Chapter 3: Municipal Bonds
Placement Ratio is high...
market for muni bonds is high
Sinking Fund
money to pay off interest and principal obligations
Tax liability calculation
Mill Rate X property's assessed value
The spread in a muni competitive bid is
Bid - Production
Which type of bond fluctuates more in prices (due to interest rates/market)?
Municipal bonds
Where are bond bids are solicited?
The (Daily) Bond Buyer
Competing facilities
a facility should not be placed where better alternatives are easily available
flow of funds statement is contained in the
bond contract
another name for YTM
"called basis"
bond placement ratio
$ dollar value of new issues sold/ dollar $ value of new issues offered
1 mill=
$0.001 OR 1/1000
Legal Opinion
(The first thing an issuer must do to get a new municipal issue) *it determines whether and how the bonds may be offered*
Negotiated underwriting
(option for setting bond terms) *issuer appoints investment banker* -the investment banker assists in raising capital by underwriting new securities/becoming the issuing agent -establishes interest rate and offering price
Competitive bidding
(option for setting bond terms) *municipality publishes an invitation to bid, investment bankers respond with bid* -bid representing the lowest net interest cost to issuer is the winner of bid
Eastern Account
(syndicate account) undivided account, each underwriter is allocated a portion of the issue
Western Account
(syndicate acct) divided account, each underwriter is responsible for its own underwriting allocation
TIC / True Interest Cost
-cost comparison of proceeds received and coupon interest paid + time value of money Time value of cash flows
Revenue sources
-utilities (water, sewer, electric) -housing -transportation (airports and toll roads) -education (dorms and student loans) -health (hospitals and retirement centers) -industrial (industrial development and pollution control) -sports (concessions)
Two types of municipal securities
1. General Obligation (GO) Bonds 2. Revenue Bonds
Types of Revenue Bonds
1. IDRs/IDBs 2. Special Tax Bonds 3. Special Assessment Bonds 4. Moral Obligation Bonds 5. PHAs, NHAs
Three type of maturity schedules to muni and corporate debt issues
1. Term Maturity 2. Serial Maturity 3. Balloon Maturity
Three entities entitled to issued municipal securities
1. US territories (Virgin Islands, Puerto Rico, Guam) 2. State Governments 3. Local Governments
Other names for catastrophe calls (2)
1. calamity call 2. extraordinary mandatory call
What is included on the MUNICIPAL debt statement?
1. estimated full valuation of taxable property 2. est. assessed value of property 3. population/demographics 4. debt
What order are distributions made under a net revenue pledge?
1. operating and maintenance expenses 2. debt service. 3. debt service reserve 4. surplus
Coterminous Debt
2+ taxing agencies that share the same geographic boundaries and are able to issue debt separately
A legal opinion evaluates which of the following features of a municipal issue? 1Marketability. 2Legality. 3Tax-exempt status. 4Economic feasibility.
2/3
What else (other indexes) is the Bond Buyer compiled of?
40 Bond Index 20 Bond Index 11 Bond Index Revdex 25
New Housing Authority (NHAs)
develop and improve low-income housing backed in full faith and credit of the US gov't
Principal Transaction
BD either buys securities from customers and puts them in own inventory OR sells securities from own inventory to customers
Another name for Trust Indenture
Bond resolution
Tax-equivalent yield formula
Muni Bond Yield/(100% - tax bracket %)
Tax-free equivalent yield formula
Corporate Bond Yield X (100% - tax bracket %)
Which of the following competitive bids on a new municipal issue is most likely to be awarded the bid? A) 6% coupon with no premiums over par. B) 8% coupon with premiums over par. C) 7% coupon with no premiums over par. D) 6% coupon with premiums over par.
D
Calculation for Net Overall Debt
Direct Debt + Overlapping Debt
Another name for term bonds
Dollar bonds
Industrial Development Revenue Bonds
IDR/IDB - muni authority issues bonds to construct facilities or purchase equipment (which is then leased to a corporation) -ultimately responsibility for principal and interest rests with the corporate leasing facility
True Interest Cost
IR calculation that weights early interest payments more heavily to give greater value to dollars today over dollars to be paid in the future
SIMPLIFIED tax liability calculation
Mill # X (drop the last 3 zeroes off of the property's assessed value) 7 x 200 0.007 x 200,000
Gross Revenue Pledge
Issuer pays DEBT services FIRST from gross revenues THEN EXPENSES (ops and maint) second
Net Revenue Pledge
Issuer pays EXPENSES FIRST from gross revenues THEN DEBT services second from net revenues
What taxes are associated with GOs?
Property/Ad Valorem taxes
What are term bonds quoted by?
Quoted by price
What are serial bonds quoted by?
Quoted by yield to maturity
PHA/NHAs
Section 8 Bonds
What taxes are associated with revenue bonds?
Special taxes
What does it mean when price/yield is 100%?
YTM = coupon rate, bond is offered at par
How are municipal bonds priced?
YTM basis /basis quote
A municipal bond rating service would consider all of the following when evaluating a revenue bond EXCEPT a. the public's attitude toward debt b. the debt service coverage ratio c. feasibility studies d. operating revenues
a
Insurance covenant
a promise to insure any facility built so bondholders can be paid off if the facility is destroyed or becomes inoperable
Rate Covenant
a promise to maintain rates sufficient to pay expenses and debt service
Maintenance covenant
a promise to maintain the equipment and facilities
Catastrophe clause
a promise to use insurance proceeds to call bonds and repay bondholders if a facility is destroyed
Nominal Quote
a quote given for information only
Good Delivery
a security that is negotiable and is ready to be transferred from seller to buyer
Good faith deposit
deposit contributed by each syndicate involved in a competitive bid underwriting (1-2% of par value)
bond contract
describes the nature of the contract and the issuers' duties to bondholders. comprised of: bond resolution (trust indenture)
Sinking Fund Account
account to accumulate funds to pay off term bonds at or before maturity date
Term Maturity
all principal matures at a single date
closed-ended (additional bonds test)
allow no further issuance of bonds with equivalent lien on assets or revenues
Open-ended (additional bonds test)
allowing further issuance of bonds with the same status and equal claims on assets or revenues if permitted under the provisions of the bond indenture
Syndicates
an account that helps spread the risk of underwriting an issue among a number of underwriters -JP Morgan + Raymond James, Wells Fargo,
who signs an official statement for a new municipal issue
an official/officials of the issuer
Yield to Maturity
annualized return of the bond IF held to maturity
Quotations
any bid or offer on municipal securities
Which of the following best describes how a syndicate determines the amount to bid for a new municipal issue?
average reoffering price - spread (price public pays) - amount syndicate will charge to bring issue to market
Public Housing Authority Bonds (PHAs)
backed by rental income from the housing -if the income isn't sufficient, the government will back the payments
What are revenue bonds backed by?
backed by specific revenue source (self-supporting) - from revenues generated by the project for which the debt was issued
what are the sources of funds for GO bonds
backed by the issuing municipality's taxing power -STATE: income taxes, sales taxes -LOCAL: property taxes, fines, license fees
Limited Tax Bond (GO)
bond secured by a specific tax (income tax) issuer is limited to what tax(es) can be used to service the debt -more risky
Special Assessment Bonds/Special District Bonds
bonds issued to finance the construction of public improvements such as streets, sidewalks, sewers -benefited property is taxed
Serial Maturity
bonds mature at different dates (according to a predetermined schedule) -once a year
Special Tax Bonds
bonds supported by sales, tobacco, fuel, business license taxes (other than ad valorem)
Which of the following statements regarding callable municipal bonds are TRUE?
call premiums tend to decrease over time Call premiums are stated as a percentage of the principal amount to be called
Tax and revenue anticipation notes (TRANs)
combination of TANs and RANs
Build America Bonds (BABs)
created to assist in reducing costs to issuing municipalities and stimulating the economy. Taxable obligations. -pay taxes on interest received -tax credits given
Which of the following bodies may NOT incur overlapping debt? a. school district b. county highway department c. park board d. state government
d
placement ratio is low
dealers show concern about bidding on new issues
Additional Bonds Test
either open or closed-ended If closed: any additional bonds issued will be subordinated to the original issue unless the funds are specifically required to complete construction of the facility
Flow of Funds statement
establishes the priority of payments made from a facility's revenues
Churning
excessive trading in a customer's account / ignores the client's interests and only seeks to increase commission
What is exempt when you buy a muni bond issued by Puerto Rico?
exempt at all levels (F/S/L)
Tax Anticipation Notes (TANs)
finance current operations in anticipation of future tax receipts / helps municipalities to even out cash flow between tax collection periods
Revenue Anticipation Notes (RANs)
finance operations in anticipation of future revenues from revenue producing projects or facilities
Coupon yield
fixed interest rate based on a percentage of the bond's par value
Operations and Maintenance
funds from revenue fund used to pay current operating and maintenance expenses - remaining funds are net revenues
Municipal Securities Rulemaking Board - MSRB
governs the issue and trade of municipal securities
(Variable Rate) Demand Notes (VRs)
have a fluctuating interest rate and are usually issued with a put option
Debt Service Coverage Ratio
how many times annual revenues will cover debt service -associated only with revenue bonds -2:1 is good for typical revenue bonds -5:4 is good for utility revenue bonds (sewer, water, electricity)
Voter Approval
if an issuer wishes to issue GO bonds that would put it above its statutory limit, a public vote is required
Tax rate is expressed:
in mills 1 mill equals $.001 [$1 per $1,000]
Tax Benefits of Muni Bonds
interest is only taxed at the level the bond is issued at
Net Interest Cost
interest rate calculation proceeds issuer receives + total coupon interest paid
what happens when visible supply is small?
interest rates are likely to fall
What happens when visible supply is large?
interest rates increase
Grant Anticipation Notes (GANs)
issued with the expectation of receiving grant money from the federal government
Balloon Maturity
issuer pays part of a bond's maturity before final maturity date, largest portion is paid off at maturity
Legislative apportionment
issuer's legislature would have to apportion money to satisfy the debt but it is not legally obligated to do so
What [typical] investor looks for tax-free muni bonds?
more appropriate for high tax bracket investors
General Obligation Issues (GOs)
municipal bonds issued for capital improvements that benefit the entire community -backed by full faith and credit
Broker's Broker
municipal broker specialized in trading only with other banks and municipal brokers / act behalf of another broker/ to protect identity
Exemptions of trust indentures
municipal issues (muni) bonds by the Trust Indenture Act of 1939
Moody's MIG ratings are for?
notes
Variable Rate Muni Bond
offers interest payments tied to the movements of another specified interest rate, like adjustable rate mortgage -price of bonds remain stable
Electronic Municipal Market Access
online site to location key information about muni securities for retail, non-professional investors
Another word for coterminious
overlapping debt
standard order priority for allocation of muni bond issues
presale, syndicate, designated, member
writing the scale
process of establishing the reoffering yield (price) for each maturity
Ad valorem
property taxes
Example of coterminous debt
property taxes on a home support county, city, and school district debt obligations
Coterminous debt only occurs in what situations?
property taxing situations
Construction Loan Notes (CLNs)
provide financing for the construction of housing projects
Thomson Muni Market Monitor (Munifacts)
provides the most up-to-the minute information relevant to the secondary muni bond market -**already trading bonds**
The Bond Buyer
published every business day and service as an authoritative source of information on primary market muni bonds -publishes the 30-day visible supply and the placement/ratio indexes
Relationship between capital gains and muni bonds
report and pay taxes on capital gains, interest can be tax exempt
Books and records covenant
requires outside audit of records and financial reports
Another name for Variable rate muni bonds
reset bonds (reset to market interest rate)
Tax Reform Act of 1986
restricts the federal income tax exemption of interest for muni bonds to public person bonds (GO) 10%+ goes to private parties, not tax exempt
Uniform Practice
rules for settling transactions between municipal security firms
when-issued confirmation
securities are authorized but not issued
Municipal Bonds
securities issued by a government that isn't the federal government (or agency) STATE/LOCAL GOV'T -issued for public works, construction projects -second in safety
Municipal Notes
short-term securities that generate funds for a municipality that expects other revenues soon -less than 1 year
Bond Anticipation Notes (BANs)
sold as interim financing that will eventually be converted to long-term funding through a sale of bonds
Issuers of GO bonds
state and political subdivisions (counties, cities, taxing districts)
Moral Obligation Bonds
state/local issued - state legislature has the authority to appropriate funds and to pay bondholders if revenues insufficient *issued in times of financial distress
GOs are backed by
tax collections
placement/acceptance ratio index
the % of the total dollar value of new issues sold versus total dollar value of new issues offered for sale the prior week
Agency Transaction
the BD acts for the accounts of others by buying or selling securities on behalf of customers
Statutory limits
the amount of debt that a municipal government may incur
Economic Justifications
the facility being built should be able to generate revenues, do a feasibility study. -is it feasible?
Placement ratio of 90% means:
the market has absorbed 90% of the dollar volume of bonds issued this week, 10% left in dealer's inventory
collection ratio
the percentage of property taxes that are actually collected -for evaluating GO bonds
Flow of funds
the priority of disbursing the revenues collected
Trust Indenture definition
the trustee protects the bondholders in making sure that the municipality abides by certain protective covenant/promises
Exemptions to states and interest
there are some states that are tax exempt at federal and state level depending where investor LIVES. -Ex: live in CA and buy a CA state bond the interest is exempt from state and federal tax return. IF you live in AZ and buy a CA state bond you have to pay taxes to AZ still
30 day visible supply
total dollar volume of municipal offerings expected to reach the market in the next 30 days
Revenue Bonds
used to finance a municipal facility that generates sufficient income -not subject to statutory debt limits -no voter approval
Debt Service Account
used to pay interest and principal maturing in current year and serves as a sinking fund for term issues
Double-Barreled Bonds
when a muni bond is backed by BOTH a source of revenue and taxing ability of the issuer (full faith and credit of issuer)
Bona Fide Quote
when a muni dealer is the one to give/distribute/publish a quote -the quote must be realistic to the market value of the bond
