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Bond Issue Basics: A Debt and PlanCon Primer Against the Backdrop of the Great Recession By Christopher Brewer, Esq. Dinsmore & Shohl LLP.

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Presentation on theme: "Bond Issue Basics: A Debt and PlanCon Primer Against the Backdrop of the Great Recession By Christopher Brewer, Esq. Dinsmore & Shohl LLP."— Presentation transcript:

1 Bond Issue Basics: A Debt and PlanCon Primer Against the Backdrop of the Great Recession By Christopher Brewer, Esq. Dinsmore & Shohl LLP

2 All Debt is a Loan of Money Returned in Installments at a cost -- of Interest

3 If you have ever taken a home mortgage, then you have experienced all of the elements of any bond issue. The difference is one of amount and the mechanics needed to accommodate large amounts.

4 Finding Your Lender Is Financing packaged with Asset? Is Financing packaged with Asset? (Xerox, GE Capital, Dell) Is Amount under $1.5 MM? Is Amount under $1.5 MM? Is Term under 5 years? Is Term under 5 years?

5 Survey/Seek Proposals from Banks Recognize Bank’s Own Tax Position/Portfolio Needs Variable Rate (Under 70% of Taxable) Variable Rate (Under 70% of Taxable) Rate Reset (3 to 5 years) Rate Reset (3 to 5 years) Make whole provision on prepayment Make whole provision on prepayment Transfer of accounts Transfer of accounts Bank Fees Bank Fees If not a Bank Loan, perhaps a Bond Pool?

6 Uneeda Bond Issue? If so, you need bond investors. How do you find them?

7 Taxpayers School District Investment Banking Firm Bond Investors

8 BANK LOAN – Single Creditor, Single Interest Rate, Monthly Cycle, Equal (Level) Payments, Standard Period (Term) PRIVATE OFFERING – Limited Number of Investors, Blend of two Alternatives BOND ISSUE – Multiple Investors, Multiple Interest Rates, Semi-Annual Cycles, Customized Payments, Customized Term

9 Alternative Methods of Finance

10 Direct Source vs. Brokered Source

11 Public Offering of School District Bonds

12 Terminology Translator Home Mortgage Mortgage Application CollateralCo-signer Credit Score Payment Principal Amortization Interest Rate APRPrepaymentPenalty Bank Fee Points Title Opinion Servicing Agent Bond Issue Official Statement Security Bond Insurance/Letter of Credit Credit Rating Debt Service Principal Maturity Coupon (Rate) YieldRedemption/CallPremiumDiscount Original Issue Discount Bond Opinion Paying Agent

13 Alternative Amortization Structures Level Principal Level Principal Level Debt Service Level Debt Service Wrap Around Debt Service Wrap Around Debt Service Phasing (first 2 to 3 years) Phasing (first 2 to 3 years) Match Debt to Useful Life; other Capital Needs/Borrowings Match Debt to Useful Life; other Capital Needs/Borrowings Expected Financial Circumstances Expected Financial Circumstances

14 Level Annual Debt Service

15 Wraparound Debt Service

16

17 Alternative Credit Structures General Obligations – Taxes Special Obligations – Enterprise Revenues Non-appropriation – Asset Backed

18 Alternative Issuers School District Itself School District Itself State Public School Building Authority* State Public School Building Authority* Local Authority (Vo-Tech or Swap)* Local Authority (Vo-Tech or Swap)* Local Bond Pool Authority* Local Bond Pool Authority* *School District delivers note/loan agreement

19 Uses and Sources Construction Bids/Estimates Cash Contribution Land or Interest in Land Grants Construction Manager/Architect Bond Proceeds Furniture Fixtures & Equipment Interest Earnings Planning/Permits Bond Discount (One-Time vs. Draw- Bond Insurance Down Funding) Legal (Bond and Local) Rating Agency Financial Advisor Printing Paying Agent

20 Designing Your Bond Issue School District vs. Bond Investor School District vs. Bond Investor Needs/Abilities/Goals Needs/Abilities/Goals Market Reception Case in Point : BABs in Europe Yield Curve Positioning Case in Point : Short tax-exempts; Long BABs

21 Alternative Bond Sale Methods Negotiated (Private) Competitive (Public) [Design / Build] [Design / Bid] [Design / Build] [Design / Bid] More Trust by School District Less Trust by School District Less Risk on Banker More Risk on Banker Less Risk on Banker More Risk on Banker Components of Discount Management (35%) / Underwriting (65%)

22 Planning for Construction Workbook “PlanCon” Capital Cost Reimbursement is “Pay-As-You-Go” Little to no PDE input to bond structure Payment must be from School District Revenues (Not accrued or capitalized interest) Full Cash by District = Full Cash by PDE (1 year rule) Debt Amortization by District = Debt Service Reimbursement by PDE

23 Eligible Project Costs ($ x students adjusted by certain costs) Divided By Total Project Costs Project Eligible % x MVAR equals Effective Reimbursement *Not available until receipt of bids (PlanCon G/H), but PDE will reimburse prior payments but PDE will reimburse prior payments *Temporary Percentage until Final Accounting (PlanCon J) Net Debt Service Solutions *Watch assumptions *Changes in Project Eligible % or MVAR will distort net debt solutions

24 PlanCon D – Project Accounting Based on Estimates Fiscal Constraints D-17 25% of Local Revenues D-17Test for Fiscal Distress D-18Mills on Market Value (Local vs. Statewide) Problematic for Poorer School Districts Problematic for Debt Free School Districts

25 PlanCon G – Project Accounting Based on Bids PlanCon H – Financing PlanCon K – Refinancing * “Never-Pay-More” Rule Inclusion of New Money or Increase of Total Debt Service will reduce Project Eligible % * Pure Savings (whether up-front, over time or back-end) will retain Project Eligible % retain Project Eligible % * Cost of Issuance on School District * New debt service schedule may interrupt reimbursement

26 Act 1 Constraints Act 1 does not limit what you can borrow; it limits whether you can pay for it. Referendum Referendum Qualified Costs Limitation Qualified Costs Limitation Phase-in/Wrap-Around Structures Phase-in/Wrap-Around Structures (Capital Appreciation Bonds?) (Creative use of Build America Bonds?)

27 Local Government Unit Debt Act Limitations Principal Amount Limits Total School District Debt ≤ Last 3 years’ Average Revenues x 2.25 x 2.25 PlanCon Subsidized Debt May be Excluded Pay–Back Limits Capitalized Interest – construction plus 1 year Principal Deferral – 2 years or construction period plus 1 year Final Maturity ≤ Useful Life Total Debt Service – Level or Wrapped to Level (Downward Cascading Permitted)

28 Local Government Unit Debt Act Procedures 3 Day Advance Notice 3 Day Advance Notice Board Resolution Board Resolution Covenant to Budget, Appropriate and Pay Covenant to Budget, Appropriate and Pay “Acceptable” Purchase Proposal “Acceptable” Purchase Proposal Post Adoption Notice Post Adoption Notice 15 Calendar day approval cycle 15 Calendar day approval cycle Appeal to Commonwealth Court Appeal to Commonwealth Court Advent of “Parameters” Resolution Advent of “Parameters” Resolution

29 Federal Tax Law Interest earned on obligations of a state or local government are excluded from gross income. In 1914, a right of federalism? In 2010, a federal subsidy and privilege IRC Sections 103 and 141 through 150 contain innumerable limits and conditions on the privilege.

30 Primary Restriction - Arbitrage Arbitrage is the practice of making money by moving an item between markets Marco Polo - tea ; Dutch colonists – beads Local Governments – tax-exempt bond proceeds into taxable investments

31 Abusive Device – issuing bonds sooner, or in an amount larger, or allowing them to remain outstanding longer, than is necessary to accomplish the governmental purpose.

32 Three Point “Reasonable Expectations” Test Substantial Binding Obligation to expend 5% incurred within 6 months Substantial Binding Obligation to expend 5% incurred within 6 months 85% of proceeds expended within 3 years 85% of proceeds expended within 3 years Proceed with Due Diligence Proceed with Due Diligence “Reasonable” does not mean possible or promised; it means “likely, as assessed by a third party observer”

33 Arbitrage Rebate Small issuer exemption ($5MM or $15MM Construction) Small issuer exemption ($5MM or $15MM Construction) Spending exemption Spending exemption - 6 month - 18 month - 24 month construction

34 Refundings Use of proceeds of new issue to prepay previous issue Use of proceeds of new issue to prepay previous issue Keys are Interest Rate and Redemption Period Keys are Interest Rate and Redemption Period Current Refunding : Old Bonds Paid off within 90 days of issue Advance Refunding : Old Bonds Paid off later than 90 days of issue

35 Build America Bonds Must meet all regular Tax Exempt Qualifications Interest is Taxable Federal Government will Reimburse 35% of Interest Expense

36 Qualified School Construction Bonds Primary compensation to investor is a tax credit “Supplemental Coupon” approximately 1.5 to 2.0%


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