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Municipal Bonds — Common Terms

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Municipal Bonds — Common Terms HNW_NRG_C_Inset_Mask Municipal bonds — common terms With approximately $3.8 trillion outstanding securities, municipal bonds are one of the most popular investment choices. What follows is a brief glossary explaining some of the more commonly used terms unique to the municipal bond industry. Ad valorem tax — A tax levied by a Bank qualified bonds — Describes Book entry — A form of ownership municipality based on the “value” a class of municipal securities that where possession of the security of a property. In many cases, it is enjoy a tax-advantaged status is not evidenced by a physical the ability to levy an ad valorem tax when purchased by commercial certificate but rather by an electronic which secures general obligation banks. There are several criteria entry in the investor’s account at a municipal bonds. an issue needs to meet in order to bank or brokerage firm. be designated “bank qualified” and Advance refunding — The process Certificates of Participation meeting this qualification is not by which outstanding municipal (COPs) — COPs have been used by necessarily a reflection of an issue’s securities are refinanced through the municipalities to pay for prisons, credit quality. Individual investors can issuance of new bonds. The proceeds office buildings, schools, libraries, also purchase “bank qualified” bonds. from the sale of the new bonds are vehicles, and a number of other typically invested in U.S. government Bond insurance — A type of projects. They are a form of lease or agency securities with the cash insurance policy that a bond issuer revenue bond that permits the flow from these securities used to purchases that guarantees the investor to participate in a stream meet the debt service requirements repayment of the principal and all of lease payments relating to the of the old bond issue. Often at the associated interest payments to the acquisition or construction of specific first optional call date of the original bondholders in the event of default. equipment, land or facilities. COPs bond issue, the cash flow from the Bond issuers buy insurance to are not viewed legally as “debt” U.S. government or agency securities enhance their credit rating in order to because payment is tied to an annual is used to retire the outstanding reduce the amount of interest that it appropriation by the government bonds. This process is also referred to needs to pay. body. As a result, COPs are seen by as pre-refunding. rating agencies as providing weaker Build America Bond (BAB) — Taxable security and often carry ratings that Alternative minimum tax (AMT) — municipal bonds that feature tax are a notch or two below an agency’s A separately computed tax that credits or federal subsidies for general obligation rating. applies only if it exceeds an bondholders and state and local individual’s regular tax liability. government bond issuers. They Competitive bid — A method of The purpose of AMT is to prevent were introduced in 2009 as part submitting bids to underwrite new taxpayers who enjoy certain tax of President Obama’s American securities in which the securities are benefits from avoiding a reasonable Recovery and Reinvestment Act awarded to the underwriting group tax liability on their income. to create jobs and stimulate the presenting the best price and terms. economy. BABs attempt to achieve This is a sealed bid system used by this by lowering the cost of borrowing many municipalities, railroads, and for state and local governments in utilities as opposed to a single bid financing new projects. negotiated sale. Investment and insurance products offered through RBC Wealth Management are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, or guaranteed by, a bank or any bank affiliate, and are subject to investment risks, including possible loss of the principal amount invested. Page 2 of 3 Municipal bonds — common terms, continued Covenants — Enforceable General obligation bond (GO) — A Moral obligation bond — In addition promises made by the issuer of bond secured by the “full faith and to being secured by the revenues a bond designed to protect the credit” of an issuer with the authority from a specific project, this bond interests of bondholders. For to levy taxes. The authority to levy also enjoys a non-binding pledge that instance, an issuer may pledge taxes may or may not be statutorily any shortfalls in funds necessary to not to sell additional parity debt limited. A Limited Tax Bond or LTGO meet debt service requirements will unless a revenue test is met. is a type of general obligation bond be made up through an appropriation in which the taxing authority pledges by the state legislature. As the Dated date — The date from which to repay debt is specifically limited name implies, the obligation is only a municipal bond begins to accrue as to rate or amount. An Unlimited “moral,” and the state legislature is interest. The dated date may be Tax GO or UTGO is a type of general under no legal obligation to cure any different from the delivery date. obligation bond in which the taxing deficiencies in debt service. Defeasance — Usually associated authority pledged to repay debt is not Municipal/treasury ratio — The with the refunding of an outstanding limited as to rate or amount. Municipal/Treasury Ratio or M/T bond issue, defeasance refers to Gross revenue pledge — A pledge Ratio for short, is a comparison of the legal termination of the rights that all revenues received will be the current yield of municipal bonds and interests of bondholders under applied to pay debt service prior to US Treasuries which provides a specific circumstances. to payment of any expenses. It is way to assess the relative value of De minimis/OID — Important tax- generally considered to be superior municipal securities to treasuries. related issues pertaining to “market to a net revenue pledge. If the M/T Ratio is below 100% then discount” municipal securities municipal bonds are yielding less IDB or IDR or industrial purchased in the secondary market. than treasuries; if the M/T Ratio is development (revenue) bond — A The level of the discount relative above 100% then municipal bonds are type of revenue bond issued by a to a formula-driven threshold yielding more than treasuries. state or local development authority determines whether the gain is on behalf of a corporate borrower to Negotiated sale — A method of taxed as ordinary income (the finance the construction of industrial selling securities in which the discount exceeds the threshold) facilities. The security for an IDB issuer has entered into an exclusive or capital gains (the discount is rests with the general credit of the underwriting agreement with an within the threshold). Original Issue corporate borrower. They are not underwriting syndicate. Unlike Discount (OID) refers to bonds backed by the full faith and credit of a competitive sale, the issuer issued at a price below par value. the issuing municipality. entertains only a single bid with the Both of these issues could result main negotiating points being the in unintended tax consequences Junior lien bonds — Bonds interest rate and the purchase price for municipal bond investors. that have a subordinate lien of the issue. Most municipal revenue against pledged revenues. Double-barreled bonds — Bonds bonds are priced through negotiation. secured by a specific source of Lease rental bonds — A type of bond Net revenue pledge — A pledge revenue as well as by the general secured by lease payments. The party that all revenues received will be obligation pledge of an authority with leading the financed project must applied to pay debt service after taxing powers. appropriate the necessary funds from the payment of certain expenses, its general fund in order to make the Escrowed-to-maturity (ETM) — usually operations and maintenance lease payments. Similar to advance refunding, this expenses. Generally considered to be type of refunding involves the Letter of credit or LOC — A inferior to a gross revenue pledge. purchase of a pool of securities commitment made by an institution, Official statement or final OS — designed to pay principal and interest typically a commercial bank, to honor The final version of the document on an outstanding issue all the way to demands for the payment of principal published by the issuer giving its final maturity date as opposed to or interest on a bond if the issuer is pertinent information on the sale of an earlier optional call date. unable to do so. securities. Included in the final OS is information on the bond’s structure, security, and redemption features. Page 3 of 3 Municipal bonds — common terms, continued Preliminary official statement Senior lien bonds — Bonds Term bonds — Bonds of an issue (POS) — The preliminary version having a prior or senior lien structured so that a large part or of the document published against pledged revenues. the entire principal is retired at a by the issuer, giving pertinent single maturity date. Often the bond Serial bonds — Bonds of an information on the sale of securities. indenture provides for a sinking fund issue that is structured so Information contained in the POS to retire a portion of a term bond a portion of the principal is is subject to revision and is used prior to its stated maturity according retired at regular intervals. to gauge investor interest in a to a predetermined schedule. sale of securities. It is sometimes Sinking fund — A fund established Thirty-day visible supply — referred to as a “red herring” due under the bond indenture that The principal amount of bonds to the red lettering on the cover. provides for the retirement of debt on scheduled to be sold through a pre-arranged schedule.
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