Introduction to Municipal Bonds A. Reid Cavnar Senior Vice - - PowerPoint PPT Presentation

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Introduction to Municipal Bonds

• A. Reid Cavnar

Senior Vice President Reid.cavnar@merchantcapital.com

2011 Fall Leadership Summit Marriott, Columbia, South Carolina September 27-28, 2011

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M E R C H A N T & I N V E S T M E N T B A N K I N G

What is a Municipal Bond?

• A debt security issued by a state, municipality, or county to finance capital

expenditures. – Municipal bonds are exempt from federal taxes and from most state taxes, especially if you live in the state in which the bond is issued

• Concept of the “taxable yield equivalent”.

– Because municipal bonds are generally tax-exempt, investors are willing to accept lower rates on tax-exempt debt Example: 3.65% tax-exempt interest = 5.62% equivalent taxable yield for an investor in a 35% tax bracket

• There are five (5) basic types of municipal bonds: 1) General Obligation Bonds, 2)

Revenue Bonds, 3) Lease Revenue Bonds, 4) Tax Allocation Bonds and 5) Special Tax and Assessment Bonds

Slide 2

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Who Issues Municipal Bonds?

• State & Local Governments

– Cities, counties, states, special districts, schools, etc. – Conduit issuers: economic development authorities (ex. JEDA)

• Non-Profit Organizations

– Universities, charter schools, hospitals, affordable housing

• Nonfinancial Corporate Business

– Industrial development bonds (IDB)

Slide 3 SOURCE: Bloomberg. As of 1Q 2011

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The Size of the Municipal Bond Market.

Slide 4 14,401 15,503 13,614 13,959 12,766 12,659 10,830 11,721 13,826 6,527 $0 $50,000,000 $100,000,000 $150,000,000 $200,000,000 $250,000,000 $300,000,000 $350,000,000 $400,000,000 $450,000,000 $500,000,000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 SOURCE: Bloomberg. Please note yellow box indicates total number of issues (1) Reflects market conditions as of September 1, 2011 ($MM)

(1)

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Who Buys Municipal Bonds?

• Retail Investors

– High net-worth individuals

• Institutional Investors

– Mutual Funds – Investment advisors – Commercial banks – Bank trust departments – Insurance companies

Slide 5

Retail 37% Mutual Funds 37% Banks 9% Insurance Co. 16% Other 6%

SOURCE: Bloomberg. As of 1Q 2011

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M E R C H A N T & I N V E S T M E N T B A N K I N G

Credit Ratings

• Rating Agencies

– Standard & Poor’s, Moody’s and Fitch Ratings – Analyze credit quality of bonds and assign a rating

• Purpose of Ratings

– Assess issuer’s ability to repay bonds through maturity

• Rating timing

– Initially determined prior to bond issuance – Continuously renewed (annually) to help investors determine bond value – May be amended over time to reflect changes in the credit quality of the debt

Slide 6

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Bond Ratings / Credit Quality

Slide 7

Moody’s Standard & Poor’s Fitch Ratings Aaa AAA AAA Aa1,Aa2,Aa3 AA+,AA,AA- AA+,AA,AA- A1,A2,A3 A+,A,A- A+,A,A- Baa1,Baa2,Baa3 BBB+,BBB,BBB- BBB+,BBB,BBB- Ba1,Ba2,Ba3 BB+,BB,BB- BB+,BB,BB- B1,B2,B3 B+,B,B- B+,B,B- Caa1,Caa2,Caa3 CCC+,CCC,CCC- CCC+,CCC,CCC-

Investment Grade

Most charter schools are rated in the triple-B category

Non Investment Grade

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Charter School Rating Criteria

• When analyzing a charter school, rating agencies focus on the following areas:

– Operating profile

• Charter school legislation, funding mechanism, charter renewal history, wait

list, academic offerings (special focus) – Governance

• Composition of Board of Directors, management company (if applicable)

– Financial Information

• Audited financial statements, operating performance, budget practices,

financial projections

Slide 8

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Charter School Rating Criteria (continued)

– Project Scope

• New construction or acquisition of current facility, location of school (if new

construction), construction risk mitigates – Covenants and Legal Framework

• Debt service coverage ratio, days cash on hand, additional bonds test

Slide 9

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M E R C H A N T & I N V E S T M E N T B A N K I N G

Bond Issuance Steps

• Step 1

– Determine objective (new construction, acquisition)

• Step 2

– How much can the charter school bond for? Variable or fixed rate?

• Step 3

– Develop credit presentation (enrollment, renewal history, financial audit)

• Step 4

– Bonds are sold to investors using credit rating

• Step 5

– Bond closing and delivery of proceeds

Slide 10

Determine Charter School Objectives Financial Structuring Rating Agency Presentation Marketing & Sale of Bonds Bond Closing

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