Introduction to Project Financing (Bonds 101) Todd Hagen and Bruce Kimmel – Ehlers Mary Ippel – Briggs & Morgan Ehlers Public Finance Seminar – February 4, 2010
Presentation Outline Financing Policy Decisions Key Players in Bond Issuance Infrastructure Financing and Funding 9 Focus on Minnesota Cities and Counties 9 Projects: Streets, Utilities, Municipal Buildings, Equipment
Building a Bond Issue Overview of Bond Issuance Process
Financing Policy Decisions Definition #1: Financing vs. Funding 9 Financing: How municipality pays for project (cash, debt) 9 Funding: Current and/or future revenue sources used With Cash: current year revenues or reserve funds With Debt: future tax levies, assessments, utility fees
Definition #2: Pay-as-you-go vs. Pay-as-you-use 9 Pay-Go: Do projects only as current/reserve funds permit 9 Pay-Use: Do projects as needed, pay costs over time
Financing Policy Decisions Pay-Go (Cash) or Pay-Use (Debt)? 9 Not necessarily an either-or decision; municipality can combine cash and debt financing. 9 Which is financially feasible given project costs, current levy and tax base, utility user rates and customer base? 9 How does this financing decision affect municipality’s ability to meet existing obligations and complete future projects? 9 How does estimated bond interest expense compare to projected cost inflation if municipality decides to wait?
Financing Policy Decisions What is a Municipal Bond? 9 Contract between a municipality (issuer) and investor (bondholder), in which the issuer pledges a future revenue source to the repayment of the amount borrowed 9 Ability to borrow is governed by Minnesota Statutes 9 Interest on Minnesota (state/local) bonds is exempt from federal and state income taxes 9 Higher effective yield means that bondholders will accept a lower interest rate than on a comparable taxable investment 9 Typical bondholders are higher-income (higher tax bracket) individuals, banks, mutual funds and insurance companies
Key Players in Bond Issues The Issuer (You): The issue must meet your needs and goals Financial Advisor: Helps issuer plan and execute bond sale, represents issuer in dealings with other market players Bond Counsel: Provides opinion on legal authority and taxexempt / taxable status of bond issue Rating Agency: Provides independent assessment of issuer creditworthiness, assigns letter “grade” to inform investors Underwriter: purchases bonds from issuer, then sells them to investors or holds for own investment account Investor: individual or institution (mutual fund, insurance co.)
Player Compensation Financial Advisor: Issuer pays flat fee for financial advisor services (preliminary structuring through bond closing) Bond Counsel and Rating Agency: Issuer pays flat fee for services, even though counsel’s opinions and credit rating assessment benefit all parties to the transaction Underwriter: Issuer pays broker-dealer in the form of “underwriting spread” (e.g. $10 per $1,000 of bonds) 9 Broker-dealer can also profit by reselling bonds to investors at prices higher (and interest rates lower) than initial purchase 9 Underscores benefit of competitive sales in most “normal” situations
GFOA Recommendations
Selecting Financial Advisors (2008): “A financial advisor represents the issuer, and only the issuer, in the sale of bonds…If an issuer is contemplating the possibility of selling bonds through a negotiated sale, the financial advisor should be retained prior to selecting the underwriter(s).”
Selecting Underwriters for Negotiated Bond Sales (2008): “Issues must keep in mind that the roles of the underwriter and the financial advisor are separate, adversarial roles and cannot be provided by the same party….A financial advisor represents only the issue and has a fiduciary responsibility to the issuer.” 8
Statutory Authorization
Each entity’s ability to issue debt is governed by powers derived from MN Statutes 9 Different rules for cities, counties, school districts, HRA/EDAs (focus here on cities and counties)
Chapter 475 is the “foundation” for most types 9 Add 429 (assessment), 444 (utility), 469 (TIF/Abate)
Debt Limit: 3% of taxable market value 9 Applies primarily to 100% levy supported debt 9
Infrastructure Financing Assessment and Utility Bonds are General Obligations 9 All tools described here (except lease transactions) are general obligations: often payable from funds other than property tax levy but ultimately a “full faith and credit obligation” of the municipality
Bonds vs. PFA / Rural Development Loans 9 Statutory requirements (e.g. Chapter 429 for assessment-funded bonds, Chapter 444 for utility-funded bonds) apply whether municipality issues bonds or obtains PFA / RD loan financing 9 Bond counsel must give an opinion that the bond / loan is legally valid and that interest earned by investors is tax-exempt
Infrastructure: Streets G.O. Improvement Bonds – Chapter 429 9 9 9 9
At least 20% of project costs paid with special assessments G.O. pledge increases credit quality, lowers interest rates Can combine with utility bond authority to fund project Benefit received must equal or exceed assessment on parcel
9 Question: How will potential prepayments, deferrals, early payoffs and delinquencies affect the bond size/structure – and future revenues available to pay bond debt service?
Temporary Improvement Bonds 9 Allows municipality to delay long-term borrowing until all costs are know, consolidate several Projects into one issue
Infrastructure: Streets Assessment / Chapter 429 Resources 9 Bond counsel must verify validity of proceedings! 9 League of MN Cities: “Special Assessment Guide” (515A1A.3) – search for title at www.lmc.org 9 Briggs & Morgan: “Procedures for Financing Local Improvement Projects under Minnesota Statutes, Chapter 429” – ask Briggs or Ehlers for PDF
Infrastructure: Streets G.O. Street Reconstruction Bonds 9 Levy-supported bonds when assessments aren’t appropriate 9 Uses: “utility replacement and relocation and other activities incidental to the street reconstruction, turn lanes and other improvements having a substantial public safety function, realignments…and local share of state and county road projects” 9 Requires public hearing, unanimous vote approval by governing body, 30-day reverse referendum (citizen petition) period 9 No legal limits on annual debt service or total bond par amount
Infrastructure: Utilities G.O. Improvement Bonds – Chapter 429 9 Same considerations as with street projects 9 Benefit test can be difficult to meet with expensive projects
G.O. Utility Revenue Bonds – Chapter 444 9 Water, Wastewater, Stormwater, Streetlights – but not Streets 9 Eligible for state credit enhancement (S&P AAA rating) 9 Issuer must covenant to maintain utility user rates, connection charges and other system revenues at levels adequate to pay costs of operations and debt service
Both assessments and utility fees may be collected from tax-exempt property (churches, schools, etc.)
Infrastructure: Buildings G.O. “Referendum” Bonds EDA/HRA Lease Revenue Bonds 9 City/County EDA/HRA owns building, leases to City/County for term of bond debt service 9 City/County lease payments subject to annual appropriation (question of project essentiality) 9 Bonds may be eligible for state credit enhancement 9 More complex than standard G.O. bond deal (leases, legal descriptions, etc.)
Infrastructure: Buildings G.O. Capital Improvement Plan (CIP) Bonds 9 One or more projects described in five-year Plan 9 Requires public hearing, majority vote approval by governing body, 30-day reverse referendum (citizen petition) period 9 Bonds may be eligible for state credit enhancement 9 Cities: Cumulative annual CIP bond payments limited to 0.16% of taxable market value (TMV) – City X: $1 billion TMV x 0.16% = $1.6 million annual limit – Est. maximum bond @ 4.5% over 20 years = $20.8 million 9 Counties: Cumulative d/s limit is 0.12% of TMV
Infrastructure: Buildings G.O. County Jail Bonds 9 Eligible for state credit enhancement 9 Cumulative annual bond payments limited to 0.09671% of TMV
County Jail Lease Revenue Bonds 9 Eligible for state credit enhancement 9 Not subject to annual appropriation 9 Cumulative annual bond payments limited to 0.10% of TMV
G.O. County Courthouse Bonds 9 May be eligible for state credit enhancement 9 Maximum bond principal outstanding limited to 0.0403% of TMV (very small authority)
Capital Equipment
G.O. Equipment Certificates of Indebtedness 9 Public safety equipment, ambulance and other medical equipment, road construction and maintenance equipment, and other capital equipment; computer hardware and software 9 Expected useful life > terms of certificates 9 Maximum repayment term of 10 years
Par amount limited to 0.25% of TMV 9 If over 0.25%, publication required and possible reverse referendum to stop issuance 18
ARRA Bonds: 2009 - 2010 Build America Bonds 9 Can be issued for new public infrastructure projects only 9 Taxable interest rates, with 35% rebate from federal government 9 Still needs a MN statutory authority (e.g. Chapters 429, 444)
Recovery Zone Economic Development Bonds 9 Can be issued for new public and/or private projects 9 Taxable interest rates, with 45% rebate from federal government
Recovery Zone Facility Bonds 9 Like industrial development bonds, with fewer restrictions 9 Credit is the business; challenging to sell in risk-averse market
Building a Bond Issue
How much to borrow 9 100% debt or combined with cash financing?
Term of repayment 9 Longer term lowers annual payment, but rates increase as term extends (plus higher overall cost)
Repayment revenue and future impacts 9 Where will future revenues come from? 9 How will this affect ability to do other things? 20
Building a Bond Issue
Essential to build a bond issue around the specific needs of your project
In addition to project costs, must cover: 9 9 9 9
Cost of issuance and discount Capitalized interest, if any Debt service reserve, if any Do not rely on engineer’s estimate of finance costs
Pass reimbursement resolution early in project process, to preserve ability to cover preliminary costs (e.g. design, easements) with bond issue, at the right time 21
Building a Bond Issue
Project needs make the foundation of a bond issue Consider all costs: Project Costs
Land Construction Design Legal/administration 22
Costs of Issuance
Project
Costs of
Costs
Issuance
Financial advisor Bond counsel Rating agency Discount or underwriters fees Misc: trustee, insurance, if any
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Capitalized Interest
Capitalized Interest
Project
Costs of
Costs
Issuance
Funds to pay interest until other revenue available Potential buffer to fiscal impacts Amount needed may be reduced by investing bond proceeds 24
Debt Reserve
Capitalized
Debt
Interest
Reserve
Project
Costs of
Costs
Issuance
Needed for revenue bonds (usually not GO) Cash flow protection for bond holder Amt = less of 3 tests Can use to make last debt service payment Can use investment earnings to pay d/s 25
G.O. Bonds – Capitalizing the Issue Underwriter’s Discount = Compensation to Buyer of Bonds (1.50% of total)
City of Anywhere, MN Sizing Worksheet
General Obligation Bonds of 2009
Projects
Costs
Street Construction
2,000,000
Engineering Fees Total Amount Needed to be Financed Plus: Undewriter's Discount (1.50%) Issuance Expenses Capitalized Interest Subtotal Plus: Rounding
Issue Size
40,000 2,040,000
32,100 32,000 35,718 2,139,818 183
$2,140,000
Issuance expenses = fees to Financial Advisor, Bond Attorney, Paying Agent & Rating Company Capitalized Interest = monies borrowed to pay interest until levied funds are available Rounding amount = funds needed to gross up to the next $5,000 increment 26
G.O. Bonds – Debt Service Schedule City of Anywhere, MN
Bonds closed on 8/1/2009
Debt Service Schedule
$2,140,000 General Obligation Bonds, Series 2009
Interest pmt due on 2/1/2010
"AAA" rates as of January 12, 2009
Year 8/1/2009 2/1/2010 2/1/2011 2/1/2012 2/1/2013 2/1/2014 2/1/2015 2/1/2016 2/1/2017 2/1/2018 2/1/2019 2/1/2020 2/1/2021 2/1/2022 2/1/2023 2/1/2024 2/1/2025 2/1/2026 2/1/2027 2/1/2028 2/1/2029
Total
Principal
90,000 90,000 90,000 90,000 95,000 95,000 100,000 100,000 105,000 110,000 110,000 115,000 120,000 125,000 130,000 135,000 140,000 145,000 155,000
$2,140,000
Rate
1.70% 1.85% 2.00% 2.20% 2.40% 2.60% 2.80% 3.00% 3.25% 3.50% 3.60% 3.70% 3.80% 3.95% 4.00% 4.05% 4.10% 4.15% 4.20%
Interest
35,717.50 71,435.00 69,905.00 68,240.00 66,440.00 64,460.00 62,180.00 59,710.00 56,910.00 53,910.00 50,497.50 46,647.50 42,687.50 38,432.50 33,872.50 28,935.00 23,735.00 18,267.50 12,527.50 6,510.00
911,020.00
Total P & I
35,717.50 161,435.00 159,905.00 158,240.00 156,440.00 159,460.00 157,180.00 159,710.00 156,910.00 158,910.00 160,497.50 156,647.50 157,687.50 158,432.50 158,872.50 158,935.00 158,735.00 158,267.50 157,527.50 161,510.00
3,051,020.00
Cap. I
(35,717.50)
Net P & I
161,435.00 159,905.00 158,240.00 156,440.00 159,460.00 157,180.00 159,710.00 156,910.00 158,910.00 160,497.50 156,647.50 157,687.50 158,432.50 158,872.50 158,935.00 158,735.00 158,267.50 157,527.50 161,510.00
City would not have set levy in previous year to make payment: capitalized interest is funded to make this pmt. Payments set up for level P & I over life of issue, but could be structured in any number of ways – increasing debt service, interest only in first years, no principal in middle years, and so on
(35,717.50) 3,015,302.50
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Bond Issuance Process Competitive vs. Negotiated Sale 9 Factors: Bond amount, duration, how quickly issuer needs $$ 9 Trade-off: In general, competitive sales cost more upfront than going to local bank, but achieve lower long-term interest rates
Rules of Thumb for Choosing Sale Method 9 Bonds < $100,000: Negotiated sale direct with one local bank, using applicable market rate information 9 Bonds > $100,000: Limited competitive sale – solicit bids from several local banks via term sheet 9 Bonds > $500,000: Full competitive sale – solicit bids from open market via official statement
Bond Issuance Process Typical Timeline for Full Competitive Sale 9 Week 1: Municipality and advisor (and engineer) work out bond par amount, structure, and sale method based on project needs 9 Week 2: Advisor prepares sale notice and “pre-sale report”, bond counsel prepares council/board resolutions 9 Week 3: Advisor has pre-sale discussion with elected officials 9 Weeks 4-5: Advisor prepares official statement, advertises with underwriters, helps municipality obtain credit rating (if applicable) 9 Week 6: Advisor accepts bids; municipality awards bonds 9 Weeks 6-8: Advisor and bond counsel prepare closing documents 9 Week 9: Municipality receives bond proceeds
Thank You
Todd Hagen
Bruce Kimmel
(651) 697-8508
[email protected]
(651) 697-8572
[email protected]
Mary Ippel (651) 808-6620
[email protected]
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