debt structuring debt essentials: accessing the market california debt and investment advisory...
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Debt StructuringDebt Essentials: Accessing the MarketCalifornia Debt and Investment Advisory Commission
February 2, 2011
Scott Nagelson, Managing [email protected], 415.229.1428
2
Introduction
At this point, the Issuer has made several decisions:
Identified a need to borrow money
Identified a revenue stream to pay debt service
Assembled a finance team
Bond counsel/Disclosure counsel
Investment banker
Financial advisor
It’s now time to STRUCTURE THE FINANCING!
3
Topics
Types of Debt Obligations
Sizing the Bond Issue
Debt Service Structure
Refunding Bonds
Ratings
Credit Enhancement
Variable Rate Debt
Managing Interest Rate Swaps
4
Types of Debt Obligations
There are many types of debt that California governments issue:
General Obligation Bonds
TRANs
Lease Revenue Bonds
Certificates of Participations
Revenue Bonds
Sales Tax Bonds
Pension Bonds
Special Tax Bonds
Tax Allocation Bonds
Assessment Bonds
5
Types of Debt Obligations
The type of debt being issued can directly affect the structure of the bond issue
Reserve Fund Requirement
Additional Bonds Test
Debt Service Coverage Requirements
Term
Tax Treatment
Call Features
Leased Assets
6
Sizing the Bond Issue
Project or Construction Fund
Capitalized Interest Fund
Debt Service Reserve Fund
Costs of Issuance
Underwriting Discount
Depending on the type of debt and the nature of the plan of finance, proceeds of the bonds may be used for a number of purposes
Refunding Escrow
7
The Project Fund
Fund acquisition of the asset or construction of the project
Based on actual costs or reliable estimates
Net Funded or Gross Funded?
Gross Funded – Deposit exact amount required to pay for asset or project
Net Funded – Amount deposited plus interest earnings during the drawdown period sufficient to fund project
8
Refunding Escrow
Refinance outstanding bonds
Current refunding or advance refunding
An amount of proceeds sufficient to pay principal and interest on the prior bonds is deposited into an escrow account
Escrowed funds are used to pay off the prior bonds at the call date or maturity
9
The Capitalized Interest Fund
Bonds proceeds used to pay interest for a finite period of time
Interest is capitalized for a number of reasons
Until a project/asset can produce revenue
Until the issuer has beneficial use (COPs, Lease Revenue Bonds)
Until revenue is projected to be sufficient to pay debt service
2012 20132011
Jan 1
Bonds Issued
Jul 1 Jan 1 Jul 1 Jan 1 Jul 1
Int Pmt Date
Int Pmt Date
Int Pmt Date
Int Pmt Date
Int Pmt Date
Project Construction Period
Interest Paid From Bond Proceeds
10
The Debt Service Reserve Fund
Provides additional security for investors
Found in most credits with the exception of GO Bonds and Pension Obligation Bonds
Tax Code limits the size of the Reserve Fund to the lesser of:
Maximum Annual Debt Service
125% of Average Annual Debt Service
10% of Par Amount
Fund is invested with earnings usually going as an offset to debt service
Debt Service Reserve Fund Surety Policy
11
Costs of Issuance
Bond proceeds may be used to pay certain eligible costs
Bond Counsel and/or Disclosure Counsel
Financial Advisor and Trustee/Paying Agent
Rating Agencies
Appraisal, Feasibility Study, Engineer’s Report
Special Tax Consultant
Title Insurance
Bond Insurance and/or Surety Bond Premium
Letter of Credit fees
Professional
Services
Professional
Services
CreditEnhanceme
nt
CreditEnhanceme
nt
12
Underwriting Discount
Underwriter’s compensation and expenses
Average Takedown
Management Fee
Expenses
At closing, Underwriter pays for bonds an
amount less the underwriting discount
$100,000,000 Par
(650,000) Less discount of 6.50/$1,000
$ 99,350,000 Purchase Price
Expressed as dollars per thousand dollars
of bonds (e.g., $6.50/$1,000)
Components
Components
FundingMethod
FundingMethod
13
Sizing Example
Net Funded Construction Fund
Capitalized Interest Fund
Debt Service Reserve Fund
Costs of Issuance
Underwriting Discount
14
Sizing Assumptions – Ammonia Springs Clean Water Authority
4/1/2011 $ 10,000,000
10/1/2011 $ 10,000,000
4/1/2012 $ 10,000,000
10/1/2012 $ 10,000,000
$ 40,000,000 Total Project Cost
Project Cost and Draw ScheduleProject Cost and Draw Schedule
Bonds Dated: 1/1/2011Bonds Dated: 1/1/2011
Final Maturity: 1/1/2041Final Maturity: 1/1/2041
15
Sizing Assumptions – Ammonia Springs Clean Water Authority
$200,000 Legal, FA, TrusteeRatings, Printing, Misc.
40bps Bond Insurance Premium(Total Debt Service
x .40%)
$6.50/bond Takedown, Management Fee,
Expenses
Costs of IssuanceCosts of Issuance
Bonds InsuranceBonds Insurance
Underwriting DiscountUnderwriting Discount
16
Sizing Assumptions – Ammonia Springs Clean Water Authority
Lesser of:
Maximum Annual Debt Service
125% of Average Annual Debt Service
10% of Par Amount
Through 2-year Construction Period1/1/2013
Debt Service Reserve FundDebt Service Reserve Fund
Capitalized InterestCapitalized Interest
17
Sizing Assumptions – Ammonia Springs Clean Water Authority
Fund Rate Earnings Go To:
Capitalized 2.50% ConstructionInterest FundFund:
Construction 2.50%Construction
Fund: Fund
Debt Service 5.0%Construction
Reserve (Bond FundFund: Yield)
Reinvestment
Assumptions
Reinvestment
Assumptions
18
Sizing Example – Net Funded Project Fund
Sources of Funds:
Par Amount: $ 46,390,000
Total Sources of Funds: $ 46,390,000
Uses of Funds:
Project Fund $ 38,723,636
Cap Interest Fund: $ 4,008,591Debt Service
Reserve Fund: $ 2,795,850
Bond Insurance: $ 357,550
COI: $ 200,000
Underwriter’sDiscount: $ 301,535
Rounding: $ 2,838
Total Uses of Funds: $ 46,390,000
1/1/2011 Initial Deposit: $ 38,723,636
Project Fund Earnings $ 968,704
Cap Interest Fund Earnings $ 112,609
Debt Service ReserveFund Earnings $ 195,051
Total Project Cost $ 40,000,000
19
Sizing Example – Capitalized Interest Fund
Sources of Funds:
Par Amount: $ 46,390,000
Total Sources of Funds: $ 46,390,000
Uses of Funds:
Project Fund $ 38,723,636
Cap Interest Fund: $ 4,008,591
Debt Service
Reserve Fund: $ 2,795,850
Bond Insurance: $ 357,550
COI: $ 200,000
Underwriter’sDiscount: $ 301,535
Rounding: $ 2,838
Total Uses of Funds: $ 46,390,000
1/1/2011 Initial Deposit: $ 4,008,591
7/1/11 Interest Payment ($ 1,005,697)
1/1/12 Interest Payment ($ 1,005,697)
7/1/12 Interest Payment ($ 998,599)
1/1/13 Interest Payment ($ 998,599)
Fund Balance on 1/1/13 $ 0
20
Sizing Example – Debt Service Reserve Fund
Sources of Funds:
Par Amount: $ 46,390,000
Total Sources of Funds: $ 46,390,000
Uses of Funds:
Project Fund $ 38,723,636
Cap Interest Fund: $ 4,008,591
Debt ServiceReserve Fund: $ 2,795,850
Bond Insurance: $ 357,550
COI: $ 200,000
Underwriter’sDiscount: $ 301,535
Rounding: $ 2,838
Total Uses of Funds: $ 46,390,000
Lesser of:
Maximum Annual Debt Service $ 2,795,850
125% of AverageAnnual Debt Service $ 3,491,698
10% of Par Amount $ 4,639,000
21
Sizing Example – Bond Insurance Premium
Sources of Funds:
Par Amount: $ 46,390,000
Total Sources of Funds: $ 46,390,000
Uses of Funds:
Project Fund $ 38,723,636
Cap Interest Fund: $ 4,008,591
Debt ServiceReserve Fund: $ 2,795,850
Bond Insurance: $ 357,550
COI: $ 200,000
Underwriter’sDiscount: $ 301,535
Rounding: $ 2,838
Total Uses of Funds: $ 46,390,000
Total Principal & Interest $89,387,448
x.40%
Bond Insurance Premium $ 357,550
22
Sizing Example – Costs of Issuance
Sources of Funds:
Par Amount: $ 46,390,000
Total Sources of Funds: $ 46,390,000
Uses of Funds:
Project Fund $ 38,723,636
Cap Interest Fund: $ 4,008,591
Debt ServiceReserve Fund: $ 2,795,850
Bond Insurance: $ 357,550
COI: $ 200,000
Underwriter’sDiscount: $ 301,535
Rounding: $ 2,838
Total Uses of Funds: $ 46,390,000
Costs of Issuance:
Bond Counsel: $100,000
Financial Advisor: $ 50,000
Trustee: $ 5,000
Rating Agencies: $ 30,000
Printing: $ 7,500
Miscellaneous: $ 7,500
Total COI: $200,000
23
Sizing Example – Underwriting Discount
Sources of Funds:
Par Amount: $ 46,390,000
Total Sources of Funds: $ 46,390,000
Uses of Funds:
Project Fund $ 38,723,636
Cap Interest Fund: $ 4,008,591
Debt ServiceReserve Fund: $ 2,795,850
Bond Insurance: $ 357,550
COI: $ 200,000
Underwriter’sDiscount: $ 301,535
Rounding: $ 2,838
Total Uses of Funds: $ 46,390,000
Underwriting Discount:
Takedown: ($3.50/bond): $ 162,365
Management Fee($1.00/bond): $ 46,390
Expenses: ($2.00/bond): $ 92,780
Underwriter’s Discount ($6.50/bond): $301,535
24
Debt Service Structure
Sample Structures
Current Interest vs. Deferred Interest
Optional Redemption
Refunding Considerations
25
Level Debt Service
DSRF Implications
Lesser of:
Maximum AnnualDebt Service $ 2,795,850
125% of AverageAnnual Debt Service $ 3,491,698
10% of Par Amount $ 4,630,000
Bond Insurance Implications
Total Principal & Interest: $ 89,387,448
x.40%
Insurance Premium $ 357,550
DSRF ImplicationsBond Insurance
Implications
$0
$1
$2
$3
$4
$5
$6
$7
Millions
$46,390,000AmmoniaSprings Clean Water Authority
Revenue Bonds
26
“Wrapped” Debt Service
DSRF Implications
Lesser of:
Maximum AnnualDebt Service $ 4,469,658
125% of AverageAnnual Debt Service $ 4,144,838
10% of Par Amount $ 4,825,500
Bond Insurance Implications
Total Principal & Interest: $106,107,854
x.40%
Insurance Premium $ 424,431
DSRF ImplicationsBond Insurance
Implications
$0
$1
$2
$3
$4
$5
$6
$7
Millions
$48,255,000AmmoniaSprings Clean Water Authority
Revenue Bonds
27
Short Maturity
DSRF Implications
Lesser of:
Maximum AnnualDebt Service $ 6,041,629
125% of AverageAnnual Debt Service $ 4,144,838
10% of Par Amount $ 4,825,500
Bond Insurance Implications
Total Principal & Interest: $ 54,359,382
x.40%
Insurance Premium $ 217,438
DSRF ImplicationsBond Insurance
Implications
$0
$1
$2
$3
$4
$5
$6
$7
Millions
$46,630,000AmmoniaSprings Clean Water Authority
Revenue Bonds
28
Structuring the Bonds
Serial Bonds
Mature “serially” by year
Take advantage of positively sloped yield curve
Term Bonds
Single coupon covering multiple years
Retired with annual Sinking Fund Payments
Maturity Schedule
Maturity
(Jan 1)
Principal
Amount
Interest
Rate Yield
2012 780,000 1.820% 1.820%
2013 795,000 2.070% 2.070%
2014 815,000 2.370% 2.370%
2015 830,000 2.670% 2.670%
2016 855,000 3.020% 3.020%
2017 880,000 3.220% 3.220%
2018 910,000 3.370% 3.370%
2019 940,000 3.520% 3.520%
2020 970,000 3.630% 3.630%
2021 1,005,000 3.740% 3.740%
2022 1,045,000 3.840% 3.840%
2023 1,085,000 3.940% 3.940%
2024 1,130,000 4.030% 4.030%
2025 1,175,000 4.110% 4.110%
2026 1,220,000 4.180% 4.180%
2027 1,275,000 4.270% 4.270%
2028 1,325,000 4.350% 4.350%
$7,610,000 4.72% Term Bonds maturing J anuary 1, 2033
$9,600,000 4.81% Term Bonds maturing J anuary 1, 2038
$12,145,000 4.84% Term Bonds maturing J anuary 1, 2041
$46,390,000
Ammonia Springs Clean Water Authority
Water Revenue Bonds
Dated: January 1, 2011 Due: January 1, 2041
29
Current or Deferred Interest Bonds
Current Interest Bonds
Pay interest at stated coupon
Interest typically paid every 6 months
May be sold at par, at a premium or at a discount
Investor’s yield determined by price paid for the Bond
$0
$100
$200
$300
$400
$500
$600
$700
$800
$900
Thousands
Principal
Interest
30
Current or Deferred Interest Bonds
Capital Appreciation Bonds
“Zero” coupon or deferred interest bonds
Interest accretes to maturity
Sold at a deep discount
Investor’s yield determined by price paid for the Bond
$0
$100
$200
$300
$400
$500
$600
$700
$800
$900
Thousands
31
Other Considerations
Optional Redemption
Standard optional redemption period is 10 years
Callable bonds generally have a higher yield than non-callable bonds
Par Bonds, Original Issue Discount Bonds, and Original Issue Premium Bonds
Coupon Yield Price
Par Bond 5.00% 5.00% 100%
Discount Bond 5.00% 5.10% 98% (est)
Premium Bond 5.00% 4.90% 100.9% (est)
32
Refunding Considerations
Advance Refunding
Old Bonds are not currently subject to optional redemption
New Bond proceeds are used to fund an escrow that defeases old bonds to call date
Escrow invested in Treasury (SLGs) with maximum permitted yield equal to bond arbitrage yield
Can only advance refund one time
Current Refunding
Old Bonds are currently subject to optional redemption
New Bond proceeds are used to redeem old bonds
33
Ratings and Credit Enhancement
The Rating Agencies
Obtaining a Rating
Bond Insurance
34
The Rating Agencies
Aaa AAA AAAAa1, Aa2, Aa3 AA+, AA, AA- AA+, AA,
AA-A1, A2, A3 A+, A, A- A+, A, A-Baa1, Baa2, Baa3 BBB+, BBB, BBB- BBB+, BBB, BBB-Ba1, Ba2, Ba3 BB+, BB, BB- BB+, BB,
BB-
MIG-1, MIG-2, MIG-3 SP-1+, SP-1, SP-2 F-1+, F-1, F-2, F-3(Notes) (Notes) (Notes)
VMIG-1, VMIG-2, A-1, A-2, A-3 LOC (Commercial Paper
VMIG-3 (Commercial (Commercial and VRDBs)Paper and VRDBs) Paper and VRDBs)
Lon
g-T
erm
Lon
g-T
erm
Sh
ort
-Term
Sh
ort
-Term
35
Obtaining a Rating
A typical rating agency package might include:
3 years of audited financial statements
Current and proposed budget
Bond Documents, including:
Trust Indentures
Lease Agreements
Installment Sale Agreements
Redevelopment Loan Agreements
Preliminary Official Statement
Special Reports
Sizing and Debt Service Schedules
Timing and Responsibility Schedule
Distribution List
36
Obtaining a Rating
It is often useful to meet with the rating analysts to:
Describe the project
Get feedback on the structure
Describe salient aspects of security
Review demographics and economics of service area
On-site or at rating agency offices
37
Bond Insurance - The Good Old Days
Once upon a time, bond insurance was readily available and widely used
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
$500
Billion
s
Insured Uninsured
Total Municipal Issuance 2001-2010
38
Bond Insurance - A More Limited Role
2007 Top Bond Insurers
Rank Bond Insurer
Par Amt
($mil)
Number of
Issues
1 FSA 48,988.5 1,702
2 AMBAC 48,859.1 1,081
3 MBIA Insurance Corporation 46,398.2 1,037
4 FGIC 30,712.4 375
5 XL Capital Assurance Inc. 13,654.5 587
6 CIFG NA 4,927.1 351
7 Assured Guaranty 3,729.6 144
8 Radian Asset Assurance Inc 2,375.4 207
9 ACA Financial Guaranty Corp 648.7 31
2010 Top Bond Insurers
Rank Bond Insurer
Par Amt
($mil) # Issues
1 Assured Guaranty/ AGM 26,769.7 1,700
In 2008, most of the insurers lost their “AAA” ratings due to losses associated with sub-prime mortgage bond insurance
Today, only AGM is active with “AA” category ratings
39
Variable Rate Bonds
Historical Interest Rates
Structuring Options
Pros and Cons of Alternative Structures
Managing Interest Rate Swaps
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
SIFMA
RBI Index
40
Variable Rate vs. Fixed Rate
Securities Industry and Financial Markets Association (SIFMA) Index (formerly BMA)
vs. Bond Buyer Revenue Bond Index (RBI)
A Ten Year History
SIFMA 10 Year Avg = 1.89%
RBI 10 Year Avg = 5.13%
41
Pros vs. Cons of Variable Rate Structures
CONS
Less flexibility to refinance
Historically higher cost
Poor hedge for floating rate assets
Interest rates may rise
Takes more time to manage
Bank renewal and trading risk
More challenging to budget
PROS
No interest rate risk
Easier to budget
Less time to manage
Historically lower cost
Easier to restructure/refinance
Hedge for floating rate assets
Fix
ed
Rate
Fix
ed
Rate
Vari
ab
le R
ate
Vari
ab
le R
ate
PROSPROS CONSCONS
42
Variable Rate Issuance over Time
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
Billion
s
Variable Fixed-Rate
Total Municipal Issuance 2001-2010
43
Introduction to Variable Rate Structures
Historically, there have been a number of ways for issuers to achieve variable rate exposure in the municipal market
Commercial Paper
Variable Rate Demand Bonds
Auction Rate Securities
Indexed Floaters
Fixed Receiver Swaps
44
Variable Rate Structuring Options
Commercial Paper
Can be drawn down and paid back as needed
Outstanding CP is remarketed for a maximum of 270 days
Bank credit facility required for liquidity
Money Market Funds are the primary investor
Often used to fund construction draws and then taken out with long-term bonds
Interest rate determined by CP
45
Variable Rate Structuring Options
Variable Rate Demand Bonds
Long-term bond with rate that resets periodically (daily, weekly, monthly, etc.)
Investor can “put” bonds on short notice (allows bond to trade at par)
Bank credit facility required to support put
Interest rate determined by Remarketing Agent
46
Credit Facilities
2007 Top Letter of Credit Providers
Rank Firm Amount Issues
1 Bank of America 2,364.6 101
2 J P Morgan Chase 2,340.6 85
3 Wells Fargo Bank 1,688.6 98
4 SunTrust Bank 1,354.4 57
5 Regions Bank 1,295.8 42
6 The Bank of New York Mellon 1,024.8 60
7 LaSalle Bank 955.1 40
8 US Bank 821.8 77
9 KeyBanc 814.0 40
10 Sovereign Bank 699.8 29
2010 Top Letter of Credit Providers
Rank Firm Amount Issues
1 J P Morgan Chase 2,852.4 38
2 Bank of America 2,278.4 36
3 Wells Fargo Bank 837.2 28
4 Barclays Bank PLC 483.7 5
5 PNC Bank NA 458.3 11
6 TD Bank NA 326.9 6
7 Citibank 257.3 5
8 Union Bank NA 255.8 7
9 RBS Citizens NA 193.1 2
10 SunTrust Bank 185.0 2
Bank Credit capacity has been constrained since 2008
Fewer banks with less capital has driven LOC pricing to high levels
Approximately $80 billion of bank credit facilities supporting variable rate bonds will be up for renewal in 2011
47
Variable Rate Structuring Options
Indexed Floating Rate Bonds
Interest rate resets based on an index (i.e. SIFMA or LIBOR)
Rate typically based on a spread over the index (i.e. SIFMA + 50 bps)
No need for a Remarketing Agent
Investor does not have a put, so no need for a bank credit facility
Index period is typically less than 5 years. At the end of the index period, the issuer remarkets the bond for another index period or switches to a different variable rate mode
48
Variable Rate Structuring Options
Auction Rate Securities
Long-term bond with rate that resets periodically (weekly, monthly, etc.)
No “put” feature and thus, no bank facility
Rate reset via Dutch Auction process
The ARS market died in 2008 with the demise of large scale bond insurance
49
Variable Rate Alternatives At-A-Glance
Summary of Variable Rate Alternatives
Managing Existing Interest Rate Swaps
Many issuers have converted floating rate bonds to synthetic fixed rate by entering into interest rate swaps
IssuerIssuerFixed rate Payment
Variable Rate Payment
CounterpartyCounterparty
Variable Rate Bonds
Variable Rate Bonds
Variable Rate Payment
50
Interest Rate Swaps Have a Number of Risks
Basis RiskSwap variable rate received and the actual bond variable rate does not match perfectly
• LOC bank is downgraded, causing bonds to trade at higher spread to SIFMA
• Market rates compress
Tax Event Risk
Changes in income tax rates alter the value of tax-exempt interest rates relative to taxable interest rates
• If tax rates go down, variable bond yield will go up
Counterparty Risk
Swap counterparty will not perform pursuant to the contract’s terms. For example if the swap provider defaults or its credit rating declines
• Lehman, DEPFA, AMBAC, UBS
Termination Risk
A material decline in credit worthiness could lead to a termination of the swap and require a payment to be made to or from the issuer depending on prevailing market conditions at the time of termination
• Negotiate favorable credit triggers and terms for collateral posting
• Monitor the mark to market value of the swap
51
If You Have an Interest Rate Swap…
Monitor the bank providing liquidity for the variable rate bonds
Rating
Expiration Date of credit facility
Trading characteristics
Monitor the performance of your Remarketing Agent
Monitor the credit rating of your swap counterparty
Monitor long-term interest rates
As rates go up, termination values should fall
May create an opportunity to terminate the swap
52
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