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Bond Basics, Jim Stewart and Jim Buie

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  • 1. BOND BASICS
  • 2. Table of Contents
    • Introduction
    • Bond Financing Team
      • Issuer
      • Financial Advisor
      • Investment Banks (Underwriter)
      • Underwriter’s Counsel
      • Bond Counsel
      • Paying Agent/Registrar
      • Rating Agencies
    • Overview of Bond Structures
      • Fixed Rate Bonds
      • Variable Rate Bonds
    • Investing Bond Funds
      • PFIA Requirements
      • Investment Policy and Strategy
      • Arbitrage
    • Resumes
    • Glossary of Bond Financing Terms
  • 3. Introduction This presentation is designed to give superintendents and school business officials information that will enhance their understanding of the bond issuance process as it relates to school districts in the state of Texas.
  • 4. Introduction   The 3rd Called Session of the 79 th Texas Legislature passed into law House Bill 1 that contains some helpful tools for schools districts, such as; the high school allotment, establishment of education research centers, a clearinghouse for “best practices,” teacher pay raises, etc. With the same stroke of the pen the Legislature created some serious academic and financial concerns for school districts. Raising accountability standards to new levels and compressing the state’s property tax rate both pose challenges to already stressed systems. Source: TEA (Texas Education Agency).
  • 5. Steps Required to Issue Tax-Exempt Bonds
    • Identify projects to be financed
    • Choose a financing team
      • Financial Advisor
      • Investment Banking Firm(s) (commonly called the Underwriter(s))
      • Bond Counsel
      • Underwriter’s Counsel
      • Credit Enhancement Provider
    • Obtain voter approval
    • Gather documents for due diligence
    • Develop credit and rating materials
    • Draft bond and disclosure documents and secure necessary approvals
    • Evaluate financing and legal structure
    • Market and Sell Bonds
  • 6. Factors to Designing a Long-Term Capital Structure
    • Borrower’s financing goals
    • Anticipated sources of repayment for borrowing
    • Borrower’s willingness and ability to assume risk
    • Market environment currently and at the time debt is incurred
    • Credit availability now and in the future
    • Anticipated future borrowing needs
    • The diagram below highlights the primary capital funding options available to a borrower
    Spend internal cash Borrow externally with tax-exempt bonds Public debt market Private placement Fund Balance Borrow externally on a taxable basis Bank loan Public debt market Floating rate Fixed rate
  • 7.
    • Role of the Financial Advisor
      • Devise and monitor a plan of finance that will insure that the district’s bonds are (i) issued at the lowest possible interest cost in a given market, (ii) are structured commensurate with the district’s I&S tax rate capabilities and (iii) provide flexibility that will allow the district to meet future issuance needs.
      • Work with the district’s staff and/or underwriter’s counsel to compile preliminary and final offering documents (POS/OS).
      • Compile a notice of sale document if the bonds are to issued via the competitive bid process.
      • Assist in the selection of investment banking firms (underwriters) if the bonds are to be issued via the negotiated sale process.
      • Assist the district in compiling information for rating agency presentations and in making such presentations.
    Financial Advisor
  • 8. Financial Advisor
      • Assist in the evaluation of whether credit enhancement is recommended and if so, assist in obtaining such enhancement .
      • If a negotiated sale process is utilized – be involved in setting the interest rates at which the bonds will be offered to the public (coupons and yields), and monitoring the progress of the sale during the order period.
      • If a competitive sale process is used – evaluate the bids submitted and recommend that they be accepted (or not accepted).
      • Review draft closing documents and monitor the closing process.
      • Provide assistance and advice on investment of bond proceeds.
    Role of the Financial Advisor (Cont’d)
  • 9. Choosing a Method of Sale
    • Yearly Sale ($) Amounts by Method of Sale
      • Since 1997 Negotiated Sales have gradually increased from 75% to 80% of overall issuance
  • 10. Investment Banking Firm(s) (commonly called the Underwriter(s))
    • Role of the Underwriter
      • To purchase the district’s bonds directly from the district and re-offer (sell) them to investors.
    • Types of Bond Sales
    • Negotiated sale - District hires an investment banking firm (or firms) to underwrite its bonds at a negotiated price. The financing structure is determined in accordance with the district’s specific needs or requirements relative to I&S tax rate preferences and/or refunding objectives.
    • Size of negotiated underwriting team
        • With exception of financings under $10, most issuers will hire a team of from 2 to 6 investment banking firms (depending on the size of the issue).
    • Selection process
        • Recommendation
        • Request For Proposals
        • Request For Qualifications
  • 11. Investment Banking Firm(s)
    • Key investment banking firm specialists involved in the underwriting process
      • The “ banker ” – called an investment banker, this specialist is part of the investment banking firms Public Finance Department. “Bankers” generally have broad knowledge of the capital markets, debt instruments, debt structuring,document preparation, and marketing/distribution procedures. One of their responsibilities is to solicit potential issuers with the goal of being included as a member of the issuer’s underwriting team. Once their firm is hired they serve as the key contact/liaison person and coordinate with all parties to the financing to execute the underwriting.
      • The “ underwriter ” – an investment banking firm’s specialist who is directly responsible for pricing a district’s bond issue; i.e., determining the lowest possible combination of coupons and yields that will “sell” in the marketplace at the time of pricing.
      • The “ sales representatives ” – the persons who actually contact potential investors and sell the district’s bonds to those investors.
  • 12.
    • Steps in the negotiated underwriting process
      • Structuring - the lead investment banking firm (senior managing underwriter) is usually involved in the initial structuring and/or determining the plan of finance.
      • Hiring of underwriter’s counsel - the senior managing underwriter, the financial advisor and the issuer will jointly agree on a firm via consultation among themselves.
      • Documentation process.
      • Net Designations or Group Net
      • Pre-sale marketing activities by salesforce.
      • Pre-sale pricing calls among the underwriters, the FA and the issuer.
      • Order period - usually 2 hours during which the bonds are sold.
      • Sign bond purchase agreement - the district and the senior managing underwriter.
    Investment Banking Firm(s)
  • 13.
    • Underwriter’s compensation for negotiated financings
      • The underwriters receive what is known as the underwriter’s discount, which is subtracted from bond proceeds at closing.
      • Following is an example of a typical underwriter’s discount on a $20,000,000 par value, PSF guaranteed, negotiated, fixed rate school financing executed in Texas.
    Investment Banking Firm(s)
  • 14.
    • The percentage of liability for each participating underwriter varies and is usually determined by the district and its financial advisor
    Investment Banking Firm(s)
      • Competitive bid sale - a district invites a broad spectrum of investment banking firms to submit interest rates at which they will purchase the district’s bonds. The firm(s) submitting the lowest interest cost, wins.
      • When underwriters receive an invitation to bid on a district’s bond issue, they may, depending on the size of the issue, decide to form a syndicate of underwriters in order to spread the risk. Many such syndicates are already in place, and the senior managing position is rotated among the members as different deals are bid.
  • 15. Bond Counsel
    • Role of Bond Counsel
    • Certifies that the issuer has legal authority to issue the bonds.
    • Drafts ordinances, resolutions, indentures, notices of sale, tax certificates and any other legal documents that may be required (excluding preliminary and final official statements which are compiled by either the Financial Advisor or Underwriter’s Counsel)
    • Reviews all legal documents prepared by other counsels and any documents compiled by other parties to the transaction.
    • Coordinates information with the Texas Attorney General and obtains the AG’s approval of the issue.
    • Provides a legal opinion as to the tax status of the bonds.
    • Coordinates the closing of the transaction.
  • 16. Underwriter’s Counsel
    • A law firm representing the underwriters and paid out of the underwriter’s discount.
    • Duties of underwriter’s counsel
      • Drafts the POS and OS in financings where there is no financial advisor or the financial advisor opts not to compile the POS/OS.
      • Drafts the Agreement Among Underwriters (AAU) which states the procedures that will be followed by the underwriters, and establishes the percentage of liability for each participating underwriter.
      • Drafts the Bond Purchase Agreement (BPA) between the district and the underwriting team.
      • Compensation – generally ranges from 25 cents per $1,000 par value issued to $1.00 per $1,000 issues, depending on the size of the financing.
  • 17. Rating Agencies
    • Role of the Rating Agencies
    • To assign a credit rating to the bonds based on an assessment of the district’s ability and willingness to make full and timely payments of interest and principal over the life of the bonds.
    • General
    • Once a school district is rated, the agencies periodically review the district’s financial and operational information. Rating agencies have developed a review process for municipalities and school districts seeking an upgrade in their ratings.
    • There are currently three nationally recognized rating agencies commonly used by municipal issuers in the United States: Moody’s Investors Service, Standard & Poors, and Fitch. These firms are headquartered in New York and have branch offices in key cities across the country.
                                                                       
  • 18. Rating Agencies
      • Following are the credit quality rating categories for each of the the three primary rating agencies:
  • 19. General Obligation Bonds
    • Requires Voter Approval
    • “ Pledge”: Full Faith and Credit of the Taxing Entity
    • “ Source of Payment”: Debt Service Paid by Property Tax
    • Highest Rated Type of Bond
    • Lower Interest Rates
    • Used to Finance Any Type of Public Projects
    • Subject to Debt Limitations
  • 20. Fixed Rate Bond Structure
    • Interest rates are set for the life of the bond issue.
    • Current interest bonds – interest paid semi-annually and principal paid annually.
    • Capital appreciation bonds – also called zero coupon bonds because there is no coupon; the bonds are sold at a discount and interest accretes to their maturity value.
    • Are usually issued when interest rates (the yield curve) is at levels considered to be low from a historical perspective.
    • Are usually issued to be callable in ten years at par plus accrued interest.
  • 21. Variable Rate Bond Structure
    • Variable rate bonds are usually issued when the interest rate yield curve for fixed rate bonds is at an unattractive (high) level.
    • Final maturity of the bonds can be tailored to the life expectancy of the assets being financed; however, the interest rate is reset either daily, weekly or monthly, meaning that the issuer benefits from pricing the bonds as if they are short-term in duration instead of long-term. (Rates are most always lower on the short end of the yield curve than on the long end, but in some instances, the yield curve can become relatively flat or even inverted).
    • The bonds may be put back (by the investor) to the issuers remarketing agent on a daily, weekly or monthly basis at which time they are sold to a different investor.
    • Generally, issuers rated less than double A must get credit enhancement for the bonds – either through insurance, or a letter of credit. School districts in Texas have in the past been able to obtain AAA ratings on their variable rate bonds by virtue of the PSF guarantee.
  • 22. Variable Rate Bond Structure
    • If the bonds are not backed by a letter of credit, generally, the issuer must obtain a liquidity facility in case the remarketing agent for some reason is unable to re-sell the bonds that are put back.
    • The bonds have no pre-payment penalty and can be called in whole or in part upon 30 days written notice.
    • The bonds are typically sold to large money market funds, corporations and high net worth individuals.
  • 23. Variable Rate Interest Modes
      • Daily
      • Weekly
      • Adjustable Rate
    • Interest rate resets each business day
    • Interest payments are typically made on the first business day of each month
    • Bonds can be redeemed at par upon short (e.g. 35 days’) notice
    • Interest rate reset weekly (e.g. Tuesday for Wednesday settlement)
    • Interest payments are typically made on the first business day of each month
    • Bond can be redeemed at par upon short (e.g. 35 day’s) notice
    • Most widely used interest rate mode in the market
    • Borrower chooses the length of time between interest rate resets
    • Bonds can be redeemed at end of adjustable rate mode
    • Interest payments are typically made at the end of each adjustable rate period*
    • Bonds operating in an adjustable rate mode under 270 days are not subject to continuing disclosure requirement (SEC Rule 15c2-12)
    • Bonds operating in an adjustable rate mode over 270 days are subject to the continuing disclosure requirement (SEC Rule 15c2-12)
    • SEC Rule 15c2-12 requires an organization to make available annually audited financial statements and other relevant financial and market information to each nationally recognized municipal securities information repository (“NRMSIR”)
  • 24. Variable Rate Interest Hedging
    • Issuers can hedge their variable rate risk by swapping the variable rate to a fixed rate
      • An interest rate swap is accomplished as described below:
      • A school district will be paying variable rate interest to the holders of the district’s variable rate bonds for as long as the bonds are outstanding.
      • The district will enter into an agreement with a swap counterparty, i.e., a financial institution such as a bank or Wall Street Investment banking firm to receive an interest rate payment form the swap counterparty equal to (or approximately equal to) the amount of interest the district is paying to its variable rate bondholders. This step neutralizes the district’s interest rate commitment.
      • At the same time the district agrees to pay the swap counterparty a fixed rate of interest, and as a result has effectively “swapped” the interest rate on the variable rate bonds from variable to fixed.
      • Interest rate swaps may be effected for any period of time desired (from one year to final maturity of the bonds, subject to approval of the swap counterparty).
  • 25. Variable Rate Interest Hedging
      • While swapping a variable interest rate to a fixed interest rate eliminates the district’s exposure to an escalation in market interest rates, the district is still subject to three categories of risk
        • Basis Risk - The risk that the spread relationship between the variable rate being paid by the district to its bondholders (usually the 7 day weekly rate) and the variable rate being received by the district from the swap counterparty (usually the Bond Market Average (BMA) or a percentage of LIBOR, will change.
        • Counterparty credit risk – the risk that the swap counterparty’s credit will deteriorate.
        • Tax Risk – the risk that the underlying tax rates or taxing structure in this country could be significantly changed.
  • 26. Investing Bond Funds
    • Public Funds Investment Act
      • Chapter 2256 of the Texas Government Code
    • Board Policy CDA (Legal)
      • Contains the Requirements of Chapter 2256
    • Board Policy CDA (Local)
      • Contains Local Options Adopted by the Board of Trustees
    • Federal Laws and Regulations
      • Internal Revenue Service Arbitrage Regulations
  • 27. Investing Bond Funds
    • PFIA Requirements
      • Investment policy, investment strategy and investment officer
      • Standard of care
      • Training requirements
      • Authorized investments
      • Investment reports
      • Selection of authorized brokers
  • 28. Investing Bond Funds
    • Investment policy, investment strategy and investment officer
      • Written
        • Include authorized investments, maximum maturities, monitoring and delivery versus payment
      • Investment strategy for each type of fund
      • Annual review
      • Designated investment officer(s)
      • Disclosure requirements
      • Present policy to all offering to provide investments
  • 29. Investing Bond Funds
    • Standard of care
      • Investments shall be made with judgment and care, under prevailing circumstances, that a person of prudence, discretion, and intelligence would exercise in the management of the person's own affairs, not for speculation, but for investment, considering the probable safety of capital and the probable income to be derived. (2256.006)
        • preservation and safety of principal
        • liquidity
        • yield
  • 30. Investing Bond Funds
    • Training requirements
      • Attend at least one training session from an independent source approved by the governing body of the local government containing at least 10 hours of instruction within 12 months after taking office or assuming duties
      • Attend an investment training session not less than once in a two-year period and receive not less than 10 hours of instruction from an independent source approved by the governing body of the local government
  • 31. Investing Bond Funds
    • Authorized investments
      • Government securities
      • Certificates of deposit
      • Repurchase agreements
      • Securities lending program
      • Banker’s acceptances
      • Commercial paper
      • Mutual funds
      • Guaranteed investment contracts
      • Investment pools
  • 32. Investing Bond Funds
    • Investment reports
      • Required quarterly
        • describe in detail the investment position of the entity on the date of the report
        • be prepared jointly and signed by all investment officers of the entity
        • summary statement of each pooled fund group
        • book value and market value of each separately invested asset at the beginning and end of the reporting period by the type of asset and fund type invested
        • maturity date of each separately invested asset
        • account or fund for which each individual investment was acquired;
        • compliance of the investment portfolio
  • 33. Investing Bond Funds
    • Selection of authorized brokers
      • At least annually, review, revise, and adopt a list of qualified brokers that are authorized to engage in investment transactions
  • 34. Investing Bond Funds
    • Board policies
      • Can be more restrictive than the PFIA
      • Usually require annual investment reports in addition to quarterly reports
      • Establish criteria for benchmarking investments
      • Provide time limitations on specific funds
  • 35. Investing Bond Funds
    • Arbitrage
      • Interest on a bond is not excludable from income for federal income tax purposes if the bond is an "arbitrage bond.“
      • According to IRC § 148(a), a bond is an arbitrage bond if at the time of the issuance of the bond, the issuer reasonably expects that all, or a portion, of the proceeds of the bond will be directly or indirectly used to:
        • acquire higher yielding investments; OR
        • to replace funds which are used to acquire higher yielding investments.
        • In addition: A bond is an arbitrage bond if the issuer intentionally uses any portion of the proceeds of the bonds as described above.
  • 36. Investing Bond Funds
    • Arbitrage rebate
      • The difference in interest earned on investments of the bond proceeds and the interest paid on the bonds
        • If the bonds are sold at 4% and the proceeds are invested at 5%, the rebate will be the amount of interest generated by the 1% difference
      • Due at least every five years during the life of the bonds, final payment is due 60 days after final bond is redeemed
  • 37. Investing Bond Funds
    • Exceptions
      • Based generally on how quickly the proceeds are spent
        • Small issuer exception (less than $5,000,000)
        • Six-month exception
        • Eighteen-month exception
        • Two-year construction exception
  • 38. Investing Bond Funds
    • Two-year construction exception
      • 10 percent within six months of issue
      • 45 percent within 12 months of issue
      • 75 percent within 18 months of issue
      • 100 percent within two years
        • With reasonable retainage not to exceed five percent
  • 39. Investing Bond Funds
    • Selecting the right investment – my preferences
      • Government securities
      • Certificates of deposit
      • Repurchase agreements
      • Investment pools
  • 40. Investing Bond Funds
    • Develop a draw schedule for the bond program
    • Match the maturities of the investments to the draw schedule
    • Use investments that are authorized by your investment policies
    • Safety of principal is foremost
  • 41. Investing Bond Funds
    • Real Examples
      • 2001 Bond Program - $100,000,000
        • Repurchase agreement
        • Pools
      • 2004 Bond Program - $86,000,000 (2 issues)
        • Laddered government securities
        • Pools
      • 2006 Bond Program - $46,000,000
        • Repurchase agreement
  • 42. Investing Bond Funds
    • Example Program - $40,000,000
      • Immediate needs - $5,000,000
        • Certificates of deposit
        • Pools
      • Construction needs - $35,000,000
        • 18-month time frame
          • Laddered government securities
          • Repurchase agreement
          • Pools
  • 43. Resume
    • Jim Stewart Telephone: 512.423.5926
    • Director Fax: 214.965.7684
    • 2001 Ross Avenue, Suite 4500
    • Dallas, TX 75201
    • Email Address: [email_address]
    • Mr. Stewart joins Raymond James & Associates' Public Finance Department with 4 years of Investment Banking experience and is responsible for the continued development of the firm's client base in the public school sector in Texas.  He has extensive experience in K-12 finance, having served as a school superintendent in four school districts for thirteen of his thirty years in public education.  While in the public school sector, Mr. Stewart passed two school bond elections and has expertise in the marketing process of school bonds and the management of school debt.  During his tenure as a Banker, Mr. Stewart has served as Investment Banker on the issuance of more than $7.9 billion of debt.
    • Mr. Stewart received his Bachelor's Degree from Southwest Texas State University and his Master's Degree from Lamar University.  He has been a guest lecturer at the University of Texas, San Antonio, Schreiner College, and Sul Ross State University and later served one year as an Adjunct Professor at Sul Ross State University teaching graduate level courses in the Education Department.  Mr. Stewart is also a lifetime member of the Texas Association of School Administrators.  He is a Registered Representative with the Municipal Securities Rulemaking Board and currently holds the following NASD licenses:  General Securities Representative (Series 7), Municipal Securities Principal (Series 53) and Uniform State Law (Series 63).
  • 44. Resume
    • Jim Buie, CGFM Telephone: 214.965.7644
    • Director Fax: 214.965.7684
    • 2001 Ross Avenue, Suite 4500
    • Dallas, TX 75201
    • Email Address: [email_address]
    • Mr. Buie joined Raymond James & Associates in 2008, and is responsible for the continued development in the Southwest region. He has 17 years experience in investment banking and management having spent the last four years with Banc of America Securities LLC in Dallas serving as investment banker on more than $7.28 billion of debt with an emphasis in State agency transactions, municipal government, school district debt, higher education, 501c3, and transportation. From 1999 until January 2004, Mr. Buie served as the Executive Director of the Texas Bond Review Board, overseeing approximately $11.17 billion of debt issuance on behalf of the State of Texas. Jim’s prior experience also includes serving as Senior Bond Analyst for the State of Oklahoma – State Bond Advisor’s Office and the Executive and Legislative Bond Oversight Commissions and work with the cities of Garland and Lewisville, Texas, primarily in the areas of capital planning, debt analysis, budgeting and finance.
    • Mr. Buie earned a B.A. in Business Administration from Austin College and a M.B.A. from Midwestern State University. Jim is a Certified Government Finance Manager (CGFM) and is a Registered Representative with the Municipal Securities Rulemaking Board and currently holds the following NASD licenses: General Securities Representative (Series 7), and Uniform State Law (Series 63).
  • 45. Glossary of Bond Finance Terms Accrued interest . Coupon interest accumulated on a bond or other obligation since the last interest payment or, for a new issue, from the dated date to the date of delivery. Usually interest on municipal bonds is payable semi-annually, every six months. When you buy a bond in mid-term you are only entitled to the interest the bond earns after you buy it. The interest earned previously, the accrued interest, belongs to the seller. Ad Valorem Tax . A state or local government tax based on the value of real property as determined by the county tax assessor. Advanced Refunded Bonds . A municipality or school district may sell a second bond issue at a lower interest rate cost, placing the proceeds of the issue in an escrow account from which the first issue's principal and interest will be repaid when due. Amortization of Debt . The annual reduction of principal through the use of serial bonds or term bonds with a sinking fund. Arbitrage . The interest rate differential that exists when proceeds from a municipal bond - which is tax-free and carries a lower yield - are invested in taxable securities with a yield that is higher. The 1986 Tax Reform Act made this practice by municipalities illegal solely as a borrowing tactic, except under certain safe-harbor conditions. Assessed Valuation . A municipality's worth in dollars based on real estate and/or other property for the purpose of taxation, sometimes expressed as a percent of the full market value of the community. Authorizing Ordinance . A law that when enacted allows the unit of government to sell a specific bond issue or finance a specific project.
  • 46. Glossary of Bond Finance Terms Available School Fund (ASF): Created by the Texas Constitution of 1876, the ASF is made up of earnings from the Permanent School Fund and constitutionally dedicated motor fuel taxes and other miscellaneous revenue sources. The bulk of ASF revenue is distributed on a per capita basis to school districts. The annual amount is about $370 per student in 2002-2003. A portion of the ASF provides funding for textbooks and technology. Average Daily Attendance ( ADA ): ADA is a method of counting students for the purpose of providing state aid to school districts. Currently, Texas counts students in attendance each day and averages the attendance count over the year. Average Life . The average length of time an issue of serial bonds and/or term bonds with mandatory sinking funds and/or estimated prepayments is expected to be outstanding. It also can be the average maturity of a bond portfolio. Balloon Maturity . An inordinately large amount of bond principal maturing in any single year. This is also referred to as a Term Bond. B.A.N. (Bond Anticipation Note) . A short-term security, one year or less, used for interim financing to be repaid from the proceeds of a planned long-term bond issue. Base Point (or Basis Point) . One one-hundredth of one percent (1/100 % or 0.01 percent). Thus 25 basis points equal one-quarter of one percent, 100 basis points equal one percent. This is typical in-group, professional bond talk. Bid . An offer to buy at a fixed price or yield. As opposed to Ask, which is an offering to sell. Bond or note . A security whereby an issuer borrows money from an investor and agrees and promises, by written contract, to pay a fixed principal sum on a specified date (maturity date) and at a specified rate of interest.
  • 47. Glossary of Bond Finance Terms A Bond . A unit of debt, $1000 of principal or par amount. For 200 years municipal bonds were sold in $1000 denominations. Since the mid-1970s the minimum bond denomination has been $5000; that being said, "A Bond" is bought, sold, referred to and priced as if it were $1000. Bond Counsel . A lawyer who writes an opinion on the bond or note as to its tax exempt status and the authenticity of its issuance. Their “bond counsel” opinion is meant to assure the bond investor, however, the issuer pays them. Bond Fund (Tax-Exempt) . A Bond Fund is a portfolio of municipal bonds sponsored or administered by registered investment companies. These companies offer shares to investors either through (1) closed-end funds or unit investment trusts, which offer shares of a fixed portfolio of municipal bonds; or (2) open-end or managed funds, which offer shares in a managed portfolio of municipal bonds whose size will vary as shares are purchased or redeemed. Bond Insurance . Insurance issued by a private insurance company for either an entire issue or specific maturities that guarantees to pay principal and interest when due. Bond Insurance will typically provide a credit rating of triple-A and thus a lower borrowing cost for the issuer. The four largest monoline bond insurers are AMBAC, FGIC, FSA and MBIA, which see. Bond Premium . The amount at which a bond or note is bought or sold above its par value or face value without including accrued interest. Bonded Debt . The portion of an issuer's debt structure represented by outstanding bonds, sometimes limited by constitutional or legislative restraints. Book Entry . A system of security ownership in which the ownership is held as a computer entry on the records of a central company for its owner. The bond owner gets a computer printout as proof of ownership.
  • 48. Glossary of Bond Finance Terms Broker . Technically a broker is a bond trader in the secondary market buying from and selling to bond dealers. Its most common usage is as a description of a bond salesperson. Callable Bond . A bond or note that is subject to redemption at the option of the issuer prior to its stated maturity. The call date and call premium, if any, is stated in the offering statement or broker's confirmation. Certificates of Participation (COPs) . A form of a lease revenue bond that permits the investor to participate in a stream of installment payments, lease payments or loan payments relating to the acquisition or construction of specific equipment, land or facilities. COPs are not viewed legally as "debt" because payment is tied to an annual appropriation by the government body. As a result, COPs are seen by investors as providing weaker security and often carry ratings that are a notch or two below an agency's general obligation rating. Chapter 41 District: a Chapter 41 school district that has property wealth in excess of $305,000 per weighted student is subject to recapture provisions. Chapter 41 District refers to Chapter 41 of the Texas Education Code. Comptroller's Property Tax Division (CPTD): The CPTD is the department in the State Comptroller’s Office responsible for conducting the annual property value study that determines the taxable wealth of each Texas school district to be used to allocate state aid. Cost of Education Index (CEI) or Adjustment: The CEI is an index the state uses to adjust the Basic Allotment to account for geographic or other cost differences beyond local school district control. The CEI has not been updated since 1990. Coupon. The Coupon is the detachable part of a bond that displays the rate of interest due, and the interest payment date. When there were bearer bonds, coupons were often detached from the bonds and presented to the paying agent for payment just as one might cash a government check.
  • 49. Glossary of Bond Finance Terms Coupon Rate. The specified annual interest rate payable to the bond or note holder as printed on the bond. This term is still used even though there are no coupon bonds anymore. Covenant. A legally binding commitment by the issuer of municipal bonds to the bondholder. This is the issuer’s promise to perform or repay, conversely, an impairment of a covenant can lead to a Technical Default. Current Refunding. A refunding transaction where the municipal securities being refunding will all mature or be redeemed within 90 days or less from the date of issuance of the refunding issue. Current Yield. The ratio of the coupon rate on a bond to the dollar purchase price expressed as a percentage. Cushion Bonds. Bonds selling at a premium are called "cushion" bonds because they cushion the price volatility in an up and down market. A premium bond, by definition, has a higher-than-market coupon interest rate. The dollar price movement of a high interest rate bond is less than that of a lower interest rate bond of the same maturity when general interest rates move up or down a few basis points. Dated Date. The date carried on the face of a bond or note from which interest normally begins to accrue, the “dated date”. Dealer. A dealer is a corporation or partnership that buys and sells and maintains an ongoing position in bonds and/or notes. They are also authorized to underwrite new issues. Debt Limited. The debt limit is the maximum statutory or constitutional amount of debt that the general obligation bond issuer can either issue or have outstanding at any time.
  • 50. Glossary of Bond Finance Terms Debt Ratio . The ratio of the issuer's general obligation debt to a measure of value, like real property valuations, personal income, general fund resources, or population. Debt Service . Required payments for principal and interest. Default . Failure to pay in a timely manner principal and/or interest when due, or a Technical Default, the occurrence of an event as stipulated in the Indenture of Trust resulting in an abrogation of that agreement. A Technical Default can be a warning sign that a default on debt service is coming, however in the real world actual debt service interruption does not always occur if the problems are resolved in time. Defeased Bonds. Refunded bonds for which the payment of principal and interest has been assured through the structuring of a portfolio of government securities, the principal and interest on which will be sufficient to pay debt service on the refunded, outstanding bonds. When a bond issue is defeased, the claim on the revenues of the issuer is usually eliminated. Delinquent Taxes . Property taxes that have been levied but remain unpaid on and after the due date. Delivery . Delivery and payment must be in three business days for bonds bought or sold in the secondary market. For new issues, the time when payment is made to, and the executed bonds and notes are received from, the issuer. New-issue delivery takes place several weeks after the sale to allow the bonds and notes to be printed and signed. Denomination . The face or par amount - normally $1000 or $5000 but can be $100,000 or more in the case of a note - that the issuer promises to pay at a specific bond or note maturity. Direct Deb t. In general obligation bond analysis, the amount of debt that a particular local unit of government has incurred in its own name or assumed through annexation.
  • 51. Glossary of Bond Finance Terms Discount. The amount of dollars by which market value of a bond is less than par value or face value. Discount Bonds. Bonds which sell at a dollar price below par in which case the yield would exceed the coupon rate. The difference between the discount price and the maturity price is subject to federal capital gains tax except in the case of Original Issue Discount Bonds. Dollar Bond. Generally a term bond that is quoted and traded in dollars rather than in yield-to-maturity. They are well known issues of well known names in the market. Escrow Fund. A fund that contains monies that only can be used to pay debt service. Escrowed to Maturity. Also called an “Advanced Refunded” bond. When interest rates fall, an issuer may chose to sell a new issue called a refunding issue and use the proceeds of the second issue to pay off the original issue, much the same as a home owner refinancing a mortgage in an effort to save interest costs. The proceeds of the refunding issue are used to structure a portfolio of U.S. government securities, the principal and interest payments of which exactly match the principal and interest payments of the refunded bonds. The portfolio is placed in escrow at the paying agent and the bond issue is said to be fully defeased and escrowed to maturity. In actual practice the bonds are usually called on the first call date. Because of the U.S. Treasury backing, advanced refunded or escrowed to maturity bonds are considered the safest municipal bonds available and trade on the market as a rich triple-A. Equity: the term, in school finance, refers to fair or equal distribution of resources for schooling. This takes into account student differences and school district characteristics. The standard used by the Texas Supreme Court is a taxpayer equity standard, which means similar revenue for similar tax effort. The school finance system, in other words, is to be property wealth neutral: a district's property tax base should have little or no impact on its ability to finance the local share of the Foundation School Program.
  • 52. Glossary of Bond Finance Terms Existing Debt Allotment (EDA): The EDA program was initially authorized by the 76th Legislature in 1999. The EDA program provides assistance to school districts in making debt service payments on qualifying debt. For the 2004-2005 biennium, qualifying debt is defined as debt for which taxes were levied prior to the 2003-2004 school year. Financial Advisor . Generally an independent consulting firm, an investment-banking company, individual, or bank that advises the issuer on financial matters regarding a proposed issue and is not part of the underwriting syndicate. Fiscal Agent . Also known as the Paying Agent, the bank, designated by the issuer, to pay interest and principal to the bondholder. Fiscal Year . A 12-month time horizon by which state and local governments annually budget their respective revenues and expenditures. Often this time horizon is from July to June but can vary. Flow of Funds . The annual legal sequence by which enterprise revenues are paid out for operating and maintenance costs, debt service, sinking fund payments, and so on. Foundation School Fund: The Foundation School Fund is a dedicated stream of revenue in the state budget used exclusively to fund public education. The fund primarily consists of tax collections transferred from other state accounts. Foundation School Program (FSP): The FSP is a program for the support of a basic instructional program for all Texas school children. Currently, the FSP described in Chapter 42 of the Texas Education Code consists of two parts, or tiers. The first tier provides funding for a basic program. The second tier provides a guaranteed yield system so that school districts have substantially equal access to revenue sufficient to support an accredited program.
  • 53. Glossary of Bond Finance Terms Full Faith and Credit . The pledge of "the full faith and credit and taxing power without limitation as to rate or amount." This phrase is generally used regarding General Obligation bonds to express the pledge of utilizing all taxing powers and resources, if necessary, to pay the bond holders. General Obligation Bond. (G.O.) A bond secured by a pledge of the issuer's taxing powers (limited or unlimited). Considered the most secure of all municipal debt. General obligation bonds of local governments are paid from ad valorem property taxes and other general revenues. General Property Tax . A tax levied on real estate and personal property. Gross Debt . The sum total of a state's or local government's debt obligations. Guaranteed Yield: The guaranteed yield is a school finance plan in which the state specifies a revenue yield that it will guarantee in terms of revenue per student per penny of local tax effort. Districts adopt tax rates and levy taxes. The state makes up the difference between what each district levies locally per student and the guaranteed yield per student. High-wealth districts may raise all of their guaranteed yield revenue from local tax sources. Hold Harmless: Hold harmless provisions are common when a significant change is made to a formula or funding source. "Hold harmless" is a term used to describe a provision in new law that is designed to protect a school district from a loss of local revenue or state aid. Indenture of Trust . A legal document describing in specific detail the terms and conditions of a bond offering, the rights of the bondholder, and the obligations of the issuer to the bondholder; such document is alternatively referred to as a bond resolution. Instructional Facilities Allotment (IFA): The IFA program provides assistance to school districts in making debt service payments on qualifying bonds and lease-purchase agreements to construct instructional facilities.
  • 54. Glossary of Bond Finance Terms Interest and Sinking Fund (I&S) Tax Rate : Also referred to as the debt service tax rate, the I&S taxes pay for bonded indebtedness, facilities, and other capital needs. Interim Borrowing. (1) Short-term loans to be repaid from general revenues or tax collections during the current fiscal year (TRANs or RANs); (2) short-term loans in anticipation of bond issuance or grant receipts (BANs). Investment Grade. Bond issues that the three major bond rating agencies, Moody's, Standard & Poor's, and Fitch rate BBB or Baa or better. Many fiduciaries, trustees, some mutual fund managers can only invest in securities with an investment grade rating. Junk Bonds. Most non-rated bonds and bonds rated below investment grade. Lease-Rental Bond. Bonds whose principal and interest are payable exclusively from rental payments from a lessee. Rental payments are often derived from, earnings or taxes levied by an enterprise that may be operated by the lessee or the lessor. Also see Certificates of Participation. Legal Opinion. A written opinion from bond counsel that an issue of bonds was duly authorized and issued. The opinion usually includes the statement, "interest received thereon is exempt from federal taxes and, in certain circumstances, from state and local taxes." Letter of Credit. A form of supplement or, in some cases, direct security for a municipal bond under which a commercial bank or private corporation guarantees payment on the bond under certain specified conditions. Level Debt Service. Principal and interest payments that, together, represent more or less equal annual payments over the life of the loan. Principal may be serial maturities or sinking fund installments.
  • 55. Glossary of Bond Finance Terms Lien . A claim on revenues, assessments or taxes made for a specific issue of bonds. Limited Tax Bond . A bond secured by a pledge of a tax that is limited as to rate or amount. Local Fund Assignment (LFA): The LFA is the tax rate that a district is required to levy in order to participate in the Foundation School Program. The greater the property wealth of the district, the higher the amount of revenue generated by the LFA and the lower the amount of state aid the district will receive. Currently, the LFA is set at rate of $0.86. Maintenance and Operations (M&O) Tax Rate: The M&O tax rate is a local school district property tax rate that raises revenue to operate and maintain the district's schools. By statute, M&O taxes are subject to a maximum of $1.50 per $100 of taxable value. Maximum Annual Debt Service . The maximum amount of principal and interest due by a revenue bond issuer on its outstanding bonds in any future fiscal year. This is sometimes the amount to be maintained in the Debt Service Reserve Fund. Municipal Bond . Bonds issued by any of the 50 states, the territories and their subdivisions, counties, cities, towns, villages and school districts, agencies, such as authorities and special districts created by the states, and certain federally sponsored agencies such as local housing authorities. Historically, the interest paid on theses bonds has been exempt from federal income taxes and is generally exempt from state and local taxes in the state of issuance. Municipal Securities Rulemaking Board (MSRB). An independent self-regulatory organization established by Congress in 1975 which is charged with primary rulemaking authority - under the SEC - over dealers, dealer banks, and brokers in the municipal securities industry.
  • 56. Glossary of Bond Finance Terms Net Bonded Debt. Gross general obligation debt minus self-supporting general obligation debt, housing bonds, water revenue bonds, etc. Net Interest Cost (NIC). In general, issuers award competitive bond sales to the underwriter bidding the lowest NIC. This represents the average coupon rate weighted to reflect the time until repayment of principal and adjusted for the premium or discount. Net Revenue Available for Debt Service. Usually, gross operating revenues of an enterprise less operating and maintenance expenses but exclusive of depreciation and bond principal and interest. Thus, net revenue is defined to determine coverage on revenue bond issues. Official Statement (OS) or Offering Circular (OC). A document or prospectus circulated for an issuer prior to a bond sale with relevant facts pertaining to the proposed financing. Usually there are two OSs, the first of which is known as the preliminary, or "red herring" - so named because some of the type on its cover is printed in red. The prospectus or red herring is supposed to be available to the investor prior to the sale often used to determine interest from investors. Original Issue Discount. Certain maturities of a new bond issue may have an offering price substantially below par. The appreciation from the original price to par over the life of the bonds is treated as tax-exempt income and is not subject to capital gains tax. Pleas see Zero Coupon Bond. O.T.C. Over The Counter. Not on an exchange. OTC refers to the buying and selling method used in the secondary market for municipal bonds and unlisted stocks.
  • 57. Glossary of Bond Finance Terms Overlapping Debt. Overlapping debt is the proportionate share of the general obligation bonds of local governments located wholly or in part within the limits of the reporting governmental entity that must be paid by property owners within the unit. Par Value . Par Value is the principal or face value of a bond, usually $5,000 due the holder at maturity. It has no relation to the market value. It is considered to be 100 for pricing purposes. Parity Bonds . Revenue bonds that have an equal lien on the revenues of the issuer. Paying Agent . Also Fiscal Agent. Generally a bank that performs the function of paying interest and principal for the issuing body. Permanent School Fund (PSF): The PSF is a perpetual trust fund created by the Texas Constitution in 1876. PSF earnings go into the Available School Fund, which the state must apportion on a per capita basis to counties for students enrolled in Texas public schools after funding state textbook purchases. PSF investments include U.S. Treasury bonds, Texas municipal bonds, school district building bonds, and securities. The SBOE administers the fund under constitutional and statutory requirements. Premium . A premium is the amount by which the price exceeds the principal amount (par value) of a bond. The current yield of a premium bond will be less than its coupon rate. Price to Call . The yield of a bond priced to the first call date rather than maturity. Primary Market . The new issue market Principal . The face value of a bond, not including interest.
  • 58. Glossary of Bond Finance Terms Public Education Grant (PEG): Students in low-performing schools have the option to request to attend a different public school in the home district of the student or in another district. The amount of the PEG is the total state and local funding per student for the student's home district. The receiving district may accept or reject the student and may not charge the student tuition. Put Bond. A put bond that can be redeemed by the bondholder on a date or on a date or dates prior to the stated maturity date. Qualified Legal Opinion. Conditional affirmation of the legal basis for the bond or note issue. The average investor should avoid any but the strongest opinion by the most recognized bond approving attorneys. Rate Covenant. A legal commitment by a revenue bond issuer to maintain rates at levels to generate a specified debt-service coverage. Ratings. Various alphabetical and numerical designations used by institutional investors, Wall Street underwriters, and commercial rating companies to give relative indications of bond and note creditworthiness. Standard & Poor's and Fitch Investors Service Inc. use the same system, starting with their highest rating of AAA, AA, A, BBB, BB, B, CCC, CC, C, and D for default. Moody's Investors Services uses Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C, and D . Each of the services use + or - or +1 to indicate half steps in between. The top four grades are considered Investment Grade Ratings. Recapture: Also referred to as the “Robin Hood” provision. Recapture is a characteristic of school finance where local districts give the state locally collected property tax revenues for reallocation through the Foundation School Program. Chapter 41 of the Texas Education Code is where the recapture provision can be found and is a significant feature of the Texas school finance equalization system.
  • 59. Glossary of Bond Finance Terms Red Herring . A preliminary offering statement, subject to final change and update upon completion of sale of bonds. The name comes from the red type along the side on the cover. Redemption . Process of retiring existing bonds prior to maturity from excess earnings or proceeds of refunding bonds. It also refers to redeeming shares in a mutual fund by selling the shares back to the sponsor. Refunding Bond . The issuance of a new bond for the purpose of retiring an already outstanding bond issue. Registered Bond . A non-negotiable instrument in the name of the holder either registered as to principal or as to principal and interest. Rollback Rate: The rollback rate is a tax rate that would provide roughly the same local taxes and state aid per weighted average daily attendance (WADA) as was available the previous year, plus debt service taxes, and $0.06. Security . The legally available revenues and assets that are used to pay the bond holders. This is the key component that supports debt service. Serial Bond . As opposed to a Term Bond, which is a large block of bonds maturing in a single year, a serial bond is an issue that features maturities every year, annually or semiannually over a period of years. Short Term . Bonds or notes sold on an interim basis with tax-exempt securities for a period of from one to five years. Sinking Fund . A sinking fund is where monies are escrowed on a periodic basis to retire term bonds at or prior to maturity.
  • 60. Glossary of Bond Finance Terms Sinking Fund Schedule. A schedule of payments required under the original revenue bond resolutions to be placed each year into a special fund, called the sinking fund, and to be used for retiring a specified portion of a term bond issue prior to maturity. Special Assessment Bond. A bond secured by a levy of special assessments, as opposed to property taxes, made by a local unit of government on certain properties to pay the cost of local improvements and/or services that represents the specific benefit to the property owner resulting from the improvement. Street Name. Street name refers to the registration of bonds in the name of a dealer or other third party instead of the owner, usually for custodial or safe keeping purposes. Swap. The exchange of one bond for another. Generally, the act of selling a bond to establish an income tax loss and replacing the bond with a new item of comparable value. Tax Base. The total resource of the community that is legally available for taxation. Taxable Equivalent Yield. The yield an investor would have to obtain on a taxable corporate or U.S. government bond to match the same after-tax yield on a municipal bond. Tax-exempt Bond. Bonds exempt from federal income, state income, or state tax and local personal property taxes. This tax exemption results from the theory of reciprocal immunity: States do not tax instruments of the federal government and the federal government does not tax interest of securities of state and local governments. Technical Default . Failure by the issuer to meet the requirements of a bond covenant. These defaults do not necessarily result in losses to the bond holder. The default may be cured by simple changes of policy or actions by the issuer.
  • 61. Glossary of Bond Finance Terms Tender . The act of offering bonds to a sinking fund. Term Bond . A large block of bonds of long maturity. They may be part of a serial Bond issue; there may be more than one term bond in an issue or a single maturity. Some are subject to a sinking fund redemption. Tombstone . An advertisement placed for information purposes, after bonds or notes are sold, that describes certain details of the issue and lists the managing underwriters and or the members of the underwriting syndicate. Trustee . A bank designated as the custodian of funds and official representative of bondholders. Trustees are appointed to insure compliance with the trust indenture and represents bondholders to enforce their contract with the issuer. Underwrite . An agreement to purchase an issuer's unsold securities at a set price, thereby guaranteeing the issuer proceeds and a fixed borrowing cost. Variable Rate Bond. A bond whose yield is adjusted periodically according to a prescribed formula. Wealth: In school finance, the wealth of a district is measured in taxable property value per weighted average daily attendance (WADA). Weighted Average Daily Attendance (WADA): In Texas, students with additional education needs are weighted for funding purposes to help recognize the additional costs of educating those students. Weighted programs include special education, vocational, bilingual, gifted and talented, and compensatory education. A weighted student count is used to distribute guaranteed yield funding.
  • 62. Glossary of Bond Finance Terms Yield Curve. Graph depicting the relationship between yields and current maturity for securities with identical default risk. Yield-to-call . Return available to call date taking into consideration the current value of the call premium, if any. Yield-to-maturity. (YTM) Return available taking into account the interest rate, length of time to maturity, and price paid. It is assumed that the coupon reinvestment rate for the life of the bonds will be the same as the yield-to-maturity. Zero-coupon Bonds. A deep discount municipal bond on which no current interest is paid. Instead, at bond maturity, the investor receives compounded interest at a specified rate. The difference between the discount price at purchase and the accreted value at maturity is not taxed as a capital gain but is considered tax-exempt interest. Often used for college savings bonds.