debt structuring debt essentials: accessing the market california debt and investment advisory...

Debt StructuringDebt Essentials: Accessing the MarketCalifornia Debt and Investment Advisory Commission

February 2, 2011

Scott Nagelson, Managing [email protected], 415.229.1428

2

Introduction

At this point, the Issuer has made several decisions:

Identified a need to borrow money

Identified a revenue stream to pay debt service

Assembled a finance team

Bond counsel/Disclosure counsel

Investment banker

Financial advisor

It’s now time to STRUCTURE THE FINANCING!

3

Topics

Types of Debt Obligations

Sizing the Bond Issue

Debt Service Structure

Refunding Bonds

Ratings

Credit Enhancement

Variable Rate Debt

Managing Interest Rate Swaps

4


There are many types of debt that California governments issue:

General Obligation Bonds

TRANs

Lease Revenue Bonds

Certificates of Participations

Revenue Bonds

Sales Tax Bonds

Pension Bonds

Special Tax Bonds

Tax Allocation Bonds

Assessment Bonds

5


The type of debt being issued can directly affect the structure of the bond issue

Reserve Fund Requirement

Additional Bonds Test

Debt Service Coverage Requirements

Term

Tax Treatment

Call Features

Leased Assets

6

Sizing the Bond Issue

Project or Construction Fund

Capitalized Interest Fund

Debt Service Reserve Fund

Costs of Issuance

Underwriting Discount

Depending on the type of debt and the nature of the plan of finance, proceeds of the bonds may be used for a number of purposes

Refunding Escrow

7

The Project Fund

Fund acquisition of the asset or construction of the project

Based on actual costs or reliable estimates

Net Funded or Gross Funded?

Gross Funded – Deposit exact amount required to pay for asset or project

Net Funded – Amount deposited plus interest earnings during the drawdown period sufficient to fund project

8

Refunding Escrow

Refinance outstanding bonds

Current refunding or advance refunding

An amount of proceeds sufficient to pay principal and interest on the prior bonds is deposited into an escrow account

Escrowed funds are used to pay off the prior bonds at the call date or maturity

9

The Capitalized Interest Fund

Bonds proceeds used to pay interest for a finite period of time

Interest is capitalized for a number of reasons

Until a project/asset can produce revenue

Until the issuer has beneficial use (COPs, Lease Revenue Bonds)

Until revenue is projected to be sufficient to pay debt service

2012 20132011

Jan 1

Bonds Issued

Jul 1 Jan 1 Jul 1 Jan 1 Jul 1

Int Pmt Date

Int Pmt Date

Int Pmt Date

Int Pmt Date

Int Pmt Date

Project Construction Period

Interest Paid From Bond Proceeds

10

The Debt Service Reserve Fund

Provides additional security for investors

Found in most credits with the exception of GO Bonds and Pension Obligation Bonds

Tax Code limits the size of the Reserve Fund to the lesser of:

Maximum Annual Debt Service

125% of Average Annual Debt Service

10% of Par Amount

Fund is invested with earnings usually going as an offset to debt service

Debt Service Reserve Fund Surety Policy

11

Costs of Issuance

Bond proceeds may be used to pay certain eligible costs

Bond Counsel and/or Disclosure Counsel

Financial Advisor and Trustee/Paying Agent

Rating Agencies

Appraisal, Feasibility Study, Engineer’s Report

Special Tax Consultant

Title Insurance

Bond Insurance and/or Surety Bond Premium

Letter of Credit fees

Professional

Services

Professional

Services

CreditEnhanceme

nt

CreditEnhanceme

nt

12


Underwriter’s compensation and expenses

Average Takedown

Management Fee

Expenses

At closing, Underwriter pays for bonds an

amount less the underwriting discount

$100,000,000 Par

(650,000) Less discount of 6.50/$1,000

$ 99,350,000 Purchase Price

Expressed as dollars per thousand dollars

of bonds (e.g., $6.50/$1,000)

Components

Components

FundingMethod

FundingMethod

13

Sizing Example

Net Funded Construction Fund

Capitalized Interest Fund

Debt Service Reserve Fund

Costs of Issuance


14

Sizing Assumptions – Ammonia Springs Clean Water Authority

4/1/2011 $ 10,000,000

10/1/2011 $ 10,000,000

4/1/2012 $ 10,000,000

10/1/2012 $ 10,000,000

$ 40,000,000 Total Project Cost

Project Cost and Draw ScheduleProject Cost and Draw Schedule

Bonds Dated: 1/1/2011Bonds Dated: 1/1/2011

Final Maturity: 1/1/2041Final Maturity: 1/1/2041

15


$200,000 Legal, FA, TrusteeRatings, Printing, Misc.

40bps Bond Insurance Premium(Total Debt Service

x .40%)

$6.50/bond Takedown, Management Fee,

Expenses

Costs of IssuanceCosts of Issuance

Bonds InsuranceBonds Insurance

Underwriting DiscountUnderwriting Discount

16


Lesser of:

Maximum Annual Debt Service

125% of Average Annual Debt Service

10% of Par Amount

Through 2-year Construction Period1/1/2013

Debt Service Reserve FundDebt Service Reserve Fund

Capitalized InterestCapitalized Interest

17


Fund Rate Earnings Go To:

Capitalized 2.50% ConstructionInterest FundFund:

Construction 2.50%Construction

Fund: Fund

Debt Service 5.0%Construction

Reserve (Bond FundFund: Yield)

Reinvestment

Assumptions

Reinvestment

Assumptions

18

Sizing Example – Net Funded Project Fund

Sources of Funds:

Par Amount: $ 46,390,000

Total Sources of Funds: $ 46,390,000

Uses of Funds:

Project Fund $ 38,723,636

Cap Interest Fund: $ 4,008,591Debt Service

Reserve Fund: $ 2,795,850

Bond Insurance: $ 357,550

COI: $ 200,000

Underwriter’sDiscount: $ 301,535

Rounding: $ 2,838

Total Uses of Funds: $ 46,390,000

1/1/2011 Initial Deposit: $ 38,723,636

Project Fund Earnings $ 968,704

Cap Interest Fund Earnings $ 112,609

Debt Service ReserveFund Earnings $ 195,051

Total Project Cost $ 40,000,000

19

Sizing Example – Capitalized Interest Fund

Sources of Funds:

Par Amount: $ 46,390,000


Uses of Funds:


Cap Interest Fund: $ 4,008,591

Debt Service

Reserve Fund: $ 2,795,850


COI: $ 200,000


Rounding: $ 2,838


1/1/2011 Initial Deposit: $ 4,008,591

7/1/11 Interest Payment ($ 1,005,697)

1/1/12 Interest Payment ($ 1,005,697)

7/1/12 Interest Payment ($ 998,599)

1/1/13 Interest Payment ($ 998,599)

Fund Balance on 1/1/13 $ 0

20

Sizing Example – Debt Service Reserve Fund

Sources of Funds:

Par Amount: $ 46,390,000


Uses of Funds:



Debt ServiceReserve Fund: $ 2,795,850


COI: $ 200,000


Rounding: $ 2,838


Lesser of:

Maximum Annual Debt Service $ 2,795,850

125% of AverageAnnual Debt Service $ 3,491,698

10% of Par Amount $ 4,639,000

21

Sizing Example – Bond Insurance Premium

Sources of Funds:

Par Amount: $ 46,390,000


Uses of Funds:





COI: $ 200,000


Rounding: $ 2,838


Total Principal & Interest $89,387,448

x.40%

Bond Insurance Premium $ 357,550

22

Sizing Example – Costs of Issuance

Sources of Funds:

Par Amount: $ 46,390,000


Uses of Funds:





COI: $ 200,000


Rounding: $ 2,838


Costs of Issuance:

Bond Counsel: $100,000

Financial Advisor: $ 50,000

Trustee: $ 5,000

Rating Agencies: $ 30,000

Printing: $ 7,500

Miscellaneous: $ 7,500

Total COI: $200,000

23

Sizing Example – Underwriting Discount

Sources of Funds:

Par Amount: $ 46,390,000


Uses of Funds:





COI: $ 200,000


Rounding: $ 2,838


Underwriting Discount:

Takedown: ($3.50/bond): $ 162,365

Management Fee($1.00/bond): $ 46,390

Expenses: ($2.00/bond): $ 92,780

Underwriter’s Discount ($6.50/bond): $301,535

24

Debt Service Structure

Sample Structures

Current Interest vs. Deferred Interest

Optional Redemption

Refunding Considerations

25

Level Debt Service

DSRF Implications

Lesser of:

Maximum AnnualDebt Service $ 2,795,850


10% of Par Amount $ 4,630,000

Bond Insurance Implications

Total Principal & Interest: $ 89,387,448

x.40%

Insurance Premium $ 357,550

DSRF ImplicationsBond Insurance

Implications

$0

$1

$2

$3

$4

$5

$6

$7

Millions

$46,390,000AmmoniaSprings Clean Water Authority

Revenue Bonds

26

“Wrapped” Debt Service

DSRF Implications

Lesser of:



10% of Par Amount $ 4,825,500


Total Principal & Interest: $106,107,854

x.40%



Implications

$0

$1

$2

$3

$4

$5

$6

$7

Millions


Revenue Bonds

27

Short Maturity

DSRF Implications

Lesser of:



10% of Par Amount $ 4,825,500


Total Principal & Interest: $ 54,359,382

x.40%



Implications

$0

$1

$2

$3

$4

$5

$6

$7

Millions


Revenue Bonds

28

Structuring the Bonds

Serial Bonds

Mature “serially” by year

Take advantage of positively sloped yield curve

Term Bonds

Single coupon covering multiple years

Retired with annual Sinking Fund Payments

Maturity Schedule

Maturity

(Jan 1)

Principal

Amount

Interest

Rate Yield

2012 780,000 1.820% 1.820%

2013 795,000 2.070% 2.070%

2014 815,000 2.370% 2.370%

2015 830,000 2.670% 2.670%

2016 855,000 3.020% 3.020%

2017 880,000 3.220% 3.220%

2018 910,000 3.370% 3.370%

2019 940,000 3.520% 3.520%

2020 970,000 3.630% 3.630%

2021 1,005,000 3.740% 3.740%

2022 1,045,000 3.840% 3.840%

2023 1,085,000 3.940% 3.940%

2024 1,130,000 4.030% 4.030%

2025 1,175,000 4.110% 4.110%

2026 1,220,000 4.180% 4.180%

2027 1,275,000 4.270% 4.270%

2028 1,325,000 4.350% 4.350%

$7,610,000 4.72% Term Bonds maturing J anuary 1, 2033



$46,390,000

Ammonia Springs Clean Water Authority

Water Revenue Bonds

Dated: January 1, 2011 Due: January 1, 2041

29

Current or Deferred Interest Bonds

Current Interest Bonds

Pay interest at stated coupon

Interest typically paid every 6 months

May be sold at par, at a premium or at a discount

Investor’s yield determined by price paid for the Bond

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

Thousands

Principal

Interest

30

Current or Deferred Interest Bonds

Capital Appreciation Bonds

“Zero” coupon or deferred interest bonds

Interest accretes to maturity

Sold at a deep discount

Investor’s yield determined by price paid for the Bond

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

Thousands

31

Other Considerations

Optional Redemption

Standard optional redemption period is 10 years

Callable bonds generally have a higher yield than non-callable bonds

Par Bonds, Original Issue Discount Bonds, and Original Issue Premium Bonds

Coupon Yield Price

Par Bond 5.00% 5.00% 100%

Discount Bond 5.00% 5.10% 98% (est)

Premium Bond 5.00% 4.90% 100.9% (est)

32

Refunding Considerations

Advance Refunding

Old Bonds are not currently subject to optional redemption

New Bond proceeds are used to fund an escrow that defeases old bonds to call date

Escrow invested in Treasury (SLGs) with maximum permitted yield equal to bond arbitrage yield

Can only advance refund one time

Current Refunding

Old Bonds are currently subject to optional redemption

New Bond proceeds are used to redeem old bonds

33

Ratings and Credit Enhancement

The Rating Agencies

Obtaining a Rating

Bond Insurance

34

The Rating Agencies

Aaa AAA AAAAa1, Aa2, Aa3 AA+, AA, AA- AA+, AA,

AA-A1, A2, A3 A+, A, A- A+, A, A-Baa1, Baa2, Baa3 BBB+, BBB, BBB- BBB+, BBB, BBB-Ba1, Ba2, Ba3 BB+, BB, BB- BB+, BB,

BB-

MIG-1, MIG-2, MIG-3 SP-1+, SP-1, SP-2 F-1+, F-1, F-2, F-3(Notes) (Notes) (Notes)

VMIG-1, VMIG-2, A-1, A-2, A-3 LOC (Commercial Paper

VMIG-3 (Commercial (Commercial and VRDBs)Paper and VRDBs) Paper and VRDBs)

Lon

g-T

erm

Lon

g-T

erm

Sh

ort

-Term

Sh

ort

-Term

35

Obtaining a Rating

A typical rating agency package might include:

3 years of audited financial statements

Current and proposed budget

Bond Documents, including:

Trust Indentures

Lease Agreements

Installment Sale Agreements

Redevelopment Loan Agreements

Preliminary Official Statement

Special Reports

Sizing and Debt Service Schedules

Timing and Responsibility Schedule

Distribution List

36

Obtaining a Rating

It is often useful to meet with the rating analysts to:

Describe the project

Get feedback on the structure

Describe salient aspects of security

Review demographics and economics of service area

On-site or at rating agency offices

37

Bond Insurance - The Good Old Days

Once upon a time, bond insurance was readily available and widely used

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

$500

Billion

s

Insured Uninsured

Total Municipal Issuance 2001-2010

38

Bond Insurance - A More Limited Role

2007 Top Bond Insurers

Rank Bond Insurer

Par Amt

($mil)

Number of

Issues

1 FSA 48,988.5 1,702

2 AMBAC 48,859.1 1,081

3 MBIA Insurance Corporation 46,398.2 1,037

4 FGIC 30,712.4 375

5 XL Capital Assurance Inc. 13,654.5 587

6 CIFG NA 4,927.1 351

7 Assured Guaranty 3,729.6 144

8 Radian Asset Assurance Inc 2,375.4 207

9 ACA Financial Guaranty Corp 648.7 31

2010 Top Bond Insurers

Rank Bond Insurer

Par Amt

($mil) # Issues

1 Assured Guaranty/ AGM 26,769.7 1,700

In 2008, most of the insurers lost their “AAA” ratings due to losses associated with sub-prime mortgage bond insurance

Today, only AGM is active with “AA” category ratings

39

Variable Rate Bonds

Historical Interest Rates

Structuring Options

Pros and Cons of Alternative Structures

Managing Interest Rate Swaps

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

SIFMA

RBI Index

40

Variable Rate vs. Fixed Rate

Securities Industry and Financial Markets Association (SIFMA) Index (formerly BMA)

vs. Bond Buyer Revenue Bond Index (RBI)

A Ten Year History

SIFMA 10 Year Avg = 1.89%

RBI 10 Year Avg = 5.13%

41

Pros vs. Cons of Variable Rate Structures

CONS

Less flexibility to refinance

Historically higher cost

Poor hedge for floating rate assets

Interest rates may rise

Takes more time to manage

Bank renewal and trading risk

More challenging to budget

PROS

No interest rate risk

Easier to budget

Less time to manage

Historically lower cost

Easier to restructure/refinance

Hedge for floating rate assets

Fix

ed

Rate

Fix

ed

Rate

Vari

ab

le R

ate

Vari

ab

le R

ate

PROSPROS CONSCONS

42

Variable Rate Issuance over Time

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

Billion

s

Variable Fixed-Rate

Total Municipal Issuance 2001-2010

43

Introduction to Variable Rate Structures

Historically, there have been a number of ways for issuers to achieve variable rate exposure in the municipal market

Commercial Paper

Variable Rate Demand Bonds

Auction Rate Securities

Indexed Floaters

Fixed Receiver Swaps

44

Variable Rate Structuring Options

Commercial Paper

Can be drawn down and paid back as needed

Outstanding CP is remarketed for a maximum of 270 days

Bank credit facility required for liquidity

Money Market Funds are the primary investor

Often used to fund construction draws and then taken out with long-term bonds

Interest rate determined by CP

45


Variable Rate Demand Bonds

Long-term bond with rate that resets periodically (daily, weekly, monthly, etc.)

Investor can “put” bonds on short notice (allows bond to trade at par)

Bank credit facility required to support put

Interest rate determined by Remarketing Agent

46

Credit Facilities

2007 Top Letter of Credit Providers

Rank Firm Amount Issues

1 Bank of America 2,364.6 101

2 J P Morgan Chase 2,340.6 85

3 Wells Fargo Bank 1,688.6 98

4 SunTrust Bank 1,354.4 57

5 Regions Bank 1,295.8 42

6 The Bank of New York Mellon 1,024.8 60

7 LaSalle Bank 955.1 40

8 US Bank 821.8 77

9 KeyBanc 814.0 40

10 Sovereign Bank 699.8 29

2010 Top Letter of Credit Providers

Rank Firm Amount Issues

1 J P Morgan Chase 2,852.4 38

2 Bank of America 2,278.4 36

3 Wells Fargo Bank 837.2 28

4 Barclays Bank PLC 483.7 5

5 PNC Bank NA 458.3 11

6 TD Bank NA 326.9 6

7 Citibank 257.3 5

8 Union Bank NA 255.8 7

9 RBS Citizens NA 193.1 2

10 SunTrust Bank 185.0 2

Bank Credit capacity has been constrained since 2008

Fewer banks with less capital has driven LOC pricing to high levels

Approximately $80 billion of bank credit facilities supporting variable rate bonds will be up for renewal in 2011

47


Indexed Floating Rate Bonds

Interest rate resets based on an index (i.e. SIFMA or LIBOR)

Rate typically based on a spread over the index (i.e. SIFMA + 50 bps)

No need for a Remarketing Agent

Investor does not have a put, so no need for a bank credit facility

Index period is typically less than 5 years. At the end of the index period, the issuer remarkets the bond for another index period or switches to a different variable rate mode

48


Auction Rate Securities

Long-term bond with rate that resets periodically (weekly, monthly, etc.)

No “put” feature and thus, no bank facility

Rate reset via Dutch Auction process

The ARS market died in 2008 with the demise of large scale bond insurance

49

Variable Rate Alternatives At-A-Glance

Summary of Variable Rate Alternatives

Managing Existing Interest Rate Swaps

Many issuers have converted floating rate bonds to synthetic fixed rate by entering into interest rate swaps

IssuerIssuerFixed rate Payment

Variable Rate Payment

CounterpartyCounterparty

Variable Rate Bonds

Variable Rate Bonds

Variable Rate Payment

50

Interest Rate Swaps Have a Number of Risks

Basis RiskSwap variable rate received and the actual bond variable rate does not match perfectly

• LOC bank is downgraded, causing bonds to trade at higher spread to SIFMA

• Market rates compress

Tax Event Risk

Changes in income tax rates alter the value of tax-exempt interest rates relative to taxable interest rates

• If tax rates go down, variable bond yield will go up

Counterparty Risk

Swap counterparty will not perform pursuant to the contract’s terms. For example if the swap provider defaults or its credit rating declines

• Lehman, DEPFA, AMBAC, UBS

Termination Risk

A material decline in credit worthiness could lead to a termination of the swap and require a payment to be made to or from the issuer depending on prevailing market conditions at the time of termination

• Negotiate favorable credit triggers and terms for collateral posting

• Monitor the mark to market value of the swap

51

If You Have an Interest Rate Swap…

Monitor the bank providing liquidity for the variable rate bonds

Rating

Expiration Date of credit facility

Trading characteristics

Monitor the performance of your Remarketing Agent

Monitor the credit rating of your swap counterparty

Monitor long-term interest rates

As rates go up, termination values should fall

May create an opportunity to terminate the swap

52

This document is intended to be reviewed in conjunction with an oral presentation by representatives of Jefferies & Company, Inc. (“Jefferies”) and is therefore incomplete on a stand-alone basis. It is intended for the exclusive use of the entity identified on the cover page and may contain information proprietary to Jefferies. The fact that Jefferies has made the materials or any other materials available to you constitutes neither a recommendation that you enter into or maintain a particular transaction or position nor a representation that any transaction is suitable or appropriate for you.

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Disclaimer

debt structuring debt essentials: accessing the market california debt and investment advisory...

Documents

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type of debt

prior bonds

project slide

average annual debt

maximum annual debt

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