Chapter 14 Municipal Bond Basics

Question 1

General Obligation Bonds

Answer 1

issued for facilities that benefit the public, schools, libraries, city hall. Backed by taxes.

Need voter approval in order to issue. Statutory Debt Limits

State level- sales tax or income tax
Local level – backed by real estate taxes.( property tax)

Debt to Value ratio is significant when evaluating G.O. Bonds.

competitive bidding

pay with taxes

Question 2

Revenue Bonds

Answer 2

Not backed by taxes. Backed by user charges such as toll roads, bridges, airport fees, etc.

Can be backed by lease payments, license fees, special taxes(liquor and cigarettes, etc)

Backed by Protective Covenants. No voter approval.

Feasibility study is required to determine self-sustainability.

No Statutory Debt Limits. Flow of Funds provision( incoming revenue from tolls, fees, etc)

Debt service coverage is significant when evaluating revenue bonds.
Notes- Short term maturities, interim or temporary financing.
TAN- Tax anticipation Note
RAN- Revenue Anticipation Note
TRANs- Tax and Revenue Anticipation Note
BANs- Bond Anticipation Note

negotiated deal

Question 3

mileage rate

Answer 3

1 mil=$.0001

A piece of property has a market value of 200,00,000 and assessed at 50% of market value and taxed at the rate of 5 mils. What would the property tax revenue to the municipality be?
200,000,000 x 50%=100,000,000
100,000,000 x 5 mills or .0005= 50,000

Question 4

Municipalities have two types of debt:

Answer 4

Direct debt- debt for which the municipal entity is solely responsible.

Overlapping Debt-is the debt for which more than one municipal entity is responsible. Overlapping debt only occurs at the local government level and is supported by taxes such as a library, school district, a park district but not a AIRPORT authority (Revenue Bond)

Overlapping debt is basically where the city builds a school, a library or park where the funds are being used are for multiple surrounding city’s, meaning other people from there cities will use the library, school or park.

Contiguous Overlapping debt- debt shared by different municipalities sharing the same borders

Direct Debt+ overlapping Debt= Net Overall debt

Question 5

Double Barreled Bonds

Answer 5

some cases, revenue bonds are also backed by the full faith and credit of a city and thus they would be called double barreled bonds because they are secured from TWO sources of income.

Question 6

Trust Indenture/ Bond Indenture/ Indenture

Answer 6

describes the rights and duties of the municipality and the trustee

Trust Indenture includes the bonds reserve fund needs and

Trust documents are prepared by BOND COUNSEL, not the underwriter or syndicate.

Question 7

Protective covenants( agreements)

Answer 7

1. Maintenance covenant-requires that the facility be maintained in good operating condition
2. Debt Service or Rate covenant- covers the financial requirements plus a margin of safety. Does not cover sinking fund requirements or call provisions.
3. Insurance covenant- requires that adequate insurance be maintained on the facility to protect investors. Catastrophe Call covenant covers a project that is condemned and the bond is called.
4. Financial Report Covenant- requires an audit annual income statement and balance sheet on the facility.
5. Consulting Covenant- requires that service of a counseling engineer of good reputation be retained.
6. Anti-Discrimination covenant- requires no discrimination will be practiced in the facility hiring polices, services provided, or rates charged.
7. Additional Bond Covenant-
   a. Closed-End prohibits sale of additional bonds payable from revenues of the project
   b. Open-End- permits sale of additional bonds. Earning TEST MUST BE MET. Must meet original obligation to original bond as well as additional bonds.

Question 8

Net Revenue Pledge in SEQUENCE

Answer 8

O B D R S

a. Operation and maintenance Fund- used to maintain facility on a regular basis
b. Bond Service account and principal interest
c. Debt Service reserve fund and/or sinking fund
d. Reserve maintenance fund. Used to maintain the facility on an irregular basis.
e. Surplus fund or general fund- includes excess revenues

Question 9

Gross Revenue Pledge

Answer 9

BODRS

a. Bond Service account for principal and interest
b. Operation and maintenance fund
c. Debt Service reserve fund and/or sinking fund
d. Reserve maintenance fund, renewal and replacement(depreciation) fund
e. Surplus fund or general fund of the municipality

Question 10

Analyzing the credit worthiness of a Revenue Bond

Answer 10

1. Purpose for which the bonds are issued
2. Competing facilities
3. Coverage ratios
4. Rate covenants

Would not CONSIDER

Per capita debt
Tax collection
Overlapping debt
Interest rate movements

Question 11

Types of Revenue Bonds

Answer 11

New Housing Authority Bonds, Public Housing Authority Bonds(PHA)
Special Assessment Bonds
Special Tax Bonds
Lease Rental/Lease Revenue/ Leaseback bonds
Industrial Development Bonds or Industrial Revenue Bonds
Moral obligation Bonds
Build America Bonds

Question 12

New Housing Authority Bonds, Public Housing Authority Bonds(PHA

Answer 12

interest and principal is paid from rents collected from the tenants.

Backed by the U.S. Government. Highest Quality Municipal Bond.

Question 13

Special Assessment Bonds

Answer 13

principal and interest assessment on the benefited property such as sewer, lighting sidewalks, etc. Funds used to construct these projects.

Question 14

Special Tax Bonds

Answer 14

paid from excise levied on purchase of certain products. Example would be issuance of bonds to pay for a cancer treatment hospital with an excise tax on liquor and cigarettes to pay for the bonds.

Question 15

Lease Rental/Lease Revenue/ Leaseback bonds

Answer 15

will form an authority to sell bonds and construct a facility. The authority then leases the facility back to the city or school district. The security for this revenue bond is the lease, not the tax assessments.

Question 16

Industrial Development Bonds or Industrial Revenue

Answer 16

Bonds (RISKY)

Interest and principal is solely paid by the corporation. May be taxed.

A company or corporation who used the funds to construct or purchase facilities.

Question 17

Moral Obligation Bonds

Answer 17

revenue bonds issued by an authority created by a state or municipality for which the payment and interest is NOT legal obligation of the state or municipality. If the authority cannot pay, state legislative appropriations would be required. RISKY). Usually issued when a municipality is near or going into bankruptcy. Tax Exempted

Question 18

Build America Bonds

Answer 18

taxable municipal bonds issued for infrastructure rebuilding.
Cannot be used to refinance outstanding debt
Interest payments are fully taxable to investors.

Question 19

Zero Coupon, Refunding, other bonds and notes.

Answer 19

Bonds that are sold at deep discount which mature at face value.
Do not pay interest semi-annually but are subject to accretion “imputed interest” phantom income

May be callable

Question 20

Private Activity or Private Purpose Bonds

Answer 20

used to finance private activities. Interest on these bonds is usually subject to taxation and/or subject to Alternative Minimum Tax(AMT) preference item tax. Basically a private company serving the company such as a waste management company picking up your trash.

Question 21

Refunding Bonds

Answer 21

bonds issued by a municipality, purpose of which is to pay off existing bonds.
Reasons to issued refunding bonds are
Lower interest rates
Change the maturity or amortization schedule of the bonds
Liberalize the bonds indenture provisions

Question 22

Pre-funding and advance Refunding bonds

Answer 22

Issues new bonds whose proceeds will be used in the future to pay off existing bonds.

Proceeds of new issues are invested in U.S. securities

Principal and interest invested in government securities is pledged exclusively to the payment of principal and interest of the existing issue.( escrowed to maturity)

Pre-Funding will be redeemed on the earliest call date. Pre-funding can only be done within 90 days of the call date and can also be referred to a current refund. The redemption or call price can be more than the par value of the bond.

Advance Refunding- Non-callable and are redeemed at the original maturity date. New bonds must remain outstanding for MORE than 90 days.

Advance refunding is done to

a. restructure a debt issue
b. remove restrictive covenants(agreements)
c. reduce interest costs

Advance refunding is not done to
Pay municipality expenses
Earn profits from the difference between interest rates being paid out on the outstanding bonds and the interest being earned on the government securities.

Improves quality rating of the original issuance as bonds are backed by government securities.

Question 23

Tax Anticipation Notes

Answer 23

raise monies which will be paid off with tax receipts in the near future.

Question 24

Revenue Anticipation Notes

Answer 24

raises monies which will be paid off when certain revenues are realized or received

Question 25

Tax and Revenue Anticipation Notes

Answer 25

combination of tax and revenue notes
Bond Anticipation Notes- used to raise money which will be paid off from the sale of bonds in the future. Will issue notes to carry it through until the long term bond revenues are received.

Question 26

Grant Anticipation Notes

Answer 26

grants received by municipalities from the federal government generally from the transit authority program for the purchase of buses, trains, ferries, vans, and support equipment. Grants are dependent on CONGESSIONAL APPROPIATION.

Question 27

Municipal Bond Investment Companies

Answer 27

Municipal Bond Unit Investment Trusts(UIT) -tax exempt unit investment trust have no portfolio manager. Have a fixed portfolio

Bond Funds-open end funds, Have a portfolio manager. Reinvested

Question 28

Legal Opinion

Answer 28

Municipal bonds are delivered to the buyer with legal opinion printed on the bond. Legal opinion is a statement from a reputable independent law firm hired by the issuer.

NOTE: bond counsel does not pay for the printing of bonds.

NOTE: bond counsel would not need legislative approval for the bond issue.

A municipal bond attorney CAN NEVER guarantee that principal and interest will be paid on time for a particular issue.

Municipal bond opinion are either:

Unqualified Opinion – is absolute and unconditional. Indicates bonds are legal, valid and binding. Always want a unqualified opinion.

Qualified Opinion – specifies that the validity and tax exemption are conditional in some way or dependent on some future event or qualification. ( something may be wrong with the bond) .

Question 29

Serial Bonds

Answer 29

bonds that have staggered maturity dates(scale) Are quoted in terms of YTM. Have a balloon or term maturity.

Question 30

Term Bonds

Answer 30

also known as Dollar bonds. Dealers quote them in Dollars.
Usually have sinking funds. Can be called before its maturity date, example 20 year bond with an average life of 15 years.

Question 31

Variable-Rate or Auction-Rate Demand Bonds

Answer 31

long term municipal bonds. Interest rates are generally reset periodically on a daily, weekly, or monthly basis.

Allows bondholders to tender the bonds back to a municipal bond dealer at par plus accrued interest when interest rates are reset.

Issued in par in $100,000 increments.

These bonds provide the bondholder with some protection against the interest rate risk because the interest rate is not fixed.

Question 32

Tender Offer

Answer 32

a municipality may wish to retire its debt prior to the scheduled redemption dates. Could announce a tender offer (an offer to buy back bonds that are turned in) Bonds that are not callable.

Question 33

Sinking Fund

Answer 33

if a bond issue has a sinking fund, it ensures the municipality will have the necessary funds at hand to retire or redeem term bonds. Generally, a sinking fund is a mandatory provision that requires the municipality deposits money in the sinking fund each year.

Question 34

Callable municipal bonds

Answer 34

Callable bonds trading at premium are always priced to the call date which is the worst case scenario.

Question 35

Put Bond/Tender Option Bond

Answer 35

a feature) a put bond or tender option which allows the holder of the bond to put or redeem the bonds back to the issuer or agent usually at par on certain stated dates. This feature does NOT guarantee a customer against loss of the bond was purchases at a PREMIUM.

Question 36

Repurchase Agreement

Answer 36

a repo is an agreement whereby securities are sold by a firm with the agreement to repurchase them at a later date and agrees upon price. The agreement is usually short term and records for these agreements must be kept for three years.

Question 37

Parity Bonds

Answer 37

occurs when an issuer issues new bonds which have equal claim or rights as other bonds that were previously issued.

Question 38

Risks in the municipal bond market include

Answer 38

Interest Rate Risk
Inflationary or purchasing power risk
Market Risk
Credit Risk
Reinvestment Risk
Regulation Risk
Political Risk