermined amortization schedule.

  7. Definitions Types of Bonds • Serial Bond - Bond issue consisting of a number of bonds with different maturity dates. Bonds are issued at the same time. • Term Bond – The combination of two or more serial maturities into a single maturity. Normally, created in the latter years of an issue.

  8. Definitions • Note – An instrument containing an express and absolute promise of the maker to pay a specified person, order, or bearer, a definite sum of money at a specified time. • Loan Agreement – In Tennessee, a borrowing between a local government and a Public Building Authority. A Public Building Authority issues the actual bonds.

  9. Definitions Capital Lease - A lease that meets one or more of the following criteria (FASBS 13): • Lease term is greater than 75% of the property's estimated economic life • Bargain purchase option • Transfer of ownership at end of lease term • PV of minimum lease payments >= 90% of FMV of asset

  10. Players in Debt Issuance • Issuer – Local Government • Professionals • Financial Advisor - Business & Economic Advisor • Attorneys – Opinions and Compliance with Tax and State and Federal Securities Law • Underwriter – Securities Issues – Sales Force • Paying Agent/Registrar – Pays Bondholders and Deals with Secondary Market Trades • Trustee – Monitors compliance of the use of debt proceeds for Bondholders • Credit Rating Agency – Gives an Opinion on Credit Quality

  11. Players in Debt Issuance • Banks – Bank Loans • Holders of Municipal Securities(Second Quarter 2003) • Households - 35.2% • Mutual Funds - 15.7% • Money Market Funds – 16.2% • Closed-End Funds – 4.9% • Bank Personal Trusts – 5.3% • Commercial Banks -6.9% • Property & Casualty Insurance Companies -10.4% • Other – 5.3% Source: The Bond Market Association

  12. Players in Debt Issuance • State of Tennessee loan programs • Tennessee local development authority (TLDA) • State revolving fund loan programs TDEC • Clean water state revolving fund loan program • Drinking water state revolving fund loan program • Local government energy efficiency loan program TECD • Utility relocation loan program TDOT [TDEC and TLDA] • Qualified zone academy bond program TDE

  13. Debt Issuance Steps

  14. Debt Issuance Steps • Identify the Project • Decision to Finance a Project • Structuring of the Instrument • Preparation and Sale of the Instrument • After the Sale

  15. Steps to a Debt Issue Post Sale Activities Debt Closing Debt Sale and Marketing Preparation of Debt Documents Selecting the Method of Sale Structuring the Debt Issue Selection of Financing Method Assessment of Capital Needs Debt Issuance Steps

  16. Decision to Finance a Project

  17. Decision to Finance a Project • Use a CIP to Determine Projects to be Funded • Determine Project Cost • Determine Financing Method (Debt) • Create Request For Proposal for Financial Advisor • Select Financial Advisor & Related Professionals

  18. Decision to Finance a Project CAPITAL IMPROVEMENT PROGRAM (CIP) A CIP is a multiyear plan –usually five or six years – identifying capital projects to be funded during the planning period. The CIP identifies each proposed capital project to be undertaken, the year in which it will be started or acquired, the amount expected to be expended on each project each year and the proposed method of financing. • Source: Capital Improvement Programming: A Guide for Smaller Governments

  19. CAPITAL IMPROVEMENT PLANSeven Steps • Establish Capital Improvement Policies • Perform a Capital Inventory • Adopt Standards to Rank Project Requests • Identify Projects • Assess Funding Sources • Develop the CIP • Approve CIP and Budget • Source: Debt Issuance and Management: A Guide for Smaller Governments

  20. Capital Planning ProcessAssess Funding Sources • Pay-As-You-Go Financing • Investments • Intergovernmental Revenues (Grants, Other State & Federal Revenues) • Debt Financing • Public/Private Ventures • External Capital Contributions from Private Sources

  21. Financing Plan • A. General Fund Versus Enterprise Fund-General Questions • Available net revenue for debt service. • Is this a cash flow contributing project? • Existing versus new revenue sources? • B. Details on Financing Plan? • Role of Credit Enhancement (Bond insurance, letter of credit, etc.) • Rated versus non rated • Repayment Plan • Construction Schedule (Capitalized interest, investment program) • Historical and projected debt service coverage • Reliability of pledged revenues • Sunset on pledged revenues • Do I need a referendum? (general obligation, sales tax, county surtax, etc.)

  22. Financing Plan • B. Details on Financing Plan? (continued) • If enterprise, existing rate structure? (rate study/feasibility study, “believable” projections) • Contingencies • Tax issues 1) Ability to borrow 2) Substantive project (no ghost $) 3) “Arbitrage” considerations

  23. Bob Hope • "A bank is a place that will lend you money if you can prove that you don't need it." - Bob Hope

  24. Structuring of the Instrument

  25. Structuring of the Instrument • Form of Security • Sizing the Issue • Maturity Structure • Call Provision

  26. Structuring of the Instrument:Elements of A Traditional Municipal Security

  27. Structuring of the Instrument Form of Debt • Security • General Obligation • Tax and Revenue – Revenue Producing Project • Special Assessment Bonds • Revenue (Limited Liability) – Revenue Producing Project • Maturity – consider life of project

  28. Structuring of the Instrument Type of Debt • Bonds • Notes • Lease-Purchase Obligations

  29. Structuring of the Instrument Considerations in Selection of Instrument • Able to raise money for a project or a refunding in a timely manner, • to minimize the cost of the money raised, and • to minimize the legal and financial risks inherent in the financing structure.

  30. Structuring of the Instrument Sizing the Issue (Par Amount of Bonds) • Debt Proceeds Sufficient to Meet Estimated Project Costs • Capitalization of Certain Costs • Costs of Issuance • Interest Costs • Required Reserved Fund • Rounding Amount

  31. Structuring of the Instrument Considerations in Developing Maturity Structure Flow of Funds • When revenues are available • Taxes • Gross or net revenues 2. Types of funds • Revenue • Operation and maintenance

  32. Structuring of the Instrument: Considerations in Maturity Structure Flow of Funds –Types of Funds • Revenue • Operation and Maintenance • Debt Service • Debt Service Reserve • Repair and Replacement • Depreciation Reserve • Surplus • Construction or Project

  33. Structuring of the Instrument • Considerations in Developing Maturity Structure • Repayment Structure • Interest Payment • Current Interest • Capitalized Interest (Enterprise Funds Only) • Principal Repayment • Serial Bonds • Term Bonds • Interest Rate – Variable or Fixed

  34. Structuring of the Instrument Considerations in Developing Maturity Structure Repayment Structure – Call Feature • Optional Redemption (Call Option) – When and at what price (call premium and premium rate) • Mandatory • Extraordinary Call Provision

  35. Structuring of the Instrument Considerations in Developing Maturity Structure Miscellaneous Issues • Original Issue Discount • Premium Sale • Investment of Proceeds • Type of Sale

  36. Structuring of the Instrument Maturity Structure • Fixed-Rate Debt Service Structures • Level Principal Maturity Schedule • Level Debt Service Schedule • Graduated Principal Reduction • Deferred Principal

  37. Structuring of the Instrument Fixed Rate Debt • Advantages • The Fixed-Rate Relieves the Issuer of Any Concern That Rates Will Increase Beyond Its Ability to Pay. • Budget Estimates are Certain for the Entire Life of the Instrument. • Allows Issuer to Lock in Current Interest Rate • Protection Against Rising Interest Rates • Disadvantages • Interest Rate Determined on the Longer End of the Yield Curve • Locked in higher rate in falling interest rate market • Lack of flexibility

  38. Structuring of the Instrument • Maturity Structure • Variable-Rate Debt Service Structures • Level Principal Schedule • Graduated Principal Reduction • Deferred Principal

  39. Structuring of the Instrument Variable-Rate Debt • Advantages • Takes Advantage of Low Rates on Short-End of Yield Curve • Better Asset-Liability Management • Very Low Rates in Current Environment • Redemption or Principal Payment Reduction with 30 to 90 Days Notice • Disadvantages • Remarketing Risk • Interest Rate Risk • Ongoing Monitoring of Market Rates to Remarketing Rates

  40. Marketing and Selling the Instrument

  41. Preparation and Selling of the Instrument • Legal Issues/Bond Documents • Choosing the Method of Sale • Meeting with the Rating Agencies • Deciding on the Use of Credit Enhancements • Pricing and Sale of Bonds

  42. Legal Issues/Bond Documents • State Law – Authorization • Federal and State Securities Law - Marketability • Federal Tax Law – Tax-Exempt Status Legal Issues and Documents responsibility of attorneys: Bond Counsel, Underwriter’s Counsel Issuer’s Counsel, and Trustee’s Counsel

  43. State Law • Authorizing Statutes • Other Constitutional Provisions and Statutes (e.g. open meetings, usury, debt limitation, restrictions on lending credit, etc.) • Local laws

  44. Federal and State Securities Law • SEC Rule 15c2-12 and Municipal Securities Review Board (MSRB) Rules • Disclosure Obligation/Continuing Disclosure • State “Blue Sky” Laws

  45. Responsibility of Attorneys • Bond Counsel • Ensure compliance with federal, state, and local laws • Draft legal documents (resolution/indenture, notice of sale or Bond Purchase Agreement, tax documents, and if applicable Escrow Agreement) • Render opinion regarding exclusion of interest from federal income tax, and if applicable state and local taxes • Limited focus on disclosure and feasibility

  46. Responsibility of Attorneys • Underwriter’s Counsel • Ensure Compliance with Securities Law • Prepare Disclosure and Underwriting Documents • Conduct “due diligence”

  47. Bond Documents • Initial GO Bond Resolution • Notice • Protest Provision for GO Bonds • Revenue Bond Issuance (after Bond Resolution) • Bond Resolution (Revenue & GO) • Disclosure Documents • Official Statement [Preliminary (Red Herring) & Final] • Rule 15c2-12

  48. Bond Documents • Negotiated Sale • Bond Purchase Agreement between issuer and underwriters • Representations and warranties • Certificates and opinions – closing conditions • Competitive • Notice of Sale and Bid Form • Basis of Award

  49. Method of Sale Factors to be considered in method of sale • Investor familiarity with issuer • Credit Quality • Complexity of the issue • Issue size • Market conditions

  50. Method of Sale Competitive Sale: The issuer employs a financial advisor and bond counsel who structure the financing, prepare the legal documents and advertise the sale on a low bid basis. A bid form is signed by the issuer after approval from the legislative body.

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