What are the two main types of munis typically issued?
- Revenue bonds - backed by a revenue producing facility
- General obligation (GO) - backed the taxing power of the issuing municipality
What are the key obligations of a bond counsel in a municipal bond issuance?
- Provide a legal opinion of the issue and make sure the issue is consistent with securities law
- Confirm the issue's tax-exempt status
- Confirm the municipality's legal authority to issue the bonds
What are the two types of legal opinions for muni securities?
Qualified and Unqualified
- Qualified - This means that there are concerns or qualifications regarding the legality of the issuance; this puts the deal at risk
- Unqualified - means there are no concerns or qualifications regarding the legality of the issuance; this is preferred
What are the three types of bond maturity?
- Balloon maturity: Borrower pays off a small portion of the principal prior to maturity and pays off the remaining portion at maturity
- Serial maturity: A portion of the notional amount is set to mature at regular intervals, usually years, and each interval has a different coupon rate
- Term maturity: The entire bond matures at the same time; this is the most common type
For what types of projects to municipals use general obligation bonds?
GOs are supported by the taxing authority of the municipality issuing the bond. They are used for projects that produce no revenue and will be paid for via taxes. These include basic service projects like public schools, public parks, and public buildings.
What are ad valorem taxes?
Ad valorem taxes, also referred property taxes, help to support GO bonds that are issued by cities and counties. Property taxes are based on the assessed value of the property, which is taxed in mils. An investor will pay $1 of taxes for every $1,000 of assessed value.
What are the key factors in analyzing the credit quality of a municipal general obligation bond?
- Existing direct debt of the municipality
- Debt per capita
- Assessing the tax base of the issuer: average income, age, local industries, etc.
- Overlapping debt; sometimes a municipality shares the debt load with another because they will both use the service (e.g. a public ferry in between the two cities).
Who is entitled to collect property taxes?
Only the local city or county government
States are not allowed to collect property taxes so general obligations issued by the state depend on income, sales, and excise taxes.
What is the primary protection for the investor in municipal general obligation issues?
Constitutional Debt Limits
Some states limit the amount of debt any municipality can take on and most municipalities require a vote before issuing debt. Both of these protect investors. The city and county have a legal right to raise property taxes to pay the bondholders. This makes the GOs the safest investment for the investor. However, a limited-tax bond is less safe for an investor because it caps the degree that a city or county can raise taxes and limits their ability to pay bond holders.
What is the combination of a general obligation and revenue bond called?
In a double-barrel bond, if the revenue is not sufficient, there is a legal obligation by the municipality to make up the shortfall from taxes.
From where can a revenue bond draw income to pay bondholders?
Almost any project that individuals will pay additional monies to use. Airports, colleges, tolls, stadiums, and utilities are all examples of projects that could be supported by the fees and income generated from the completed project.
What are examples of types of analysis should be performed on revenue bonds?
Feasibility studies - revenue bonds rely on income that isn't guranteed so they are naturally riskier than GOs. Is the supporting project feasible?
User charges - are the fees for use of the project high enough to sustain debt payments based on the expected number of users?
Demographics - are there enough users in the area?
Convenants - protections in place that details the rights of the bondholders and obligations of the issuer
Where are the convenants of a revenue bond listed?
The Trust Indenture
This will contain all the obligations of the issuer as well as outlining specific protections that protect the investor. The indenture will also specify a trustee who will ensure compliance with the indenture.
What are two of the most common types of covenants?
Insurance covenant - the commitment to ensure anything built with the revenue bonds
Rate covenant - an assurance that usage rates will be kept high enough to maintain the project after completion.
Note: as much as the indenture is used by municipal issues, it isn't required, as bonds are covered under the Trust Indenture Act of 1939, which does not require indentures. Because of their use in corporate debt, it has become common for municipal securities to follow suit.
What are the two different orderings of cash flows found in the flow of funds statement for a revenue bond?
Gross Revenue vs. Net Revenue
In a net revenue pledge, all operations and maintenance are paid first. This is assumed unless a gross revenue arrangement is stated in the indenture. In the indenture, an issuer can specify a reserve fund that funds a few years of payments to investors as a buffer. In a gross revenue pledge, investors are paid first, then maintenance, then the reserve fund.
What is an industrial development revenue bond?
IDRBs are issued by a municipality to construct industrial facilities or factories that will in turn be leased to an occupant to start a business and create jobs. Their cash flow comes from the company making lease payments. Since the company makes payments, which in turn the municipality pays to bondholders, the industrial development bond will have the same credit rating as the corporation.
What is the name for revenue bonds that are also backed by a non-binding pledge of the legislature?
Moral Obligation Bonds
These bonds are backed by a revenue producing facility and non-binding pldege of the legislature. If the revenue is not sufficient, the lawmakers, at their discretion, can make up the shortfall from taxes.
What are variable rate munis?
These bonds are issued with some floating interest rate that changes periodically based on a benchmark rate such as the rate on Treasury bills. Because their interest rate changes with the market, their price tends to remain relatively stable.
What is short-term muni debt called?
These are issued with maturities of a year or less and are typically issued with the expectation of future anticipated tax or non-tax revenues that the issuer will use to pay off the debt.
What are the types of muni notes typically issued?
Tax anticipation note (TAN) - used when future tax revenue is anticipated for but the state needs the funds now
Revenue anticipation note (RAN) - used when future non-tax revenue is anticipated but the state needs the funds now
Tax and revenue anticipation (TRAN) - has two streams of income supporting the note (taxes and future revenues)
For municipal securities, what is the analog to the prospectus required for stocks and bonds under the Act of '33?
Recall that municipal securities are exempt from the Securities Act of 1933 so they are not required to issue a prospectus. However, they have a similar disclosure document called an official statement ithat is very similar to a prospectus. None of the official statement is reviewed by, nor on file with, the SEC.
What purpose does the official statement serve?
Primary disclosure document for munis
The official statement discloses material information to potential investors.
What are the two types of underwritings for muni securities?
Negotiated and Competitive Offering
What are the characteristics of a negotiated muni offering?
In a negotiated underwriting, the municipality appoints an underwriter based on a myriad of factors, including sector expertise, price, and relationship with the issuer.
What determines the winner of a competitve offering?
Lowest net cost to issuer
In a competitive underwriting, the underwriter that will cost the municipality the lowest amount of interest over the life of the bonds will be awarded the deal. In this case, best price wins, relationship with the issuer makes no difference.
What is the notice of sale?
The notice of sale is the document released by the issuer to invite bids in a competitive sale.
What forms the syndicate in a muni underwriting?
The investment bank will have its own capital on the line and after seeing the ad appear will evaluate their ability to sell the issue and determine how much capital to risk, if they have other orders, etc. Once they decide to pursue the underwriting they sign a syndicate agreement with other members to spread the risk.
What details are usually found in the syndicate agreement?
- Amount of capital commited by each member
- The identity of the lead manager of the syndicate
- How long the syndicate agreement will be in effect
- The fee for the elected manager and the spread paid to other members of the syndicate
- Outline of who shares liability for unsold bonds and in what proportion
What is the distinction between an Eastern and Western muni underwriting?
An Eastern underwriting is an undivided account, where all underwriters share liability for any unsold bonds.
A Western underwriting is an divided account, where all underwriters are only responsible for their own allotment of bonds.
During a primary issue of municipal securities, what is the order of allocation of sales?
During the primary offering, just as in a stock IPO, the offering can be oversubscribed. In this event, there is a particular order in which the syndicate will award shares:
- Presale Orders
- Group Orders
- Designated Orders
- Member Orders