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Presented By Julio F. Morales January 26, 2006 Parameters for Bond Refinancing Beyond the 3% Rule.

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Presentation on theme: "Presented By Julio F. Morales January 26, 2006 Parameters for Bond Refinancing Beyond the 3% Rule."— Presentation transcript:

1 Presented By Julio F. Morales January 26, 2006 Parameters for Bond Refinancing Beyond the 3% Rule

2 Page 1 Basic Bond Formulas: PV  Excel PV Function  =PV (rate, nperiod,PMT, FV)  30 Year 6.0%  $1.0 million Annual Debt Service  =PV (.03, 60, $500,000,0) –$13,837,781  HP 12-C PV Function  How much debt can I afford? niPVPMTFV ? $1 million $  Terms Semi-Annual 1. N = 60 periods 2. Rate = PV = ? 4. PMT = $1.0 million 5. FV = $0

3 Page 2 Measuring Savings

4 Page 3 Optional Redemption  Most municipal bonds have an optional call feature which allows issuers to repurchase bonds at a specified price on certain dates in the future  Call date usually 8-10 years  Notification: typically 30 to 60 days prior to call December 1, 2010 through June 1, % December 1, 2011 to June 1, % December 1, 2011 and Thereafter100%

5 Page 4 Current Refunding Bonds that have matured  Refinancing in which bonds are redeemed within 90 days of call date  No limit on # of current refundings (2-3 times over life of bonds)

6 Page 5 Advance Refunding  Bonds are redeemed more than 90 days from the call date  IRS allows only 1 advance refunding

7 Page 6 Structuring an Escrow & Basic Sizing

8 Page 7 Defeasance  Legal Defeasance  Escrow securities backed by full faith & credit of U.S. government (e.g., U.S.Treasuries / SLGS)  Requires bond counsel opinion  Debt removed from books  Economic Defeasance  Escrow securities not backed by full faith & credit of U.S. government (e.g., Corporates & Agencies)  Higher yield / Greater savings  Debt remains on the books

9 Page 8 Defeasance Escrow  Refunding (Defeasance) Escrow  A portfolio of “eligible securities”, as defined in the Indenture (U.S. Treasuries / SLGS)  Cash flows sufficient to pay: –Principal –Interest –Call Premium to the call date, without reinvestment

10 Page 9 Escrow Requirements

11 Page 10 Escrow Structuring  Escrow cash flow requirement = $8,769,525  Escrow funding costs = $7,631,692  Escrow can yield the same rate as the arbitrage yield on the refunding bonds (e.g., 3.64%)  Perfect escrow would cost = $7,493,310

12 Page 11 Negative Carry Perfect Escrow $7,493,310 Arb. Yield = 3.64% Escrow Cash Flow Requirements to Call Date $8,769,525 Escrow Cash Flow Requirements to Call Date $8,769,525 Escrow Yield = 3.01% Negative Carry Perfect Escrow $7,493,310  Proceeds the bond rate pays for itself > “carry”  Investment yield (3.01%) lower than bond yield (3.64%)  Inefficient Escrow: increase par value of refunding bonds by 2.1%  $138,382 in Negative Carry (“negative arbitrage”)

13 Page 12 Bond Sizing Requirements Bonds Outstanding $6.15 Million + Additional Costs 3.0% to 6.0% 1.Cost of Issuance:.50% to 1.0% 2.Underwriter’s Discount:.50% to 1.0% 3.Redemption Premium: 2.0% to 3.0% 4.Bond Insurance: (~2x principal).50% to 1.0% Current Refunding Bonds: $6,580,000

14 Page 13 Advance Refunding

15 Page 14 Bond Sizing Requirements Bonds Outstanding $6.15 Million Principal & Interest $1.6 Million 1.Cost of Issuance:.50% to 1.0% 2.Underwriter’s Discount:.50% to 1.0% 3.Redemption Premium: 2.0% to 3.0% 4.Bond Insurance: (~2x principal).50% to 1.0% 5.Negative Carry *: 1.0% to 3.0% * Advance Refunding + Additional Costs 3.0% to 10.0% Advance Refunding Bonds: $8,000,000

16 Page 15 How to Evaluate a Refunding

17 Page 16 Issuer Objectives  Debt Service Savings  Cash Flow Structuring  Consolidation of Debt  Remove Restrictive Covenants  Combination (of above)

18 Page 17 Rolling Down the Yield Curve

19 Page 18 Measuring Savings  $30,000 Avg. Annual Cash Flow Savings  $440,293 NPV Savings  6.9% of Refunded Bonds  6.7% of Refunding Bonds

20 Page 19 The Impact of Investments

21 Page 20 Gross vs. Net Refunding Must take into account impact of investments  Gross-to-Gross Refunding  Comparison solely of gross debt service  Does not take into account reinvestment of bond proceeds  Net-to-Net Refunding  Compares Net Debt Services  Takes into account reinvestment of bond proceeds

22 Page 21 Net-to-Net Refunding  Net-to-Net Refunding reflects true savings  May reduce savings level (e.g. 7.1% vs. 4.8%)

23 Page 22 Beyond the 3% Rule

24 Page 23 Key Factors in Evaluating a Refunding 1.Current vs. Historical Interest Rate Levels 2.Maturity-by-Maturity (shape of yield curve) 3.Term to maturity (years remaining) 4.Absolute level of savings: minimum $ threshold (e.g. $1 million) Evaluating an advance refunding generally more important than current refunding.

25 Page 24 Savings Formula Rule of Thumb Coupon Spread X # of Years Coupon Spread X # of Years Call Premium + Issuance Cost Savings >

26 Page 25 Current vs. Historical Interest Rates Refunding should be driven by the potential value captured  Refunding undertaken near historical low interest levels, may capture most potential savings

27 Page 26 Maturity-by-Maturity Analysis  Although overall level of savings attractive  Issuers should begin to evaluate refunding on a maturity-by- maturity basis.  Review shape of Yield curve

28 Page 27 Shape of the Yield Curve Shape of the Yield Curve + Time to Final Maturity  3.0% to 10.0% in par value required to issue refunding bonds  % spread of 100 bps more significant later years: –3 year = 300 bps / 9 years = 900 bps

29 Page 28 Adjusted Maturity-by-Maturity  Adjusted Par Value – 7% for each Maturity  Level debt service solution, places more principal in shorter maturities – distorts savings in back end.

30 Page 29 Value of Call Option  Measures Efficiency of a Refunding  Requires complex multi-variable model  Simple approximation: benchmark savings to historical low interest rates  Rates as of June 12, 2003  Efficiency of Refunding - % of potential savings

31 Page 30 Coupon Spread

32 Page 31 Capture Potential Economic Value  Benchmark to historical low interest rate level – provides simple gauge of efficiency of refunding

33 Page 32 Absolute Value & Other Considerations  “Suit Rule” – A refunding should generate more savings to the issuer than the suits (i.e., bond counsel, FA, underwriter, etc.) get paid.  Minimum $X million NPV savings, regardless of % of par value –Current Refundings –Short term to maturity  Restrictive Covenants –Debt Service Coverage –Developer payments

34 Page 33 Use of Swaps & Derivatives  Issuers may realize greater savings by using swap & derivative instruments  However, must consider that:  % of LIBOR swaps assume tax risk  Swaps are effectively non-callable  must measure the option value of the call

35 Page 34 Questions and Discussion


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