Why bother with bonds?

• State law requires a County to borrow money only using bonds or Public Finance notes -- It is illegal to take out a conventional loan at the local bank. Overview (but you can place bonds at the local bank) • Most local government bonds feature Presented by: tax-exempt interest benefits -- this Shannon Sweeney lowers the interest rate on borrowing by approximatey 1% - 1.5% David Drown Associates, Inc. (depending on term)

What is a bond? General Obligation Bonds

• A bond is a written promise to repay • General Obligation means that the bonds are borrowed money at a future date, and to guaranteed by the full, faith and credit of the pay interest in the meantime. County. • Bonds are evidenced by Certificates • G.O. Bonds are not necessarily paid with taxes –With Bearer Bonds the certificate itself is (G.O. Revs) but… evidence of ownership, and attached “coupons” • If pledged revenues fail to materialize, the County were cashed-in to collect interest payments. must levy taxes to cover bond payments (and if –With Registered Bonds, actual ownership the County refuses, the County Auditor will be records are maintained by a third party. The compelled to levy them) certificate has no actual value. Likewise, • G.O. bonds are very secure – generally very easy interest is paid automatically to the registered to sell at competitive interest rates. owner.

1 “Pure” Revenue Bonds Serial Bonds

• Revenue bonds are paid with a • Most municipal bonds specific source of revenue are structured as YIELD CURVE serial bonds 5.00% 4.50% • The full faith and credit of the issuer is • Each principal 4.00% 3.50% NOT pledged to guarantee bond payment acts like a 3.00% separate loan with a 2.50% payments. Revenue bonds can (and 2.00% do) default. unique interest rate 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 • Interest rates YEAR • Revenue bonds are often harder to increase with term sell, and have higher costs and interest rates.

Bond Pay Schedule Bond Details & Structure Bonds are really a lot different than loans. Call Protection

• Think of this issue as 10 separate little bonds. Payment Schedule & Cashflow • Call Protection -- a promise not to pay off • Each principal payment 12-Month Payment Period ending Principal Rate Interest Total bonds ahead of schedule until the call has its own separate date. interest rate. 2/1/2005 2/1/2006 45,000 2.25% 16,575 61,575 • Lots of flexibility in 2/1/2007 45,000 2.50% 15,563 60,563 – Investors prefer long call protection so they 2/1/2008 45,000 2.75% 14,438 59,438 have certainty in future bond payments. determining when principal 2/1/2009 45,000 3.00% 13,200 58,200 is paid. 2/1/2010 50,000 3.20% 11,850 61,850 – Counties prefer short or no call protection so 2/1/2011 50,000 3.40% 10,250 60,250 • Serial bonds can be 2/1/2012 50,000 3.60% 8,550 58,550 you can prepay or refund (refinance) bonds 2/1/2013 55,000 3.80% 6,750 61,750 designed to produce 2/1/2014 55,000 4.00% 4,660 59,660 without limitation, such as penalties and/or increasing or decreasing 2/1/2015 60,000 4.10% 2,460 62,460 restricted prepayment dates. 500,000 104,295 604,295 payments. – “Normal” call protection is 7 to 8 years. • 30 day month 360 day – Understanding terms of call is important. year convention

2 Bond Details & Structure Bond Details & Structure Capitalized Interest Net Effective Interest Rate

• Net Effective Interest Rate (NEI) • Capitalized Interest – – Is a calculation of total interest paid and – Additional proceeds added to the bond issue the underwriter’s discount. for the purpose of making initial interest – Sometimes referred to as Net Interest Cost (NIC) payments until identified revenue sources – Higher discount = higher NEI begin to kick in (property taxes, assessments). – Longer term = higher NEI – Principal can be deferred for a maximum of 3 – “Back-ending” principal = higher NEI years on General Obligation bonds (with exceptions – you can “blend” GO debt to soften • Competitive sales award based on this rule). lowest NEI (or NIC)

Bond Details & Structure Bond Details & Structure Net Effective Interest Rate Design Issues

$7,943.00 Underwriter's Discount Allowance 1.6547% Net Effective Rate 4.1965%

Payment Schedule & Cashflow • Principal Payment Structure (GO) Payment Schedule Revenues Account Balances 12-Month Payment TOTAL Tax Tax Surplus Account Period ending Principal Rate Interest Total PLUS 5% Increments Levies* (deficit) Balance – 3 year deferral limitation 9/1/2002 - 0.00% - - - 45,587 2/1/2003 - 0.00% 7,701 7,701 7,701 - (7,701) 37,887 2/1/2004 - 0.00% 18,481 18,481 18,481 - - (18,481) 19,405 2/1/2005 - 0.00% 18,481 18,481 19,405 6,515 - (12,890) 6,515 – Largest principal payment may not 2/1/2006 30,000 3.000% 18,481 48,481 50,905 24,756 37,876 (6,515) - 2/1/2007 35,000 3.125% 17,581 52,581 55,210 41,959 30,454 - - exceed smallest by more than five times 2/1/2008 35,000 3.250% 16,488 51,488 54,062 41,959 12,103 - - 2/1/2009 35,000 3.500% 15,350 50,350 52,868 41,959 10,909 - - 2/1/2010 35,000 3.625% 14,125 49,125 51,581 41,959 9,623 - - 2/1/2011 40,000 3.750% 12,856 52,856 55,499 41,959 13,540 - - – Both of these rules can be softened by 2/1/2012 40,000 3.875% 11,356 51,356 53,924 41,959 11,965 - - 2/1/2013 40,000 4.000% 9,806 49,806 52,297 41,959 10,338 - - 2/1/2014 45,000 4.125% 8,206 53,206 55,867 41,959 13,908 - - “combining” new debt with existing debt 2/1/2015 45,000 4.250% 6,350 51,350 53,918 41,959 11,959 - - 2/1/2016 50,000 4.375% 4,438 54,438 57,159 41,959 15,201 - - 2/1/2017 50,000 4.500% 2,250 52,250 54,863 41,959 12,904 - - – Each maturity is to be in increments of 480,000 181,951 661,951 693,739 492,816 190,779 (45,587) $1,000, but industry standard is $5,000 for conventional open market sales

3 Bond Details & Structure Bond Details & Structure Design Issues Official Statement

• Revenue Streams • Official Statement -- the disclosure – Payments should be designed to coincide with document designated revenue streams. – Describes the debt and issuer in detail. – Tax levies, tax increments, tax abatements, and – Used by investors to evaluate risk and assessments are collected semi-annually. credit-worthiness. – Not always necessary, sometimes an Offering Memorandum is sufficient.

Issuance Process: Bond Issuance Process Competitive Sale

• Competitive Sale – Solicit bids for the purchase of a County’s • Competitive sales work best when: – General Obligation issues (easy for bidders to bonds, and award to the lowest cost bidder (NEI or NIC). quickly understand) – Let market competition select the underwriter to – Rated issues work with. – Issue size is fairly large – Timing is not critical • Negotiated Sales • You are confident of getting the lowest cost – First, select a bank or underwriter to work with; financing. – Then negotiate the terms and rates for the issue.

4 Issuance Process: Competitive Sale: Negotiated Sales/Local Competitive Sale Process Placements • Negotiated sales work best when: • Select financial advisor and bond counsel. – Bond issue is complicated or involves additional • Design the bond issue. credit risk – Term, payments, call, revenue sources • Revenue Bonds • Pass resolution setting date to receive bids • IDBs, Lease deals • Prepare and distribute an Official Statement –Very small issues -- need to control issuance • Apply for Moody’s or S&P rating (optional) costs (i.e. Offering Memorandum vs. Official Statement). • Receive bids and pass resolution awarding to low bidder. –Very LARGE issues -- need to work closely with the underwriters to find enough buyers. • Close and wire funds – You want to control who buys the bonds and Process usually takes about 45 days where they are sold. – Timing is critical -- some refundings

Negotiated Sale: Negotiated Sale Process Other items

• Select a banker or underwriter. – Interview process to select banker • Bonds are governed by many different statutes. I call them “pockets” of authority (described later). – Work with local banks to “keep business in • Some General Rules: town.” There are rules that complicate this process. – Bonds payable solely from property taxes cannot exceed 3.0% of the estimated market value of a • Design the bond issue. County - the statutory net debt limit • Negotiate final rates and terms. – Most bonds paid primarily by property taxes are • Pass resolution and close usually subject to referendum vote or reverse referendum criteria. – Bonds over $1.2 million must be sold Process usually takes 2 to 6 weeks competitively, unless the city is represented by independent financial advisor.

5 Other items Other items

• General Obligation bonds must have revenue sources • Bonds can be tax-exempt if: sufficient to cover 105% of actual payments, and in a very – Project is County owned and operated -- highways, parks, few cases the coverage must be 110%. buildings, etc; or • Continuing Disclosure – If a project is privately owned, the County must have sole - “Full” required if all outstanding debt exceeds $10 million responsibility for bond payments -- no developer guarantees. - “Full” disclosure means that a disclosure statement will be prepared annually and attached to a copy of the most recent – Tax exempt status equates to an interest rate approximately audit for the County and sent to all nationally recognized 1 - 1 ½ percent lower than a taxable deal. • Arbitrage -- investing bond money at a higher rate than the municipal securities information repositories (NRMSIR). bonds. - “Limited” disclosure, which is much more common requires – Generally Not Legal. that the County simply notify the NRMSIR of a major event, – Feds limit yields on bond funds. such as defaulting on payments. Uploading audits – Proceeds must be spent within a certain time frame. electronically each year is still required. – Can’t reimburse prior cash purchases with tax-exempt bonds unless you declare beforehand via a Reimbursement Resolution.

The Bond Industry Industry Participants: Matching Investors with Issuers... Investors

• Investors like Minnesota municipal bonds $ $ $ because of: – Low risk Issuers Investors Industry Participants – Tax Exemption -- no tax on interest earnings • Investors • Individuals buy over half of all muni bonds • Underwriters • Institutions are also big buyers • Financial Advisors – Mutual funds, insurance companies -- tend to buy “investment grade” rated debt. • Bond Attorneys – Commercial banks often buy unrated bonds • Rating Agencies • Most investors buy bonds through an • Pay Agents/ Registrars intermediary brokerage firm (underwriter).

6 Industry Participants: Industry Participants: The Underwriter - (Investment (continued) Banker) The Underwriter

• Underwriters are the “wholesale • Underwriters are able to receive buyers” of the bond industry. compensation through two – They bid or negotiate to buy bonds sources. in bulk – Their brokers then resell them to Source 1 – Underwriters Discount their customers.

Industry Participants: Industry Participants: The Underwriter (continued) The Underwriter (continued)

City of St. Peter, Minnesota Miller Johnson Steichen Kinnard $805,000 General Obligation Water & Sewer Revenue Bonds, Series 2004C • Underwriters are paid from the Uses of Funds Bond Details Construction & Engineering - Sanitary 121,975 Set Sale Date 9/27/2004 Discount or “spread”; Construction & Engineering - Water 362,115 Sale Date 10/25/2004 Construction & Engineering - Storm 285,330 Dated Date 11/1/2004 Contingency 8,000 Closing Date 11/10/2004 Total Project Costs (const'n and engr.) 777,420 1st Interest Payment 2/1/2005 – They buy from issuers at a discount Underwriter's Discount Allowance 1.50% 12,075 Proceeds spent by: 12/31/2005 Fiscal Fee 8,000 to Dated Date -- the underwriters discount is Bond Counsel 4,000 Purchase Price 792,925.00 Pay Agent/Registrar 350 Net Interest Cost 164,281.25 Printing & Misc 1,000 Net Effective Rate 3.7411% typically 1/2 to 2% of the issue. Rating Agency Fee 3,500 Average Coupon 3.466% Capitalized Interest - Average Life 5.4550 806,345 Call Option 2/1/2011 – They resell bonds to customers at a Sources of Funds Purchaser Miller Johnson Steichen Kinnard Bond Issue 805,000 Bond Counsel Briggs & Morgan, P.A. price that is sometimes at par (face Cash (City Utility Funds) - Pay Agent U.S. Bank N.A., St. Paul, MN Construction Fund Earnings (Excess Proceeds) 1,345 806,345 amount of bonds.); or

7 Industry Participants: Industry Participants: The Underwriter (continued) The Underwriter (continued)

Source 2: Reoffering Price, Selling at a • Underwriters usually resell bonds to Premium: investors for a price near par (face amount); however, they are able to • The reoffering price is a second source of income for underwriters that most people are re-offer the bonds to an investor at not aware of. Often times it will be listed at premium. the bottom of a sales results tabulation. • This sales premium can serve as a • The reoffering price that can generate a significant amount of revenue for the significant second source of income underwriter. for the underwriter.

Industry Participants: Industry Participants: The Underwriter (continued) The Underwriter (continued)

• Underwriters want higher rates and low • Syndicates – are used when bond issues prices - you want the opposite. are too large for one firm to handle alone. – One firm “runs the books” -- others just sell • A competitive sale process is the best bonds way to ensure that everyone is – Local banks often participate in syndicates to secure a portion of a bond issue. charging a fair price and the County is – Syndicates are often issuer-specific -- the receiving the lowest overall cost of same firms bid together each time a certain borrowing. issuer goes to market. – Issuers typically don’t get involved in syndication, except to ensure a local bank/underwriter gets some of the bonds.

8 Industry Participants: Industry Participants: The Financial Advisor The Financial Advisor (cont.)

• The Issuer’s finance expert and Job duties (continued): advisor. They represent YOU. – Negotiate price and rate, or administer • Job duties include: the competitive bidding process. – Help develop a strategy for project – Make an award recommendation financing – Coordinate closing and transfer of funds – Design the details of the bond issue – – Assist after the sale with accounting, amount, term, payment requirements, arbitrage compliance, etc. revenue sources, etc. – Prepare the Official Statement

Fiscal Advisors are your What to look for in a good Financial “Engineers” financial advisor... Financial advisors Engineers do... do... • Commitment to long-term financial Strength – Long term vs. transaction orientation. Feasibility Studies Plan of Finance / CIP – Capital financial planning. – Goal to preserve financial strength. Street and Utility Design Bond Issue Design Plans and Specs • Willingness to help you avoid and control the issuance Official Statement of new debt. Advertise for Bids Solicit Bids • Willingness to tailor the process to your needs. Tabulate sealed bids Tabulate sealed bids – Negotiated sales & competitive sales as Award to lowest qualified appropriate. bidder Award to lowest qualified bidder – Use of non-market debt (state & federal funding sources, etc.) despite the fact those deals typically don’t involve fees for the advisor

9 Industry Participants: Industry Participants: The Bond Attorney (Bond counsel) The Bond Attorney (continued)

• Specialist attorneys -- perhaps a and perhaps most importantly…. dozen firms in Minnesota recognized as experts. – Issue a written legal opinion • Bond attorneys duties are to: • certifies the County has the authority to issue – Interpret federal, state, local, and the bonds securities laws and make sure the • certifies that interest on the bonds will be County complies with them. exempt from federal and/or state taxation. – Prepare bond documents, resolutions, agreements and other related legal documents.

Industry Participants: The Rating Agencies What is a credit rating worth?

• Major agencies are Moody’s, S & P • Depending on market conditions, one grade and Fitch means 5 to 15 basis points. • What they do: • The difference in interest rate between a rated and unrated bond issue can be significant –For a fee, rating agencies will issue a • For a $1 million bond issue with a longer term, “credit rating” for a specific bond issue. a $9,500 credit rating could save an issuer up • AAA, AA, A, Baa (investment quality) to ten times that amount in interest paid over • Ba and lower (non-investment quality) the life of the deal. – Ratings give investors an independent opinion about risk and credit quality.

10 Industry Participants: The Pay Agent/Registrar Bonds are heavily regulated

• Bonds of an issue may be owned by dozens of • General rules found in M.S. Chapter 475 govern investors scattered throughout Minnesota. all types of bond issues. • Pay Agent/Registrars make your job easier in • Special rules are scattered throughout State future years by: Statutes – each has unique requirements and – Keeping the official “register” of bond owners -- exceptions to general rules. update when bonds trade owners • When bonds are issued, a specific statute is cited – Sending invoices to County staff for upcoming as the “Authority” for the bonds. payments • Challenge is to match each project’s needs with – Receiving County payments and distributing the proper Authority. them in the right amounts to the investors. • Some forms of authority have capacity limitations.

General G.O. Bond Rules General G.O. Bond Rules

• Statutory Net Debt Limit -- Bonds payable solely from property taxes cannot exceed 3.0% of the • Minnesota law allows most bonds to estimated market value of a jurisdiction. carry a G.O. pledge, even when paid • Competitive Sales – required for GO Bonds over $1.2 from non-tax sources. million, unless the jurisdiction is represented by independent financial advisor. • Common revenue bonds (non GO): • 3-year Rule – requires some principal payment within – Housing Revenue Bonds (affordable or senior housing) 3 years – Lease Revenue Bonds – public facilities • 5 times Rule – max and min. principal payments cannot differ by more than 5 times – Tax Increment Revenue Bonds • 105% Coverage – pledged revenues must exceed bond payments by 5%.

11 Courthouse Bonds Jail Bonds

Authority: • Chapter 375.18 Sub. 3 Authority: • Chapter 641.23 Typical Projects: • Courthouse (erect, Typical Projects: • County Jail, Sheriff’s furnish, maintain) Residence Special rules or limits: • Amount limited to a levy of • No election (referendum) .04030% of market value Special rules or required if the annual payment on all bonds • Not subject to referendum limits: issued for this purpose is vote if below that threshold. less than .09671% of the estimated market value of taxable property within the County.

Capital Improvement Plan Bonds Capital Improvement Plan Bonds

Authority: • Chapter 373.40 Authority: • Chapter 373.40 Typical Projects: • Acquisition or betterment of public lands, buildings for • Must have useful life of at Special rules or the purpose of a least 5 years. limitations: courthouse, admin building, • Requires 5 yr. capital health or social service improvement plan which is building, jail, law subject to reverse enforcement center, referendum (5% petition). hospital, morgue, library, park, roads & bridges, • Three-fifths board approval public works, fairgrounds, • Annual P&I limited to .12% data storage, conservation of taxable market value easements.

12 Capital Notes Drainage Bonds

Authority: • Chapter 373.01 Subd. 3 Authority: • Chapter 103E.635 Typical Projects: • Equipment with a useful life at least equal to the Typical Projects: • Drainage Improvements term of the notes.

Special rules or • Must be 100% assessed Special rules or • Term limited to 10 yrs. • Maximum term of 23-years limits: limits: • Pledge of tax levy • General Obligation Pledge • Temporary bonds can be issued • Subject to County Debt Limit

Lease Purchase Deals G.O. TIF Bonds One alternative to a referendum vote • Often used when referendum vote or debt limit is a Authority: • Chapter 469 problem. Typical Projects • Typical Structure: : • Development Subsidies – EDA/HRA issues a revenue bond (not subject to Related Public G.O rules) Improvements – EDA/HRA signs an annual appropriation lease Special rules or • Tax Increments must fund at least with County -- uses lease payments to cover bond 20% of principal payments any payments. limits: source for balance – County Board must be able to cancel lease in any • Bonds and expenditures must be year. authorized in a TIF Plan. • Works best for essential-purpose structures where a • Not subject to net debt or referendum. County is unlikely to cancel the lease. • Interest usually w/in .25% to .5% of G.O. rates

13 Essential Function Bonds A few others… Corporate Purpose Bonds Authority: • Chapter 469.034 Typical Projects: • Low Income Housing • Tax Abatement Bonds – tax abatements Elderly Housing must cover 100% of principal. Special rules or • Can carry G.O Pledge if: • Tax Anticipation Notes – issued for cash limits: – Project revenues projected to cover 110% of bond payments flow purposes in anticipation of levy • Amount limited to one-half of 1% of receipts. the estimated market value for all projects within jurisdiction. • Projects subject to payment in lieu of taxes.

Finish Line

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