refunding opportunities in a rising rate...
TRANSCRIPT
REFUNDING OPPORTUNITIES IN A RISING RATE ENVIRONMENT
CALIFORNIA SOCIETY OF MUNICIPAL FINANCE OFFICERS
2016 Conference
Anaheim, California
Thursday, March 3, 2016
(4:00 – 5:30 p.m.)
Refunding Opportunities Panel
2016
Panelists
Nadia Sesay,
Director of the Office of Public Finance
City and County of San Francisco
David Brodsly
Financial Advisor
KNN Public Finance
Nikolai J. Sklaroff
Public Finance Investment Banker
Wells Fargo Securities
1
Refunding Opportunities Panel
2016
Introductions
Context: The Convergence of Rates
Current and Advance Refundings
Negative Arbitrage
When to Pull the Trigger
Competitive vs. Negotiated Refundings
Escrows and Investments
Assorted Topics
Audience Questions
Refunding Opportunities in a Rising Rate Environment
2
Refunding Opportunities Panel 3
CONTEXT: THE CONVERGENCE OF RATES
Refunding Opportunities Panel
2016
Rates are Near Lowest Levels in More than a Quarter Century
4
Source: Thompson Financial/Securities Data; as of February 10, 2016.
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
1991 1996 2001 2006 2011 2016
%
Current 2.68
Average 4.83
Maximum 7.00
Minimum 2.47
30 Year "AAA" MMD (%)
Tax exempt interest rates are again near 25 year lows, prompting interest in whether there are opportunities to refinance outstanding bonds.
25 Year History: 30-Year “AAA” MMD (%)
Refunding Opportunities Panel
2016
Convergence of Long-Term and Short-Term Interest Rates
5
Source: Thompson Financial/Securities Data; as of February 10, 2016.
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16
%
2Y UST 3Y UST 4Y UST
Higher Short-Term Rates Yield Curve Movement
Over the past year, long term borrowing ratings are trending lower…
But as a result of the December Federal Reserve Fed Funds Rate hike, short term taxable rates are higher
Although those too have backed off as a result of global economic concerns
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
1Y 5Y 10Y 15Y 20Y 25Y 30Y%
Today (February 2016)
December
One Year Ago (February 2015)
Refunding Opportunities Panel
2016
0
50
100
150
200
250
300
350
400
450
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
($ B
illions)
New Money Refunding Annual Average
As a Result Refunding Activity Has Grown Dramatically
6
While refunding activity has long been an important component of bond issuance in our industry, refunding activity grew dramatically in 2015
Annual Municipal Bond Volume*
Source: Bond Buyer: “A Decade of Municipal Bond Finance,” as of December 31, 2015. *Represents long-term issuance; excludes short-term notes and remarketings;
Refunding Opportunities Panel 7
CURRENT AND ADVANCE REFUNDINGS
Refunding Opportunities Panel
2016
Typical Structure: 30-Year Bonds with 10-Year Call
8
Source: Thompson Financial/Securities Data; as of February 10, 2016.
0.00
0.50
1.00
1.50
2.00
2.50
3.00
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
%
Current "AAA" MMD
10-year Call Date
Refunding Opportunities Panel
2016
At Call Date, “Roll Down” for Corresponding Maturity
9
Source: Thompson Financial/Securities Data; as of February 10, 2016.
0.00
0.50
1.00
1.50
2.00
2.50
3.00
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
%
Current "AAA" MMD Yield Curve at the Call Date
10-year Call Date
Assuming rates
unchanged for
10 years
Refunding Opportunities Panel
2016
With the “Roll Down” Comes Refunding Savings
10
Source: Thompson Financial/Securities Data; as of February 10, 2016.
0.00
0.50
1.00
1.50
2.00
2.50
3.00
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
%
Refunding Savings Current "AAA" MMD Yield Curve at the Call Date
10-year Call Date
Potential
Debt Service
Savings
Refunding Opportunities Panel
2016
Advance Refunding versus Current Refunding: No Rate Movement
11
Source: Thompson Financial/Securities Data; as of February 10, 2016.
If rates do not change, savings are greater waiting until the call date:
o Negative Arbitrage
o More Roll Down
0.00
0.50
1.00
1.50
2.00
2.50
3.00
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
%
Refunding Savings Current "AAA" MMD Yield Curve at the Call Date
10-year Call Date
0.00
0.50
1.00
1.50
2.00
2.50
3.00
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
%
Refunding Savings Current "AAA" MMD Yield Curve at the Call Date
10-year Call Date
Advance Refunding Two Years Prior to the Call Date Current Refunding at Call Date
NPV Savings
2.272%
NPV Savings
6.116%
Refunding Opportunities Panel
2016
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
%
Refunding Savings Current "AAA" MMD Yield Curve at the Call Date
10-year Call Date
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
%
Refunding Savings Current "AAA" MMD Yield Curve at the Call Date
10-year Call Date
Advance Refunding Two Years Prior to the Call Date Current Refunding at Call Date (Interest Rates Increase 100 bps)
Advance Refunding versus Current Refunding: 100 bps Increase
12
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Alas rates are dynamic and movements in rates can erode (or increase) savings
NPV Savings
2.272% NPV Savings
1.354%
Refunding Opportunities Panel 13
NEGATIVE ARBITRAGE
Refunding Opportunities Panel
2016
Negative Arbitrage: A History
14
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Borrowing Rates versus Investment Rates: 25 Years of History
In advance refunding, the proceeds are escrowed until the bonds are called
Negative arbitrage: Cost of paying long term tax exempt rates until the call date but not being able to recover the rate in escrow earnings
-6.00
-4.00
-2.00
0.00
2.00
4.00
6.00
8.00
10.00
1991 1996 2001 2006 2011 2016
%
Difference 15yr "AAA" MMD 2yr UST
Refunding Opportunities Panel
2016
Negative Arbitrage in the Context of Refundings
15
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Maturity SeriesCoupon
(%)
Refunded
Par ($)Call Date
NPV
Savings ($)
NPV
Savings (%)
Negative
Arbitrage ($)
Refunding
Efficiency
5/1/2019 2008 4.000% 10,000,000 5/1/2018 54,841 0.548% 79,593 40.74%
5/1/2020 2008 5.000% 10,000,000 5/1/2018 471,579 4.716% 73,465 86.51%
5/1/2021 2008 5.000% 10,000,000 5/1/2018 746,240 7.462% 107,871 87.37%
5/1/2022 2008 5.000% 10,000,000 5/1/2018 973,452 9.735% 150,608 86.60%
5/1/2023 2008 5.000% 10,000,000 5/1/2018 1,144,057 11.441% 195,224 85.42%
5/1/2024 2008 5.000% 10,000,000 5/1/2018 1,291,400 12.914% 231,192 84.82%
5/1/2025 2008 5.000% 10,000,000 5/1/2018 1,416,766 14.168% 264,886 84.25%
5/1/2026 2008 5.000% 10,000,000 5/1/2018 1,523,370 15.234% 294,260 83.81%
5/1/2027 2008 5.000% 10,000,000 5/1/2018 1,437,909 14.379% 315,177 82.02%
5/1/2028 2008 5.000% 10,000,000 5/1/2018 1,373,186 13.732% 331,874 80.54%
5/1/2029 2008 5.000% 10,000,000 5/1/2018 1,298,658 12.987% 350,636 78.74%
5/1/2030 2008 5.000% 10,000,000 5/1/2018 1,239,275 12.393% 365,182 77.24%
5/1/2031 2008 5.000% 10,000,000 5/1/2018 1,164,412 11.644% 383,844 75.21%
5/1/2032 2008 5.000% 10,000,000 5/1/2018 1,106,226 11.062% 398,346 73.52%
5/1/2033 2008 5.000% 10,000,000 5/1/2018 1,065,858 10.659% 408,689 72.28%
5/1/2034 2008 5.000% 10,000,000 5/1/2018 1,024,727 10.247% 419,004 70.98%
5/1/2035 2008 5.000% 10,000,000 5/1/2018 983,196 9.832% 429,314 69.61%
5/1/2036 2008 5.000% 10,000,000 5/1/2018 940,616 9.406% 439,617 68.15%
5/1/2037 2008 5.000% 10,000,000 5/1/2018 898,229 8.982% 449,914 66.63%
5/1/2038 2008 5.000% 10,000,000 5/1/2018 835,381 8.354% 460,183 64.48%
SAMPLE ISSUER
Series 2008 Refunding Savings by Maturity
Many issuers look at refundings as the relationship between savings and negative arbitrage on a maturity by maturity basis
Refunding Efficiency: (Savings) / (Savings + Negative Arbitrage)
Refunding Opportunities Panel 16
WHEN TO PULL THE TRIGGER
Refunding Opportunities Panel
2016
Interest Rate Expectations – A Year Ago
17
Source: Thompson Financial/Securities Data; as of February 9, 2015.
Federal Funds Rate Projections 30yr UST Rate Projections
Last summer, the market was awaiting the Fed to raise rates for the first time in many years, and was expected a long term trend of rising rates as reflecting the 50 economic forecasts tracked by Bloomberg.
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
1Q 2015 2Q 2015 3Q 2015 4Q 2015 1Q 2016 2Q 2016
Median Wells Fargo
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
1Q 2015 2Q 2015 3Q 2015 4Q 2015 1Q 2016 2Q 2016
Median Wells Fargo
Refunding Opportunities Panel
2016
Interest Rate Expectations – Today (“A Whole New World”)
18
Source: Thompson Financial/Securities Data; as of February 10, 2016.
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
1Q2016 2Q2016 3Q2016 4Q2016 1Q2017 2Q2017
Median High Low Wells Fargo
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
1Q2016 2Q2016 3Q2016 4Q2016 1Q2017 2Q2017
Median High Low Wells Fargo
Federal Funds Rate Projections 30yr UST Rate Projections
While the Fed increase did result in rising short term taxable rates, global concerns about the world economy have dramatically transformed rate expectations
Now economists expect short term rates to rise more steeply, while long term rates rise more modestly
Refunding Opportunities Panel
2016
Policy vs. Expectations: When to Pull the Trigger
19
Using San Francisco’s Debt Policies as an example. How to apply policy thresholds to dynamic markets? When to proceed with refunding?
Source: Debt Policy of the City and County of San Francisco, Controller’s Office of Public Finance, Last Update: June 2013
Refunding Opportunities Panel 20
COMPETITIVE VS. NEGOTIATED REFUNDING
Refunding Opportunities Panel
2016
The Great Competitive vs. Negotiated Sale Debate
21
Refunding Opportunities Panel
2016
California Trends: Competitive vs. Negotiated
22
Source: Thompson Reuters; revenue bonds issued by California City and County entities; as of December 31, 2015.
New Money Financings Refunding Financings
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Negotiated Competitive
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Negotiated Competitive
Most California City and County bonds are sold on a negotiated basis, but the the percentage has typically been even higher for refunding bonds, with nearly 80-90% of such bonds sold negotiated in the last four years.
Why consider one or the other?
Refunding Opportunities Panel
2016
What’s New About This Debate?
23
2015 characterized by extreme volatility due to low supply, changing demand and interest rate expectations and global events – timing matters!
Source: Bloomberg; as of December 31, 2016
“AAA” MMD Volatility during 2015
1.50
1.75
2.00
2.25
2.50
2.75
3.00
3.25
3.50
Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16
%
10yr "AAA" MMD 20yr "AAA" MMD 30yr "AAA" MMD
Refunding Opportunities Panel
2016
What’s New About This Debate?
24
Volatility, means risk to bidders.
Competitive underwriting fees sometimes higher than negotiated fees, as desks build in risk premium and numbers of bidders more limited
Source: Source: The Bond Buyer, "2015 in Statistics ,Midyear Review" & "2014 in Statistics, Annual Review“ *Represents underwriting spreads for competitive and negotiated municipal new issues issued from 1/1/1995 - 6/30/2015
Average Annual Gross Spread (1995 – Present)*
$3.50
$4.00
$4.50
$5.00
$5.50
$6.00
$6.50
$7.00
$7.50
$8.00
$8.50
$9.00Competitive
Negotiated
Refunding Opportunities Panel
2016
Negotiated vs. Competitive
25
Limited number of firms able to bid sizeable competitive sales
o According to Thomson Reuter’s, 2/3 of competitive bonds were purchased by only six firms in the first half of this year
oMany larger bids only get 4 to 6 bidders
Competitive underwriting fees sometimes higher than negotiated fees, as desks build in risk premium and numbers of bidders more limited
o According to the Bond Buyer, Competitive Sale underwriting fees have been higher than negotiated fees in four of the past five years*
While RFPs often focus on fees, they translate into a fraction of a basis point of cost for most long term sales – the key is rates…
Source: The Bond Buyer, "2015 in Statistics ,Midyear Review" & "2014 in Statistics, Annual Review“; Rankins sourced to Thomson Reuters *Represents underwriting spreads for competitive and negotiated municipal new issues issued from 1/1/2011 - 6/30/2015 (YTD)
Refunding Opportunities Panel
2016
Considerations
26
Greater flexibility in pricing date; ability to accelerate or delay as conditions warrant
Greater ability to manage couponing/structure and explore optimal options with buyers
Ability to pre-market bonds
Ability to target buyers – for example through Retail Order Periods, Priority of Orders, Designation Policies
Ability to move orders to different maturities, re-size based on demand, manage premium
Manage “Call Optionality” through managing coupons
Refunding Opportunities Panel 27
ESCROWS AND INVESTMENTS
Refunding Opportunities Panel
2016
Escrows and Investments
28
State and Local Government Series (“SLGS”)
Open Market Securities (“OMS”)
Cash
Bidding
Refunding Opportunities Panel 29
ASSORTED REFUNDING TOPICS
Refunding Opportunities Panel
2016
Debt Service Reserve Funds
30
The Disappearing Debt Service Reserve Fund
o Rating Agency Transparency
o Investor Appetite
o The “Drag” of Negative Arbitrage
o Reserve fund “alternatives”
But if a DSRF is Needed…
o Handling DSRF Sureties from “Fallen” Insurers
o Using New Sureties vs. Cash Funding a Reserve
Refunding Opportunities Panel
2016
Other Topics
31
Budgeting and Refunding Decisions
Debt Policies and Savings Thresholds
Build America Bonds / Taxable Bonds
Issues Unique To:
o General Obligation Bonds
o Lease Revenue Bonds and COPS
o Revenue Enterprise Bonds
oMello Roos and Assessment Bonds
o Tax Allocation Bonds
Refunding Opportunities Panel 32
AUDIENCE QUESTIONS
Refunding Opportunities Panel
2016
Continue the Dialogue…
33
Nadia Sesay, City and County of San Francisco
(415) 554-5956
David Brodsly, KNN Public Finance
(510) 208-8205
Nikolai J. Sklaroff, Wells Fargo Securities
(415) 371-2648
Refunding Opportunities Panel 34
Disclosure
This communication is for informational purposes only, is not an offer, solicitation, recommendation or commitment for any transaction or to buy or sell any security or other financial product; and is not intended as investment. The information contained herein is (i) derived from sources that Wells Fargo Securities ("WFS") in good faith considers reliable, however WFS does not guarantee the accuracy, reliability or completeness of this information and makes no warranty, express or implied, with respect thereto; and is (ii) subject to change without notice. WFS accepts no liability for its use or to update or keep it current. Products shown are subject to change and availability. WFS and/or one or more of its affiliates may provide advice or may from time to time have proprietary positions in, or trade as principal in, securities that may be mentioned herein or other securities issued by issuers reflected herein; or in derivatives related thereto. Wells Fargo Securities is the trade name for certain securities-related capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including Wells Fargo Securities, LLC, member NYSE, FINRA, NFA, and SIPC, and Wells Fargo Bank, N.A. (“WFBNA”). Municipal Derivatives solutions are provided by WFBNA. This communication is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations and does not constitute advice within the meaning of Section 15B of the Securities Exchange Act of 1934. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment, and other aspects of this communication. Neither WFS nor any person providing this communication is acting as a municipal advisor or fiduciary with respect to any transaction described or contemplated therein unless expressly agreed to in a written financial advisory or similar agreement.