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SECURITIES

MUNI BONDS 101

NIC, TIC, AIC & Yield -What’s the Difference? DECEMBER 2019

The Basics The AIC, or “All-Inclusive Cost,” is similar to the TIC in that it takes into Par Amount, , Yield & Purchase Price account the time value of money. The difference between the AIC and TIC is that the AIC also deducts the costs of issuance from the purchase Below are foundational terms that will be used when discussing price. Therefore, the AIC is the discount rate which equates the principal different measures of the cost of financing associated with a bond and semi-annual interest payments to the net proceeds received by issue. the issuer. For this reason, the AIC provides a more complete measure The par amount, also known as the principal amount, is the stated of the total cost of a bond issue. dollar amount of a given maturity or the bond issue. There are circumstances in which the AIC and the TIC are very similar The coupon is the rate at which interest is paid on each maturity of the in magnitude and times when the AIC can be materially higher. Table bond issue. Stated differently, the coupon determines the semiannual 1 below summarizes four hypothetical financings that all have a par interest payment made by the issuer to the . It’s important amount of $1,000,000 with costs of issuance totaling $25,000, and the to note that the coupon is not a measure of the cost of capital to the same TIC of 3.0% (implying a perfectly flat ). The difference issuer. between the scenarios is that the maturity of each issue is varied to be either one, five, 10 or 20 years. As is shown, the AIC is significantly The yield is the annual on each maturity of a bond issue, higher than the TIC for the one-year maturity (5.6% vs. 3.0%), and closest and is a function of the coupon and the price of the maturity. For a in value for the 20-year maturity (3.3% vs. 3.0%). This illustrates that, bond that is not subject to prepayment by the issuer, the yield is the all things being equal, the impact of issuance expenses on the issuer’s true cost of capital to the issuer, or conversely, the true rate of return to total cost of financing (i.e., the AIC) is reduced with longer maturities as the investor. For a discussion on the yield on callable premium bonds, the expenses have more years over which they are distributed. click here: Muni Bonds 101: “Premium Bonds after the Call Date”. The purchase price of a bond issue is the aggregate par amount of TIC VS. AIC COMPARISON all the maturities, plus accrued interest and original issue premium (or Difference less any original issue discount), and less the underwriter’s discount. If Maturity Par Costs of Issuance TIC AIC TIC vs. AIC the price of a given maturity’s stated par amount is greater than 100%, 1 Year $1mm $25mm 3.0% 5.6% 2.6% the maturity is priced at a premium. Similarly, if the price of a given maturity is less than 100%, the maturity is priced at a discount. The 5 Years $1mm $25mm 3.0% 3.9% 0.9% aggregate of the individual maturity’s premiums and discounts, if any, determines if the bond issue is being offered at a premium or discount. 10 Years $1mm $25mm 3.0% 3.5% 0.5% TIC vs. AIC 20 Years $1mm $25mm 3.0% 3.3% 0.3% What do they measure? And how are they different? Table 1. Source: PMA Securities, LLC 11/27/19 When a bond issue has a number of different maturities, each with its Another Way to Compare Direct Placement and own combination of coupon, price and yield, there are ways to calculate the average borrowing rate of the entire issue. For the purposes of awarding a bond issue to the best bidder on a competitively sold Another useful application for comparing the TIC to the AIC is when issue, the TIC or “True Interest Cost” is the method most commonly evaluating the cost of a direct placement versus a public offering. used today. The TIC is defined as the discount rate which equates A direct placement is a private sale of securities offered to a limited the principal and semi-annual interest payments on the bonds to the number of . A direct placement generally has lower cost of purchase price paid by the underwriter to the issuer. issuance expenses than a public offering due to the absence of an Prior to the acceptance of awarding bonds based on the TIC, interest underwriter, rating, certain legal fees and official statement preparation. cost was measured using the NIC, or “Net Interest Cost,” which is Conversely, a public offering is a sale of securities to a wide range determined by dividing the total interest payments, less any premium of investors. A public offering generally has higher cost of issuance or plus any discount, by the bond years of this issue. Unlike the TIC, the expenses because it requires the production of an offering document, NIC does not take into the account the timing of interest payments and underwriting services, and often has rating, paying agent, and therefore, it is not a present value calculation. additional disclosure related legal fees. Integrity. Commitment. Performance.tm PMA SECURITIES | MUNI BONDS 101 DECEMBER 2019

For larger and longer dated bond issues, a public offering has historically NIC, TIC, AIC AND BOND YIELD CALCULATION yielded the lowest cost of financing as measured by both the TIC and Costs Original AIC. However, as the scenarios provided in Table 1 above illustrate, Summary Issue Accrued Bond Underwriter Issuance there are circumstances when additional cost of issuance expenses Statistics Premium Discount Interest * Discount Costs can have a material impact on an issuer’s total cost of financing. This NIC Yes Yes No No Yes No is why we suggest that issuers consult with their financial advisor to TIC Yes Yes Yes No Yes No analyze the total cost of borrowing for both a direct placement and a AIC Yes Yes Yes Yes Yes Yes public offering. Bond Yield Yes Yes Yes Yes No No Table 2. Source: PMA Securities, LLC. **For some competitive sales, bond insurance can be Bond Yield (Arbitrage Yield) purchased at the of the underwriter. As such, bond insurance would be treated as part What is it? And why is it important? of the underwriter’s discount and would be included as part of the NIC and TIC calculations.

The bond yield, also known as the arbitrage yield, is calculated for a Net Interest Cost (NIC) captures the cost of financing that factors the future debt payments and the underwriter’s discount. bond issue in a manner similar to the calculation of the TIC. The bond NIC NIC = Rate which equates the future Principal & Interest payments to yield is defined as the discount rate which equates the principal and the Purchase Price semi-annual interest payments on a bond issue to the original issue proceeds. True Interest Cost (TIC) captures the present value cost of a financing that factors the future debt payments and the underwriter’s discount. TIC There are two key differences between the calculation of the purchase TIC = Discount Rate which equates the future Principal & Interest price and the calculation of original issue proceeds. The first difference payments to the Purchase Price is that the purchase price factors in the underwriter’s discount as part All Inclusive Cost (AIC) captures the present value cost of a financing that factors the future debt payments and all costs of issuance. of the calculation, but original issue proceeds does not account for it. AIC AIC = Discount Rate which equates the future Principal & Interest The second difference is that the purchase price is not reduced by the payments to the Net Proceeds amount of “bond insurance premium,” or “credit enhancement,” but original issue proceeds is reduced by bond insurance, if applicable. Bond Yield captures the present value cost of a financing that factors Bond the future debt payments and bond insurance, if applicable. The bond yield is particularly important for -exempt, new money Yield Bond Yield = Discount Rate which equates the future Principal & financings, as it is the yield used by the U.S. Treasury for the purpose of Interest payments to the Original Issue Proceeds determining compliance with tax-exempt arbitrage regulations. Table 3. Source: PMA Securities, LLC Summary Next Edition Muni Bonds 101: NIC, TIC, AIC and Bond Yield How Municipal Bonds are Sold in the Market Tables 2 and 3 (above-right) provide summaries of how NIC, TIC, AIC If you have questions or would like to discuss the summary rates in and Bond Yield are calculated. more detail, please contact any of PMA’s advisors below.

BOB LEWIS TAMMIE BECKWITH SCHALLMO MICHELE WIBERG SVP, Managing Director–IL SVP, Managing Director–IL SVP, Managing Director–WI 630.657.6445 630.657.6446 414.436.1834 [email protected] [email protected] [email protected]

ANDREW KIM STEPHEN ADAMS BRIAN DELLA STEVE PUMPER Director, Public Finance–IL Director, Public Finance–IL Director, Public Finance–WI Vice President–MN 630.657.6449 618.604.7677 414.436.3523 612.509.2565 [email protected] [email protected] [email protected] [email protected]

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