council of texas economic development finance ... - cdfa › cdfa › cdfaweb.nsf › ord...e x p e...
TRANSCRIPT
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 1
Basics of Bond Financing Seminar
Mike DavisSenior Vice PresidentMorgan Keegan & Company, Inc.Houston, TexasTel: [email protected]
Council of Development
Finance Agencies
Texas Economic Development
Council
May 15, 2008
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 2
How Bonds are Structured and Sold
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 3
How Bonds are Structured and Sold
Qualified IDBs and economic development projects are generally funded viapublic offering of tax-exempt bonds, ordirect purchase by commercial bank or finance company
Direct purchase may be more cost effective for smaller issues in comparison to public offered deal and during compression of short-term taxable vs. tax-exempt rates
Public deals may be issued in fixed rate mode with satisfactory stand-alone credit; but many borrowers lack the ratings or market recognition to access long-term debt markets independently, credit enhancement with letter of credit can bridge that gap
VRDO’s have long-dated nominal maturity, but pay short-term, variable rates of interest
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 4
Qualified 501(c)(3) Bonds
Property must be owned and occupied by 501(c)(3) organization95% of net proceeds must be used to further the organization’s exempt purposeBond proceeds may not be used to finance “religious” activityBorrowers have up to 3 years to spend bond proceedsInvestment earnings in excess of the bond yield are subject to rebate unless certain spend down provisions are metAverage maturity of the bonds may not exceed 120% of the average reasonably expected economic life of the facilities being financed with bond proceedsNot subject to Volume Cap Allocation In certain states, borrowers may need to pay “prevailing wages” to workers involved in the construction and installation of the facilitiesPublic hearing and other steps must be completed with the Public Issuer prior to closing.
Note: This list provides general guidelines related to bond qualifications. Actual bond amount will be subject to authorizing opinion from recognized Bond Counsel.
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 5
Small Issue Private Activity Bonds
95% of the net proceeds must be spent on the “project”At least 70% of net proceeds must be spent on facilities constituting “core manufacturing” activities
Up to 25% for “ancillary and related” activitiesUp to 5% for non-qualifying activities
Up to 2% of net proceeds may be used for Issuance CostsFacilities funded with Bond proceeds may not utilize MACRS depreciation system (must use the Alternate Depreciation schedule)Prevailing wages may apply in certain statesNo more than 25% of the bond proceeds may be used to acquire land$20 million capital expenditure limit applies to all capitalized or capitalizable expenditures made by the Borrower ( and all “related parties”)
3 years forward and backward from bond issuanceApplies to jurisdiction/political subdivision where bond proceeds are being spent only
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 6
Historical Tax-Exempt and Taxable Variable Interest Rates
Tax-Exempt Floaters (SIFMA Index) vs. Taxable Floaters (One-Month LIBOR)May 1998 to May 2008
0
1
2
3
4
5
6
7
8
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Yie
ld %
SIFMA (15-Year Average) = 2.86%One-Month LIBOR (15-Year Average) = 4.27%
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 7
Current Market Conditions
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 8
Current Market Conditions
Sub-prime mortgage and CDO market meltdowns have severely impacted markets, stressed bank and financial institutions’ balance sheets and liquidity positions
Market further stressed by general economic uncertainty and inflation fears
General result is flight to quality and reassessment of underlying credit fundamentals
Decoupling of relationship between taxable and tax-exempts; muni yields were over 100% of Treasuries
Municipal market is no exception -Widening credit spreads for fixed rate dealsARS and insured floater markets have seen significant disruption and fails due to negative rating outlooks and downgrades of the municipal bond insurers and reduced market liquidityInvestment banks no longer purchaser of last resort
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 9
Current Market Conditions (continued)
5 of the 7 AAA-rated insurance companies have been downgraded by at least one rating agency and have negative outlooks from all three rating agencies
Only FSA and Assured Guaranty remain Aaa/AAA/AAA with stable outlooks. Berkshire Hathaway is a new AAA-rated market entrant.
Both of the “healthy” insurance companies have been able to increase fees significantly and secure more stringent covenants due to the reduced competition.
(as of 5/14/08)
AMBAC AGC CIFG FGIC FSA MBIA XLCA BHACRatings
Moody's Aaa Aaa A1 Baa3 Aaa Aaa A3 AaaS&P AAA Aaa A+ BB AAA AAA A- AAA
Fitch AA AAA A- BBB AAA AA BB N/AOutlook
Moody's Negative Stable Stable Negative Stable Negative Negative StableS&P Negative Stable Negative Negative Stable Negative Negative Stable
Fitch Negative Stable Negative Negative Stable Negative Negative N/A
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 10
Current Market Conditions (continued)
Demand for bank liquidity and letters of credit at unprecedented levels due to ARS conversions. Wide spreads between fixed and floating rate markets is also contributing to demand for credit support for unhedged and hedged floating rate issues.
Banks have more leverage -- more selective, more fees, more restrictive covenants, and more non-interest revenue demands.
Longer term issues may arise as certain funds near exposure limits for certain credit provider names
BUT, municipal rates remain near historic lows and spread between fixed and floating rates have recently widened
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 11
Credit Quality Spreads (G.O. Credits)
10-Year Maturity Spreads to AAA MMD
January 2000 to May 2008
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
1.20%
1.40%
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08
AA to MMD AAA Ins to MMD A to MMD Baa to MMD
10-Year Maturity Spreads to AAA MMD
January 2007 to May 2008
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
1.20%
1.40%
1/07 3/07 5/07 7/07 9/07 11/07 1/08 3/08
AA to MMD AAA Ins to MMD A to MMD Baa to MMD
Question as to whether this is temporary or new pricing paradigm, particularly for lower rated credits
Credit spreads have widened significantly in last six months due to reduced market liquidity and return to focus on underlying credit fundamentals
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 12
Variable Rate vs. Fixed Rate Bond Yields
Spreads between MMD and SIFMA have widened, making variable transactions very attractiveSIFMA is currently 1.83% and BB Revenue Bond Index is 5.07%
SIFMA Index vs. Bond Buyer 25 Revenue Bond IndexMay 1998 to May 2008
0
1
2
3
4
5
6
7
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Yie
ld %
SIFMA (10-Year Average) = 2.62%BB 25 Revenue (10-Year Average) = 5.24%
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 13
Variable Rate Demand Obligations
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 14
VRDO’s are short-term securities with a long-dated nominal maturity
Interest rates reset daily or weekly with interest paid monthly
Principal generally repaid annually
Borrower may prepay at anytime without penalty
Sold through public offering and primarily purchased by tax-exempt money market funds in $100,000 denominations
Federal regulations limit the types of securities that may be purchased, with restrictions for portfolio maturity, portfolio quality and $1 NAV target
In order for VRDOs to be marketable, they must be credit enhanced by eitherletter of credit from highly rated bank,separate bond liquidity facility and municipal bond insurance policy, orself-liquidity in special circumstances
What Are Variable Rate Demand Obligations (VRDO)?
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 15
Investors who own these bonds have the option to tender bonds back to issuer for purchase at par plus accrued interest with seven days notice to the remarketing agent.
Remarketing agent will sell these bonds to another investor, if no purchaser is found (a failed remarketing) the investor is repaid at par through a draw on the letter of credit or liquidity facility.
In the case of a failed remarketing situation, the liquidity facility could be utilized or “tapped”. This means that the bank providing the liquidity facility will purchase the bonds that are not resold to another investor and has reimbursement rights against borrower.
VRDO resets based on yields of comparable bonds with similar credit and maturity, as well as supply and demand (with periodic redemption spikes)
VRDO rates are typically benchmarked to the Securities Industry and Financial Markets Association Municipal Swap (SIFMA) Index (formerly BMA) -- weighted average rate for a pool of high-grade tax-exempt short-term issues with weekly resets.
Specific loan rates may diverge from SIFMA due to issues related to underlying borrower, credit provider rating, change in tax laws, or general market conditions.
What Are Variable Rate Demand Obligations (VRDO)? (cont.)
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 16
Advantages and benefits include:Historically lowest cost of capital availableBonds may be prepaid at anytime without penaltyCredit costs are incurred only on amount of facility outstanding each yearNo continuing disclosure to public (only to credit provider)
Disadvantages and risks include:Interest rate risk – may be mitigated with certain hedging productsLetter of credit / liquidity facility renewal risk (availability and price)LOC bank risk (ratings deterioration causing VRDOs to trade at wider spread to SIFMA)Tax law change risk (bonds may trade at taxable levels if tax-exempt status ceases)Remarketing risk (bonds trade at wider than expected spread to SIFMA)Put risk (draw on facility that requires immediate reimbursement…term-out)
Interest rate risk may be mitigated via certain hedging products, but other benefits and risks introduced
Advantages and Disadvantages of VRDOs
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 17
Bank’s short- and long-term credit ratings are substituted for the borrower’s
Letter of credit typically expires in three to five years, must be renewedLOC replaced upon 1) expiration or 2) reduction in bank’s short- and long-term ratings below acceptable levelsNon-renewal or replacement results in mandatory purchase
LOC fees generally in the range of 0.50% to 2.00% per annum
Remarketing agent fees up to 0.125% per annum
Credit terms and conditions outlined in Indenture, Loan and Reimbursement Agreements
Principal amortizationDebt service coverage ratiosLiquidity requirements and additional debt limitationsLien on property, plant and equipment
Overview of Letter of Credit Backed VRDOs
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 18
With a direct pay letter of credit, the bank’s LOC is automatically drawn to satisfy regularly scheduled payments of principal and interest, as well as for failed remarketings
Borrower payments replenish or reimburse bank for drawn fundsAutomatic reinstatement for interest draws
In the event of default, borrower obligation to bank dictated by terms of Reimbursement Agreement
Loan term-out negotiated with bank (e.g. amortized over five years at bank’s prime lending rate)
Overview of Letter of Credit Backed VRDOs (continued)
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 19
Borrower’s disclosure obligations, covenants, security, and other structural elements are governed through Indenture, Loan Agreement and Reimbursement Agreement
Financial RatiosDebt service coverageLiquidity (minimum cash balances, current ratio)Leverage (funded debt to income available for debt service)
Security provisionsLien on property, plant and equipmentBank directs remedies upon event of default
Other covenants and requirementsPrincipal amortization (average maturity of 100% of useful life vs. 120% tax limit)Limits on additional debt, leases, sale-leasebacksLimits on encumbering and sale of assetsLimits on mergers and acquisitionsBoiler-plate covenants (maintenance of properties, compliance with laws, insurance, etc.)Continuing disclosure obligations to LOC bank
Disclosure / Covenants / Structural Requirements
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 20
Borrower’s disclosure obligations, covenants, security, and other structural elements are governed through Indenture, Loan Agreement and Reimbursement Agreement with the letter of credit bank
Draws under letter of credit for:
Interest - regularly monthly interest payments and upon redemptions
Redemption – to pay principal of optional, mandatory or sinking fund redemption
Liquidity – to pay purchase price of tendered bonds not successfully remarketed
Acceleration – to pay principal and interest upon acceleration (due to event of default)
Stated Maturity – to pay principal amount of bonds at final maturity
LOC and Reimbursement Agreement Provisions
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 21
Event of default under LOC include, among others:
Failure to pay bank when due any obligation owed related to draw on LOC
Default in observance or performance of stipulated covenants
Default under debt that allows such debt to be accelerated
Any material provision of documents cease to be valid and binding, or if borrower contests any such provision
Borrower bankruptcy, insolvency or assignment for benefit of creditors
Events of Default on Letter of Credit
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 22
Upon event of default, bank may exercise any of the following remedies:
Require borrower to prepay an amount equal to the available amount of the LOC
Declare all obligations to the bank as immediately due and payable
Give notice directing trustee to accelerate bonds, thereby causing LOC to expire in 15 days
Pursue any other rights and remedies under documents, or any action available at law or in equity
If no event of default has occurred, reimbursement of drawn amount due within five days and interest accrues on liquidity draw amount at bank’s Prime rate for first five days and thereafter at Prime +
If event of default has occurred, reimbursement of liquidity draw is due immediately and accrues interest at Prime +
Remedies Upon Event of Default
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 23
VRDO Bond Issue Example
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 24
Historical Tax-Exempt Variable Interest RatesSIFMA Index (Weekly Variable Rates)
15-Year History from May 1993 to May 2008
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Yiel
d %
Current Rate = 1.83%1-Year Average = 3.13%5-Year Average = 2.45%10-Year Average = 2.62%15-Year Average = 2.86%Maximum Rate = 5.84%Minimum Rate = 0.70%
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 25
Illustration of Tax-Exempt VRDO Issue
Par Amount 5,000,000$
Estimated Annual Borrowing RateVRDO Rate (assumed rate) 2.860%Letter of Credit Fee 1.500%Remarketing Agent Fee 0.125%Total Estimated Annual Borrowing Rate 4.485%
Estimated All-In Cost of Financing 4.972%
Estimated Closing CostsUnderwriting / Structuring Fee 40,000$ Bond, Bank and Underwriter's Counsel 30,000 Company Counsel 10,000 Trustee Upfront Fee and Counsel 3,000 Issuing Authority Fee TBDRating Agency Fee 10,000 Up-Front Costs - Real Estate Related Costs 10,000 Total Estimated Closing Costs 103,000$
Estimated Financing CostsInterest Expense 1,220,362$ Letter of Credit Fees 647,941 Remarketing and Other Annual Fees 125,338 Closing Costs (Detailed Above) 103,000 Total Estimated Financing Costs 2,096,641$
Total Net Debt Service 7,096,641$
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 26
VRDO Cash Flow Summary
Year DateBeginning
BalancePrincipal
Amortization InterestLetter of Credit
Remarketing Fees Trustee
LOC Draw Fees
Upfront COI Total
Present Value All-In Rate
6/1/2008 $5,000,000 $0 $0 $103,000 $103,000 $103,000 -$4,897,0001 6/1/2009 5,000,000 270,000 143,000 75,925 6,250 3,000 1,800 499,975 476,292 476,2922 6/1/2010 4,730,000 280,000 135,278 71,825 5,913 3,000 1,800 497,815 451,772 451,7723 6/1/2011 4,450,000 285,000 127,270 67,573 5,563 3,000 1,800 490,205 423,794 423,7944 6/1/2012 4,165,000 295,000 119,119 63,245 5,206 3,000 1,800 487,370 401,385 401,3855 6/1/2013 3,870,000 305,000 110,682 58,766 4,838 3,000 1,800 484,085 379,796 379,7966 6/1/2014 3,565,000 315,000 101,959 54,134 4,456 3,000 1,800 480,350 359,014 359,0147 6/1/2015 3,250,000 320,000 92,950 49,351 4,063 3,000 1,800 471,164 335,468 335,4688 6/1/2016 2,930,000 330,000 83,798 44,492 3,663 3,000 1,800 466,752 316,586 316,5869 6/1/2017 2,600,000 340,000 74,360 39,481 3,250 3,000 1,800 461,891 298,449 298,449
10 6/1/2018 2,260,000 350,000 64,636 34,318 2,825 3,000 1,800 456,579 281,042 281,04211 6/1/2019 1,910,000 360,000 54,626 29,003 2,388 3,000 1,800 450,817 264,351 264,35112 6/1/2020 1,550,000 370,000 44,330 23,537 1,938 3,000 1,800 444,604 248,360 248,36013 6/1/2021 1,180,000 380,000 33,748 17,918 1,475 3,000 1,800 437,941 233,050 233,05014 6/1/2022 800,000 390,000 22,880 12,148 1,000 3,000 1,800 430,828 218,405 218,40515 6/1/2023 410,000 410,000 11,726 6,226 513 3,000 1,800 433,264 209,236 209,236
$5,000,000 $1,220,362 $647,941 $53,338 $45,000 $27,000 $103,000 $7,096,641 $5,000,000 $0
Effective All-In Interest Rate 4.97%
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 27
Hedging Variable Rate Exposure
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 28
Hedging Interest Rate Risk of VRDOs
Borrower can enter into an agreement that mitigates the interest rate risk associated with the weekly interest rate resets of variable rate demand bonds.
Two primary methods to hedge interest rate risk of VRDOs is
Interest Rate Cap and Collar
Interest Rate Swap
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 29
Interest Rate Caps
Limits interest rate exposure for variable rate debt when Issuer purchases cap
VRDB rate+ support
costs
Periodic Payments in an Amount Equal to Index Interest Rate Above Cap
Rate
Issuer MKFP
Upfront Option Premium
Variable RateBondholders
0
2
4
6
8
10
Jan
Feb
Mar
Apr
May
Jun Ju
l
Aug
Sep Oct
Nov
Dec
Yiel
d %
BMA Index 5.50% Cap
MKFP pays difference above 5.50% cap
0
2
4
6
8
10
Jan
Feb
Mar
Apr
May
Jun Ju
l
Aug
Sep Oct
Nov
Dec
Yiel
d %
BMA Index 5.50% Cap
0
2
4
6
8
10
Jan
Feb
Mar
Apr
May
Jun Ju
l
Aug
Sep Oct
Nov
Dec
Yiel
d %
BMA Index 5.50% Cap
MKFP pays difference above 5.50% cap
Premiums more expensive the lower the cap rate or the longer the maturity
Issuer benefits from declining variable rates
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 30
Interest Rate Collars
Defines interest rate exposure within an acceptable band of rates
VRDB rate+ support
costs
Variable RateBondholders
MKFP
Periodic Payments in an Amount Equal to Index Interest Rate Above
Cap Rate Purchased by Issuer
IssuerUpfront Option
Premiums
Periodic Payments in an Amount Equal to Index Interest Rate Below
Floor Rate Sold by Issuer
0
2
4
6
8
10
Jan
Feb
Mar
Apr
May
Jun Ju
l
Aug
Sep Oct
Nov
Dec
Yiel
d %
BMA Index 5.50% Cap 4.00% Floor
MKFP pays difference above 5.50% cap
Issuer pays difference below 4.00% floor
0
2
4
6
8
10
Jan
Feb
Mar
Apr
May
Jun Ju
l
Aug
Sep Oct
Nov
Dec
Yiel
d %
BMA Index 5.50% Cap 4.00% Floor
MKFP pays difference above 5.50% cap
Issuer pays difference below 4.00% floor
MKFP pays difference above 5.50% cap
Issuer pays difference below 4.00% floor
May be structured as “costless”collar
Issuer gives up some of downside benefit in exchange for lower cost cap
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 31
Fixed Interest Rate Swaps
Contract to exchange or “swap” a fixed rate of interest for a variable rate on a notional balance (principal is not exchanged)
Variable rate received is either the SIFMA Index rate or a % of LIBOR
Swap agreement often mirrors principal amortization on underlying debt over the life of the bond issue.
Issuer has option to terminate swap at market which may result in payment to or receipt from swap counterparty. Generally, if market interest rates rise, the borrower will receive a termination payment, and if rates fall, the borrower will owe a settlement payment.
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 32
Synthetic Fixed Rate Debt (Fixed Rate Swap)
Synthetic fixed rate debt is an alternative to conventional fixed rate debt
VRDB Rate+ support
costs
Floating Rate
Issuer MKFP
Fixed Rate
Variable RateBondholders
Net cost approximates fixed swap rate plus carrying costs
Achieve lower fixed interest rate versus conventional fixed rate debt
Benefits and additional risks of synthetic structure
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 33
Illustrative Flow of Funds for Synthetic Fixed Rate Debt
33
With perfect hedge borrowing cost is fixed swap rate plus carrying costs
BMA Swap70% LIBOR
SwapBorrower PaysFixed Swap Rate (1) 3.700% 3.500%
VRDO Rate (2) 1.900% 1.900%Letter of Credit Fee 1.500% 1.500%Remarketing Agent Fee 0.125% 0.125%
Total Payments 7.225% 7.025%
Borrower ReceivesVariable Swap Rate (3) 1.830% 1.757%
Effective Costs 5.395% 5.268%
(2) SIFMA Index of 1.83% for 5/14/08 reset plus 7 bps trading spread
(3) SIFMA Index of 1.83% and 1M LIBOR of 2.51% as of 5/14/08; SIFMA is currently 72.9% of 1M LIBOR
(1) Rates as of 5/14/2008 for a fixed payer swap with an assumed 15 year average life.
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 34
Benefits and Risks
Lock-in fixed rate exposure to reduce volatility of interest rate costs
May create significant interest rate savings compared to conventional fixed rate debt
Swap may be terminated by the Issuer at anytime at market value
With any synthetic transaction, there are risks that need to be carefully considered and weighed against any financial benefits of the structure
Risks associated with underlying VRDOs and swap itself
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 35
Key Risks Associated with Fixed Rate Swaps
35
Basis Risk - floating rate received on swap does not closely match the interest rate paid on the VRDOsCounterparty Credit Risk - credit exposure to the swap provider and the risk that the swap provider is unable to make payments under the terms of the swap agreement. Mitigate by establishing high ratings requirement and collateral posting requirements.LOC Renewal Risk – Issuer may not be able to renew the LOC for the underlying variable rate bondsMark-to-Market Risk – Issuer may be required to post-collateral for negative market valuations above specified thresholdTermination Value Risk – Issuer may have to make a payment if the swap is terminated early, either at Issuer’s option or upon a termination eventTax Reform Risk – if Issuer enters into a % LIBOR swap, risk that if tax-exemption goes away, VRDO rates rise to taxable levels creating a mismatch between floating rate received on swap and VRDO interest obligation. BMA swap eliminates this risk.
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 36
Swap Documentation
36
Standard documentation under International Swap Dealer’s Association (“ISDA”) Master Agreement and accompanying Schedule (which modifies the Master Agreement), with specific trade terms detailed in the Confirmation.
ISDA MASTER AGREEMENT
• Industry standard document governing all interest rate hedging transactions
• Utilized by all Swap Providers• Addresses the following:
Netting benefits Events of default Early termination provisions Bilateral provisions Evergreen document
CONFIRMATION
• Describes specific details or economic terms of the transaction, including: Notional principal amount Reset and payment dates Specified rates and
conventions
SCHEDULE TOMASTER AGREEMENT
• Modifies the legal terms of the ISDA Master Agreement to address the individual client
• Unique to each Swap Provider• Includes the specifics of credit
support, if any, and structure
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 37
Current Market - Fixed Rates vs. Swap Rates
Curves as of 4-14-08
1.50
2.00
2.50
3.00
3.50
4.00
4.50
5.00
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
Maturity Year
Yie
ld (
%)
AAA MMDSIFMA
70% LIBOR
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 38
Current Market – MMD
Curves as of 4-14-081 3 5 7 9 11 13 15 17 19 21 23 25 27 29
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
0.00%
3.00%
6.00%
9.00%
12.00%
15.00%
18.00%
21.00%
0.00%-3.00% 3.00%-6.00% 6.00%-9.00% 9.00%-12.00%12.00%-15.00% 15.00%-18.00% 18.00%-21.00%
-
2.00
4.00
6.00
8.00
1
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 39
Current Market – SIFMA Swap
Curves as of 4-14-081 3 5 7 9 11 13 15 17 19 21 23 25 27 290.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
0.00%
3.00%
6.00%
9.00%
12.00%
15.00%
18.00%
21.00%
0.00%-3.00% 3.00%-6.00% 6.00%-9.00%9.00%-12.00% 12.00%-15.00% 15.00%-18.00%
-
8.000
1
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 40
Current Market – 70% 1M LIBOR Swap
Curves as of 4-14-081 3 5 7 9 11 13 15 17 19 21 23 25 27 290.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
0.00%3.00%6.00%9.00%
12.00%
15.00%
18.00%
21.00%
0.00%-3.00% 3.00%-6.00% 6.00%-9.00% 9.00%-12.00%12.00%-15.00% 15.00%-18.00% 18.00%-21.00%
-
2.0000
4.0000
6.0000
8.0000
1
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 41
Historical Swap Rates
SIFMA-70% of LIBOR (Jan 1985 - Apr 2008)
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
Jan-85
Jan-87
Jan-89
Jan-91
Jan-93
Jan-95
Jan-97
Jan-99
Jan-01
Jan-03
Jan-05
Jan-07
SIFMA 70% of LIBOR
SIFMA Index 1M LIBOR SIFMA/LIBORCurrent 1.800% 2.710% 66.421%1 Year Average 3.310% 4.650% 71.183%5 Year Average 2.440% 3.390% 71.976%10 Year Average 2.640% 3.870% 68.217%15 Year Average 2.860% 4.270% 66.979%*as of April 15, 2008
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 42
Historical Swap Rates & Current Analysis
Swap spreads have widened relative to the traditional fixed rate market. The 70% LIBOR swap is 154 basis points below the fixed rate MMD curve, versus the average of 66 basis points.
*Rates as of April 14, 2008
20 Yr Average Life Fixed Rate Bonds versus Swap Rates
2.753.003.253.503.754.004.254.504.755.005.255.505.756.006.256.506.757.007.25
Mar-91
Mar-92
Mar-93
Mar-94
Mar-95
Mar-96
Mar-97
Mar-98
Mar-99
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Perc
enta
ge
AAA Fixed Rate 70% of 1 Month LIBOR Swap SIFMA Swap
Avg Spread Current Spread Min Spread Max SpreadFixed vs. 70% 1 Mo. LIBOR* 0.66 1.48 0.23 1.66Fixed vs. SIFMA 0.27 1.15 -0.25 1.2170% 1 Mo. LIBOR* vs. SIFMA 0.41 0.33 -0.03 0.90*since 1994
-
Morgan KeeganE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T SE X P E R I E N C E · F O C U S · C O M M I T M E N T · R E S U L T S 43
Historical Swap Rates (Jan 2007 thru April 2008)
*Rates as of April 14, 2008
20 Average Life LIBOR vs. SIFMA Swap Rates
2.75
3.00
3.253.50
3.75
4.00
4.25
4.504.75
5.00
5.25
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08
Perc
enta
ge
70% of 1 Month LIBOR Sw ap SIFMA Sw ap Fixed