Best Practices in Debt Management: An Overview FGFOA School of Governmental Finance Sarasota County, Florida November 14, 2012
Dec 31, 2015
Best Practices in Debt Management: An Overview
FGFOA School of Governmental Finance
Sarasota County, Florida
November 14, 2012
GOVERNMENT FINANCE OFFICERS ASSOCIATION
What is the Role of the Finance Officer in Debt Issuance?
Four Primary Rating Criteria Financial Condition Debt Structure Economics/Demographics Management
Management = Creditworthiness Finance Officers responsible for variety of duties How each is managed impacts the cost of funds when it comes time
to issue enter capital markets
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Best Practices Five-year capital improvement plan integrating operating
costs of new facilities
Debt policies and debt affordability reviews
Pay-as-you-go capital funding policies
Fund balance reserve policy/working capital reserves
Contingency planning policies
Policies regarding nonrecurring revenue
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More Best Practices … Multi-year financial forecasting
Monthly or quarterly financial reporting and monitoring
Superior debt disclosure practices
Financial reporting and budgeting awards
Compliance with Governmental Accounting Standards Board standards
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The Debt Component of Your Capital Improvement Plan
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Debt Issuance Integration with Capital Improvement Plan
GFOA recommends that governments adopt comprehensive multi-year capital improvement plans (CIP) to ensure effective management of capital assets
CIP should cover at least 3 year period, preferably 5 years or more
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Debt Issuance Integration with Capital Improvement Plan
Prudent capital plans do the following: Identify needs
• Long-term horizon
Determine project costs
Prioritize capital projects• New outlays, maintenance, replacement, renewal
Develop financing strategies
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Debt Issuance Integration with Capital Improvement Plan
Financing strategies Cash Flow projections Consider all funding alternatives Reliability and stability of funding sources Affordability of strategies, including impact on debt ratios, taxpayers,
ratepayers, etc. Have to consider debt management policy
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Debt Issuance Integration with Capital Improvement Plan
Debt management policy and CIP Use policy to establish parameters for issuing debt relative to capital
projects Particularly with respect to objectives to be achieved before and after
issuance Also use for guidance with respect to debt affordability – use debt
policy as control points relative to managing CIP
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Debt Capacity Considerations
Legal Limits
Internal Policy Limits
Financial Limits
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Debt Capacity – Precious Commodity Determining “capacity” is an art not a science
Debt capacity is limited; make it count Funds borrowed for project today can’t be used for other projects
tomorrow Funds committed for debt repayment today can’t be used to fund
services tomorrow
Long-term capital planning key to managing debt capacity
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Developing a Debt Policy
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Importance of Developing a Debt Management Policy
A debt management policy improves the quality of decisions, provides justification for the structure of debt issuance, identifies policy goals, and demonstrates a commitment to long-term financial planning, including a multi-year capital plan.
GOVERNMENT FINANCE OFFICERS ASSOCIATION
Importance of Developing a Debt Management Policy
Adherence to a debt management policy signals to rating agencies and the capital markets that a government is well managed and should meet its obligations in a timely manner.
An effective debt management policy provides guidelines for a government to manage its debt program in line with available resources.
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GFOA Best Practice – Debt Policies
Purposes for which debt may be issued
Legal debt limitations
Types of debt permitted
Structural features preferred
Credit objectives
Methods of sale
Methods for selecting outside professionals
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Developing Debt Policies Identify Comparable Governments
Collect Example Policies and Borrow Ideas
Construct Indicators For Peer Group For Self / Compare
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GFOA Tools Available to Issuers – Publications
GFOA Publications Guide to Preparing a Debt Policy Benchmarking and Measuring Debt Capacity Elected Official’s Guide to Debt Issuance Elected Official’s Guide to Tax Increment Financing Budget Practices: A Framework For Improved State and Local
Government Budgeting Capital Project Planning and Evaluation: Expanding the Role of
the Finance Officer
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Method of Sale: Competitive vs. Negotiated
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Competitive vs. Negotiated Sales: The Decision
The finance officer’s decision or recommendation regarding the method in which bonds will be sold will be a leading factor in determining the financing cost of the bonds.
Method of Sale decision should be addressed in the issuer’s debt or financial policies.
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Competitive vs. Negotiated Sales: Definitions
Competitive Sale: Bond issue is prepared by the issuer and financial advisor and then offered for sale to underwriters at specified date and time. Bonds are awarded to the firm that offers the lowest True Interest Cost (TIC). Bids usually submitted electronically.
Negotiated Sale: The underwriter of the bonds is selected in advance of the sale and the pricing of the bonds (coupons, yields, spread) is negotiated by the underwriter and the issuer (with their financial advisor).
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GFOA Best Practice on Selecting the Method of Sale
“Method of Sale” Best Practices provides guidance to issuers regarding choosing between a competitive and negotiated sale.
Method of Sale Best Practices were the result of sometimes contentious discussions among GFOA Debt Committee members over two years.
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Key Components of Method of Sale BP
Issuers should select the method of sale most likely to achieve the lowest cost of borrowing.
Decision should be based on analysis of the relevant rating, security, structuring and other features of the bond issue.
If an issuer does not have dedicated, experienced debt management staff, it should hire a financial advisor to assist in making the method of sale decision.
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Key Components of Method of Sale BP
Due to the inherent conflict of interest, issuers should not use a potential underwriter to assist in the method of sale decision unless that firm has agreed not to underwrite the bonds.
Due to inherent conflicts of interest, a firm acting as an issuer’s financial advisor should not be allowed to resign in order to serve as underwriter for the proposed bonds. MSRB Rule G-23 now prohibits.
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Key Components of Method of Sale BP
Favors which favor a competitive sale include:
Bond rating of “A” or higher.
Bonds are general obligations of the issuer, or are secured by a strong, known and long-standing revenues stream (e.g. water, sewer, or electric revenues).
The structure of the bonds does not include unusual or new financing features that require extensive explanation to the bond market.
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Key Components of Method of Sale BP
Favors which favor a negotiated sale include:
Bond rating less than “A”.
Bond insurance or other credit enhancement not available or not cost-effective.
Bond structure has unique features such as pooled bonds, variable rate debt or deferred interest bonds.
The issuer desires to target underwriting participation.
Other factors that the issuer, in consultation with its financial advisor, believes favor the use of negotiation.
GOVERNMENT FINANCE OFFICERS ASSOCIATION
Key Components of Method of Sale BP
If a negotiated sale is deemed appropriate:
Engage the services of a financial advisor, unless the issuer has extensive in-house bond pricing experience and access to current bond market data.
Select underwriters through a Request for Proposals (RFP).
Remain actively involved in each step of the negotiation and sale process. (BP on “Pricing Bonds in a Negotiated Sale”)
Be aware that the relationship between the issuer and the underwriter is one of common purpose, but also competing objectives, especially at time of bond pricing. YOUR UNDERWRITER IS NOT YOUR FINANCIAL ADVISOR.
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Refunding Analysis
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Optional Redemption
Most tax-exempt 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
Par call is most common (as opposed to premium call – 101% of par)
Notification: typically 30 to 60 days prior to call
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Types of Refundings
Less than 90 days Call 2002A BondsSeptember 1, 2012
Bond proceeds used to
fund Defeasance
Escrow
Call Outstanding
Bonds
DefeasanceEscrow
Refunding Bonds
Current: Refunding bonds sold within 90 days of Call Date of refunded bonds
Escrow Yield unrestricted No limit to number of current refundings
Refunding BondsJune 1, 2012
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Types of Refundings Advance: Refunding bonds sold more than 90 days to the
1st Optional Call Date of refunded bonds Escrow yield restricted to arbitrage yield of refunding bonds 1 Advance Refunding allowed per IRS Regulations.
More than 90 days
Call 2004A BondsAugust 1, 2014
Bond proceeds used to
fund Defeasance
Escrow
Pay Principal & Interest due on Refunded Bonds until the Call Date
Call Outstanding
Bonds
DefeasanceEscrow
Refunding Bonds
Refunding BondsJune 1, 2012
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Economics of Refunding Bonds
Absolute difference in interest rates on old “refunded” bonds vs. new “refunding” bonds
Remaining term and amount of refunded bonds
Length of the escrow period
Efficiency of the escrow Ability to earn the escrow yield limit Investment dates vs. refunded bond payment dates
Cautions: Negative arbitrage (earnings) in escrow Extension of call date
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Issuer Objectives Meet Savings Threshold
GFOA recommends 3-5% NPV as starting point Debt Policy should discuss Threshold Savings
Cash Flow Structuring
Consolidation of Debt
Remove Restrictive Covenants
Or Combination of Above Objectives
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Savings Targets Establish guidelines in debt policy
Opportunity cost analysis
Different perspective for current and advance refunding
Net present value as % of par value (refunding or refunded par)
Absolute savings
Savings in excess of COI
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How to Evaluate a Refunding Current vs. Historical Interest Rate Levels
Shape of yield curve
Term to maturity (years remaining)
Absolute level of savings: minimum $ threshold (e.g. $1 million)
NPV Savings as % of par
Consider future “opportunities lost”
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Historical & Current Interest Rates are Useful for
Understanding Market Trends
Historical interest rates provide context to current rates and insight into how rates change Compare current rates to historical ranges Identify current trends Establish how rapidly rates have moved up or down
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Continuing Disclosure
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SEC Rule 15c2-12 Effective January 1, 1996 Designed to prevent fraudulent, deceptive, or manipulative acts
or practices Requires municipal debt issuers to file updated financial
information and operating data annually with EMMA (Electronic Municipal Market Access System) by a specified date and file material event notices.
Requires underwriters to reasonably determine that the issuer has complied with the rule prior to offering for sale the related securities
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The issuer must enter into a written agreement for the benefit of the bond holders to do the following:
Provide through a filing to the Electronic Municipal Market Access (EMMA) and to the appropriate State Information Depository (SID), if any, annual financial information or operating data presented in the Official Statement
Submit audited financial statements to the EMMA system and respective SID when available, if not provided as part of the annual financial information listed above
Submit a notification to the EMMA system and respective SID of any material event occurrence in a timely manner
Submit a notification to the EMMA system and respective SID of failure to comply in a timely manner
Requirements
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Material events related to bonds issued after 12/1/10, but submit the material event to the EMMA system within 10 business days of the event occurring.
Some events need to be disclosed regardless if they are ‘material’ or not: Principal and interest payment delinquencies Unscheduled draws on debt service reserves reflecting financial
difficulties Unscheduled draws on credit enhancement reflecting financial
difficulties Substitution of credit or liquidity providers, or their failure to
perform Adverse tax opinions Defeasances Rating Changes
Material Events
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New Material Events Updated in May, 2010: New Material Events
IRS proposed or final determinations of taxability Tender officers Bankruptcy, insolvency, receivership, or similar event of the
obligated person Consummation of a merger, consideration, or acquisition, or certain
asset ales, involving the obligated person, or entry into or termination of a definitive agreement to the foregoing (if material)
Appointment of a successor or additional trustee or the change of name of a trustee (if material)
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If the issuer fails to meet its annual filing requirements, the issuer must: Submit a notice of failure to comply with EMMA and the appropriate
SID Complete and submit all past due filings prior to issuing debt Create procedures to ensure the failure to file will not reoccur Disclose its failure to comply in every Official Statement for 5 years
Notice of Failure to Comply
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If the issuer fails to meet its annual filing requirements, the ease of selling its securities diminishes
The underwriter is prohibited from bidding on or offering for sale the primary offering
Rating agencies could assign a lower rating if the failed filings were deemed to be caused by poor management
The investors may not show interest in securities where the required disclosure filings are not available
In the event of a default, the investor could argue the required disclosure filings were not available for due diligence review
Higher borrowing costs
Risks of Non-Compliance
GOVERNMENT FINANCE OFFICERS ASSOCIATION
Exemptions from annual filings and material event notices
Debt issues with a total par amount of $1,000,000 or less Debt issues authorized in denominations of $100,000 if,
• Sold to no more than 35 persons who are believed to capable of evaluating risk and who are purchasing the securities for one account
• Have a maturity of 9 months or less, or• May be tendered to the issuer at par value or above every 9
months until maturity Exemptions from annual filings but not material event notices
Debt issues with a maturity 18 months or less
Debt Issue Exemptions
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Prior to bidding on or offering for sale municipal securities the underwriter must review the preliminary official statement (“POS”) and reasonably determine that issuer has complied with the rule
The underwriter must send a POS no later than 1 business day after the request of a potential customer, if available
The underwriter must receive the final official statement 7 business days after the purchase agreement and in sufficient time and quantity to accompany any confirmation that requests payment from any customer
Issuers may now submit POS documents to EMMA.
Requirements on Underwriters
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Continuing Responsibilities of the Finance Officer – Post Issuance
Compliance
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Post Issuance Compliance
Post-issuance tax compliance begins with the debt issuance process itself and provides for a continuing focus on investments of bond proceeds and use of bond-financed property. It will require identifying existing policies, the responsible people, the applicable procedures, and the affected population.
The National Association of Bond Lawyers and the Government Finance Officers Association have jointly developed a checklist to assist with issuers post issuance compliance matters (found at below website).
http://www.gfoa.org/downloads/PostIssuanceCompliance.pdf
GOVERNMENT FINANCE OFFICERS ASSOCIATION
Investment of Bond Proceeds
Principals of good investment management and understanding of inherent risks in investing bond proceeds critical Establish good guidelines for permitted investments to reduce credit
risk – SAFETY Good cash flow estimates mitigate market risk – LIQUIDITY Integration of knowledge of expected and future market conditions
with other cash flows to reduce opportunity risk – YIELD
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Investment of Bond Proceeds
Obtain projected cash flow schedules from project managers Inform internal investment officer of incoming funds Bid Investment Agreements as needed Develop process for monitoring balances in trustee held
accounts Actively monitor construction activities Develop procedures for reinvestment of bond proceeds (see
handout)
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Investment of Bond Proceeds
Initial investment – generally the “easier part” Project cash flows Capitalized Interest Debt Service Reserve Fund Cost of Issuance
Reinvestment – generally the “really hard part” Develop process to monitor and make reinvestment decisions Use of cash flow expectations v. reality
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Record Retention
Establish Record Retention Requirements and Procedures IRS record retention requirements
Term of bonds + 6 years Types of records
IRS Website www.irs.gov/taxexemptbond/index.html FAQ’s -- Record Retention Requirements (handout)
www.irs.gov/taxexemptbond/article/0,,id=134435,00.html
GOVERNMENT FINANCE OFFICERS ASSOCIATION
What is Arbitrage?
Arbitrage is the ability to earn profit by capitalizing in differences between investments or markets.
In the case of public finance, Arbitrage refers to ability to profit from investment of tax-exempt bond proceeds in taxable securities.
The ability to earn arbitrage depends on the relationship between taxable and tax-exempt rates and the shape of the yield curve.
Positive arbitrage represents earnings above the arbitrage yield. Negative arbitrage represents earnings below the arbitrage yield (i.e., “losses”).
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Arbitrage Rebate Compliance Activities
Internal monitoring of rebate compliance Recommend annual calculations during construction period
Set aside annual rebate liability in Rebate Fund Get it out of the Construction Fund
Paying rebate is not bad, just need to monitor and pay as required
Pay attention to requirements in Tax/Arbitrage Certificate
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Compliance with Bond Covenants and Agreements
Develop internal tickler system from beginning Keep up-to-date Don’t reinvent the wheel with every deal; similar reporting
requirements are okay and always preferred Keep as simple as possible
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Bond Project Monitoring
Critical to complete reinvestment activities Active involvement with project staff
Regular conversations Understanding of current and future capital needs
Review project encumbrance and expenditure needs Understand project delays
Implications for timely commencement of debt service Develop contingency plan if significant project delays
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Questions