Chapter 8: Municipal Securities

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Official Statement

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This document contains detailed information about the new bonds, as well as the financial condition of the issuer. It also inlcudes the legal opinion

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Triple Tax-Exempt

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Bonds issued by a territory or possession of the United States, such as Puerto Rico, the U.S. Virgin Islands, Guam, and American Samoa are not subject to federal, state or local taxes.

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Treasury Arbitrage Restrictions

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Restriction that prohibits state and local governments from refinancing debt and placing the proceeds into an escrow fund that invests in treasuries that yield above a certain rate

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Types of Municipal Bonds

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General Obligation Bonds (GOs) and Revenue Bonds

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General Obligation Bonds

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Who Issues: State and Local municipalities

Issuance Requires: Voter Approval

Source of Funds backing bonds: State - secured by income, sales, and other state collected taxes. Local - secured by property tax

Bonds provide funding for: General Operating expense of a municipality and capital improvement project like roads, parks, schools, government buildings

Analysis Should Consider:
- Economic Character of Community
- Assessed property values
- Employment rates
- Industries that constitute the community's employment
Issuer's fiscal responsibility
Existence of unfunded pension liabilities
Debt Statement

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Ad Valorem Tax

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Tax on the assesed value of real estate. It is the source of funds local governemnts use to support their expense

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Mill

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equal to .1% of the assessed value

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Limited Tax General Obligation Bonds

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Certain governmental entities, such as schools districts, have a legal limit on the tax rate tehy may level

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Debt Statement

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Direct Debt
Net Direct Debt
Overlapping Debt

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Direct Debt

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All the debt (bonds and notes) issued by the municipality

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Net Direct Debt

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The direct debt (all issues) minus any self-supporting debt, such as revenue issues and note issues. In general, the net direct debt is only the general obligation debt

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Overlapping Debt

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Debt of polity entity, such as a county or school district, where its tax base overlaps the tax base of another polityal entity, such as a city or town within the country or school district

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Conterminous

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A type of overlapping debt that occurs when a city and school district lie within the same boundaries.

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Revenue Bonds

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Who Issues: State or local governments, an authority, or agency

Issuance Requires: Feasibility study

Source of Funds backing bonds: Collected revenues generated by the financed project (e.g. concessions, tolls, user fees, rental or lease payments)

Bonds provide funding for: Airports, water and sewer systems, bridges, turnpikes, hospitals

Analysis Should Consider:
- Debt service coverage ratio
- Bond's Indenture
- Covenants
- Flow of Funds

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Types of Revenue Bonds

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- Industrial Development Revenue (IDR) bonds and Pollution Control Revenue (PCR) bonds
- Special Tax bonds
- Special Assessment bonds
- Double-Barreled bonds
- Moral Obligation bonds
- Taxable Municipal bonds
- Public Housing Authority (PHA) and New Housing Authority (NHA) bonds
- Advance Refunded Municipal Bonds and Escrowed to Maturity bonds
- Private Activity bonds

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Industrial Development Revenue (IDR) bonds and Pollution Control Revenue (PCR) bonds

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Bonds that are issued by municipalities and secured by a lease agreement with a corporation. They are issued to build a facility for a private company.

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Special Tax bonds

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Bond that are payable only from the proceeds of a special tax, e.g. highway bonds payable from an excise on a gasoline tax.

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Special Assessment bonds

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Bonds that are payable from an assessment on those who directly benefit from the facilities. Examples include water and sewer systems, sidewalks, and streets.

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Double-Barreled bonds

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Bonds are backed by two sources of revenue. Normally a combination of tax dollars and revenue dollars from the project being constructed will be used to pay the debt service on the bonds.

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Moral Obligation bonds

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Bonds that are secured by the revenue of a project. However, if revenues are not sufficient to pay debt service requirements, the state (or state agency) is morally obligated (but not legally required) to provide the funds needed.

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Taxable Municipal Bonds

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Bonds that can be issued as a result of the enactment of the Tax Reform Act of 1986.

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Tax Reform Act of 1986

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This act limited a state's ability to issue tax-exempt private activity bonds to $150 million, or $50 per cpaital. In addition, the Act limited certain tax-exempt organiztions (i.e. universities) to $150 million in total outstanding tax-exempt debts. These bonds include student loan bonds, certain housing bonds, and industrial and economic development bonds.

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Public Housing Authority (PHA) and New Housing Authority (NHA) bonds

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Bonds that were issued for construction of low-income housing. They are further guaranteed by the full faith and credit of the U.S. government through the Department of HUD. *These bonds are no longer issued but may still be traded in the secondary market.

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Advance Refunded Municipal Bonds and Escrowed to Maturity Bonds

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Also known as prerefunded or defeased buonds. Bonds that's outstanding obligations have been collateralized by U.S. government securities.

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Private Activity Bonds or Alternative Minimum Tax (AMT) bonds

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Tax-exempt bonds issued by or on behalf of local or state government for the purpose of providing special financing benefits for qualified projects. The financing is most often for projects of a private user, and the government generally does not pledge its credit.

These bonds are used to attract private investment for projects that have some public benefit. (There are strict rules as to which projects qualify.) This type of a bond results in reduced financing costs because of the exception of federal tax.

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Debt Service Coverage Ratio

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The ratio of net revenue (gross revenue minus operationg and maintenance expenses) to debt service

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Feasibility Study

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consultant report to determine if the project can produce the needed revenues

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Trust Indenture or bond resolution

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A contract between the borrower (the issuer) and the lender (the trustee, which representas the bondholders's interests)

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Rate Covenant

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The issuer pledges to maintain rates at a level sufficient to meet operation and maintenance costs, debt service, and certain reserve funds

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Maintenance Covenant

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The issuer pledges to maintain the project in good working order

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Insurance Covenant

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The issuer pledgeds to carry insuarance on the property

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Financial Reports and Audit

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The issuer pledges to maintain proper records. An accounting firm will be retained to do an outside audit

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Closed-end indenture

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No additional bonds may be issued against the same security.

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Nondiscrimination Covenant

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The issuing body pledges not to grant special rates to any person or group

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Catastrophe Call

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Allows an issuer to call an entire issue in situations which are beyond its control, such as condemnation, fire, flood, or earthquake

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Flow of Funds

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Describes the priority for disbursing the revenues generated by the facility.
1. Revenue Fund
2. Operation and Maintenance Fund
3. Debt Service (Bond Service) Fund
4. Debt Service Reserve Fund
5. Reserve Maintenance Fund
6. Replacement and Renewal Fund
7. Sinking Fund
8. Surplus Fund

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Net Revenue Issue

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Net Revenues (gross revenues less operating and maintenance expenses) are pledged toward paying debt service

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Gross Revenue Issue

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Gross revenues are pledged to pay debt service.

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Municipal Notes

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1. Tax Anticipation Notes (TANs)
2. Revenue Anticipation Notes (RANs)
3. Bond Anticipation Notes (BANs)
4. Construction Loan Notes (CLNs)

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Tax Anticipation Notes (TANs)

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Issued to finance municipal current operations in anticipation of future tax receipts from property taxes or other tax receipts. They are usually general obligation securities

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Revenue Anticipation Notes (RANs)

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Issued for the same purpose as TANs except that the anticipated revenues are other than general tax receipts such as federal or state subsidies. They are usually general obligation securities

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Bond Anticipation Notes (BANs)

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Issued to obtain financing that will eventually be financed through the sale of long-term bonds

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Construction Loan Notes

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Issued by municipalities to provide funds for construction of a project that will eventually be funded by a bond issue

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Tax-exempt commerical paper

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Municipal note that has a maximum maturity of 270 days and is normally backed by a bank line of credit

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Moody's Investment Grade Ratings

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MIG 1 (VMIG1): Best Quality
MIG 2 (VMIG2): High Quality
MIG 3 (VMIG3): Favorable Quality
MIG 4 (VMIG4): Adequate Quality

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S&P Ratings

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SP - 1: Strong capacity to pay principal and interest
SP - 2: Satisfactory capacity to pay principal interest
SP - 3: Speculative capacity to pay principal and interest

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Bond Issuers

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American Municipal Bond Assurance Corpoartion (AMBAC), the Municipal Bond Investors Assurance Corporation (MBIA), and the Financial Gurantee Insurance Company (FGIC)

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Yield Basis

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Price quotation for a security expressed in terms of yield to maturity. This will usually only be quoted on fixed-income securities such as bonds.

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Concesion

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A selling group's compensation in a stock or bond underwriting agreement. The dealer concession = 1/2 point ($5 per bond)

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Basis Book

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Shows the dollar price necessary to receive a desired yield to maturity for a bond with a specific coupon rate.

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Pricing of Bunds

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- A bond selling at a discoutn will always be priced to maturity
- A bond selling at a premium, which is callable at par, will always be priced to the cal.
- A bond selling at a premium, which is callable at a premium, may be priced to maturity or to the call, whichever give the lower yield.

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Yield to Worst

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The yield to maturity if the worst possible bond repayment takes place. If market yields are higher than the coupon, the yield to worst would assume no prepayment. If market yields are below the coupon, the yield to worst would assume prepayment. In other words, yield to worst assumes that market yields are unchanged.

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Accrued Interest

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The interest that has accumulated on a bond since the last interest payment up to, but not including, the settlement date.

There are two methods for calculating accrued interest:
1. 360-day year method, used for corporate and municipal bonds
2. 365-day year method, used for government bonds

Calculation: Principal X Rate X Time

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Dated Date

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The date at which interest begins to accrue on a fixed-income security. Investors who purchase a fixed-income security between interest payment dates must also pay the seller or issuer any interest that has accrued from the dated date to the purchase date, or settlement date, in addition to the face value.