fundamentals of municipal bond finance

© 2016 McNees Wallace & Nurick LLC www.mcneeslaw.com

Harrisburg, PennsylvaniaJune 30, 2016

Fundamentals Of Municipal Bond FinancePennsylvania State Association of Boroughs

570 Lausch Lane, Suite 200

T 717-581-3723

[email protected]

Donna L. Kreiser, EsquireFinancial Services and Public Finance Group

Lancaster, PA 17601100 Pine Street

T 717-237-5462

[email protected]

Timothy J. Horstmann, EsquireFinancial Services and Public Finance Group

Harrisburg, PA 17101

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What is a Municipal Bond Or Note?

Municipal bonds (“munis”) are debt instruments issued by local governments or their agencies to finance public-purpose projects A bond is a debt instrument that is typically sold to the public and is

negotiable (tradable) An investor who buys a municipal bond lends money to an issuer

who in turn promised to pay the investor a specified amount of periodic interest and to repay the principal amount on a specified maturity date

A note is a loan privately held by a traditional lending institution Commonly referred to as a note, bank loan or direct bank

placement


Why Use Municipal Bonds?

If properly structured, interest on municipal bonds in most cases is exempt from federal, state and local taxation (depending on jurisdiction of investor)

Investor is willing to receive a lower interest rate because they will not have to pay income tax on the interest

Thus provides a low cost of funding of governmental projects – delivers efficient market-based pricing


Types Of Municipal Bonds

Government bonds (general obligation bonds) – provide funding for permissible governmental projects

Conduit bonds – issued by government issuers, the proceeds of which may be loaned to authorized third parties


General Obligation Bond/Note

Pledge of the full faith, credit and taxing power of municipality

Supported by the government issuer's ability to levy taxes

Bondholders can go to court to force government issuer to raise taxes, if necessary, to pay debt service


Revenue Bond/Note

Generally, not a tax pledge; Supported by the specific revenue stream of the

facility/enterprise/system being financed; Most common types: water and sewer systems; Other types: parking systems, electric systems,

airports, transportation systems, toll revenue


Types Of Municipal Borrowings

To finance capital projects – new roads, new schools new hospitals, etc.

To finance cash flow needs (subject to state law and tax law restrictions)

To refinance outstanding debt (refundings)


What Is a Refunding?

Issuer issues new debt to refinance an outstanding obligation Refundings are used to (i) defease or eliminate restrictive

covenants, or (ii) lower debt service payments Issuers may refinance outstanding obligations under the

optional redemption provisions (call date) established during the original financing Optional redemption permits a borrower to refinance or prepay

bonds prior to maturity Timing of the bond refunding as compared to the call date

determines whether the transaction is deemed a “current” or “advance” refunding


Current Refunding

Redemption or a refinancing within 90 days of call date Allows an issuer to obtain the benefit of lower interest rates when the outstanding bonds

are currently callableo Proceeds from the sale of the refunding bonds (at lower rate of interest) are used

to redeem the prior bonds (at a higher rate of interest)o The outstanding debt is considered defeased after the refunding is completedo No restrictions on number of times a particular bond issue can be currently

refunded

Issuer

Refunding BondsPrior Bonds

Retired on call date Proceeds redeem prior bonds


Advance Refunding

Redemption more than 90 days prior to call date Allows an issuer to obtain the benefit of lower interest rates when the outstanding bonds

are not currently callableo Proceeds from the sale of the refunding are used to purchase securities, which are

deposited into an escrow accounto The escrow account is structured so that the principal and interest earned on the

securities are sufficient to pay all principal and interest on the outstanding bonds up to and including the call date

o The outstanding debt is considered defeased after the refunding is completedo Bond issue limited to one advance refunding (Tax Reform Act of 1986)

Issuer

Prior Bonds Refunding BondsEscrow Fund

Retired on call date Pays principal and interest payments on Prior Bonds until

Call Date

Proceeds purchase securities for deposit into Escrow Fund


Financing Team ParticipantsUnderwriter /

Investment BankerBond Trustee / Paying Agent /

RegistrarBond Counsel

Primary responsibility is the sale and distribution of bonds to investors

Underwrite or purchase unsold balances to lock interest rates for the Issuer

Coordinates Financing Team and closing activities

Drafts underwriting documents

Generates and reviews bond documents required to complete financing

Provides opinions as to tax exemption and issuance of the Bonds.

Coordinates legal activities with Solicitor

Coordinates Closing

Bank which holds the proceeds of the bonds and the funds established under bond documents

Disburses proceeds

Collects payments from Borrower and makes principal and interest payments to bondholders

Enforces Borrower’s obligations for the benefit of bondholders

Rating Agency

Reviews structure of transaction and Borrower’s credit strengths and vulnerabilities

Applies a formal rating to the Bonds

Borrower’s Counsel(Solicitor)

Lawyer responsible for protecting the interests of the Borrower

Works with Bond Counsel in drafting resolutions/ordinances and certain opinions

Bond Insurer

Company that supports a borrower’s credit in exchange for a fee or a premium, in the form of enhancement through a bond insurance policy

May not be applicable depending on underlying credit rating


Principal Documents

Resolution/Ordinance: Prepared by Bond Counsel; lays out the terms of the bonds and all the mechanics of the bond issue and authorizes the issuance of the bonds

Bond Purchase Agreement: Prepared by the Underwriter or Underwriter's Counsel. In this agreement, the Underwriter agrees to purchase, or underwrite, the bonds from the Borrower and to offer the bonds to potential investors

Preliminary Official Statement (“POS”): Prepared by the Underwriter or Underwriter’s Counsel (and/or the Financial Advisor) and the Borrower. It describes the transaction, the Borrower, and the credit enhancer, if applicable. It is used primarily by the Underwriter to sell the bonds to investors

Official Statement (“OS”): Prepared by the Underwriter or Underwriter’s Counsel (and/or the Financial Advisor) and the Borrower. This is the primary disclosure document and reflects the final terms of the transaction such as interest rates and redemption provisions. Essentially the POS but with the final sales results

Bond Opinion: Prepared by Bond Counsel, represents the legal interest of bond holders and addresses the main legal issues: that the bonds constitute legal, valid, and binding obligations of the borrower, and that the interest on the bonds is exempt from federal income taxation under applicable tax laws

Continuing Disclosure Agreement: Agreement by the borrower to disseminate annual financial information and material event disclosures to the public


Sample Financing TimelineWeeks 1 – 2

Structure Bond IssueWeeks 3 – 7

Arrange Sale of BondsWeek 8

Conduct Bond SaleWeeks 9 – 12

Coordinate Settlement

Appoint Professionals

Kickoff Meeting to discuss financing parameters and timing

Develop Structuring Options

Begin drafting legal documentation and offering document

Begin preparing Rating Agency credit package

Prepare schedule of events

Develop the terms of the bond sale

Conduct Financial Analysis

Circulate draft bond documents

Submit credit packages to bond insurers (if applicable)

Determine trustee/paying agent/registrar

Begin marketing of bonds

Print and Mail Preliminary Official Statements

Update Issuer on market conditions

Prepricing update on market conditions

Price and Market Bonds

Sign Bond Purchase Agreement

Finalize Official Statement

Submittal of DCED package

Print and Mail Official Statement

Finalize Bond Documents

Pre-Closing and Closing


Post Issuance Compliance

Priority matter for the IRS Elements of a Post Issuance Compliance Plan:

Address post issuance tax compliance Address post issuance disclosure requirements Address other bond document requirements*GOOD IDEA TO HAVE POST ISSUANCE COMPLIANCE

POLICY EVEN IF ISSUER ONLY DOES BANK LOANS, BECAUSE ISSUER MUST INDICATE ON IRS FORM 8038-G WHETHER IT HAS A POLICY


Post Issuance Compliance Policies

Adopted by Formal Resolution of Governing Body

Appointment of Responsible Party for Monitoring Compliance

Annual Compliance Checks – nature of compliance activity

Retention of Records Awareness of Remedial Actions


Continuing Disclosure

Under SEC Rule 15c2-12, underwriter must reasonably determine that the issuer has undertaken in writing to provide continuing disclosure

Issuer executes a Continuing Disclosure Agreement or Continuing Disclosure Certificate (Requirements also stated in Official Statement)


Scope Of Continuing Disclosure

Annual financial information/statements – annual budgets and other relevant financial information (determined, in part, by nature of financing);

Material event notices Disclosures must be made within particular time

frames


Material Events Include:

Principal and interest payment defaults; Non-payment related defaults; Rating changes; Defeasance of bonds; Fifteen total events


Electronic Municipal Market Access ("EMMA")

Became effective July 1, 2009 Annual financial information and any material

event notices must be submitted in an electronic format to the MSRB through its web-based system known as EMMA (emma.msrb.org)


Contact Information

Tim is a public finance and tax attorney at McNees. He is a member of the Firm’s Public Finance Group and also practices in the Corporate & Tax, Municipal Recovery, and Public-Private Partnerships groups.

Tim has spent his entire legal career advising clients in matters related to state, local and federal taxation. He advises banks and financial institutions, governmental issuers, school districts and nonprofits on the structuring of taxable and tax-exempt revenue bond and general obligation bond financings for a variety of capital projects, including manufacturing facilities, hospitals and other health care facilities, parking facilities, schools and higher education institutions and water and sewer projects. He has also

advised both the buyers and sellers of public assets in the context of public-private and public-public partnerships.

Tim writes extensively on matters of interest to the tax-exempt bond community, and has authored articles for publication in a variety of sources, including The Legal Intelligencer. He regularly speaks on topics of municipal finance and tax law at seminars sponsored by various state organizations, including the Pennsylvania State Association of Boroughs, the Pennsylvania Municipal Authorities Association, and the Pennsylvania Bar Institute.

Donna is co-chair of the Financial Services and Public Finance group and also practices in the Municipal Recovery and Public-Private Partnerships groups. Donna focuses her practice on municipal and project finance law, including economic development, transportation, government, health care, and education. She serves as bond counsel, underwriter's counsel, trustee's counsel, bank counsel and borrower's counsel for state, county, and municipal clients and for economic development authorities and non-profit entities in the implementation and financing of major capital initiatives that benefit public, private and non-profit entities (including, for example, hotel, hospital and health care facility, university and water and sewer transportation and treatment facility projects) and debt refinancings for public, for-profit and non-profit organizations. In addition, Donna

counsels issuers on general obligation borrowings. Donna's practice also includes commercial lending and business transactions.

As former deputy general counsel in the Pennsylvania Governor's Office of General Counsel (OGC), Donna was OGC's chief legal liaison with the Pennsylvania Housing and Finance Agency, the Department of Community and Economic Development, and the Pennsylvania Infrastructure Investment Authority. She was OGC's liaison on all public finance transactions, working directly with the issuing agencies.

100 Pine Street

T [email protected]

Timothy J. Horstmann, EsquireFinancial Services and Public Finance Group

Harrisburg, PA 17101


fundamentals of municipal bond finance

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