municipal bond

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Municipal Bonds Ashish Agarwal Gaurav Shah (A056) Jatinder Bir Singh Tuli (A062) Nikita Malpani (A046) Priya Chhabria (A017) Urvashi Jha

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Page 1: Municipal Bond

Municipal BondsAshish Agarwal

Gaurav Shah (A056)Jatinder Bir Singh Tuli (A062)

Nikita Malpani (A046)Priya Chhabria (A017)

Urvashi Jha

Page 2: Municipal Bond

What are Municipal Bonds?

Cities

Countries

School districts

Special-purpose districts

Redevelopment agencies

Public utility districts

Publicly owned airports and seaports

Any other governmental entity below the state level

Issued by

Page 3: Municipal Bond

Exempt from the federal income tax

Exempt from the State income tax

Interest Payment

Free to trade anytime once they are purchased by the investor

Investment in state and local government projects

•Yield usually lower than taxable bond

>> NOT ALL MUNICIPAL BONDS ARE TAX-EXEMPT<<

Page 4: Municipal Bond

Working of Municipal Bonds inthe West

Issuer InvestorCash

Promise to Repay

Governed by an extensive system of laws and regulations, which vary by state

Bonds bear interest –fixed/ variable rate, subject to a cap known as the maximum legal limit

Interest & Face value

Page 5: Municipal Bond

Repayment period- few months to 20 or 30 yrs, even longer

Bond proceeds to be spent on one time capital projects within 3-5 yrs of issuance

Tax exempt status- investors accept lower interest payments

Attractive source of financing for municipal entities as borrowing rate- lower

Page 6: Municipal Bond

Municipal Bonds

Principal + Interest

Project Cash Flows

Investors

Sp

ecia

l G

uar

ante

e R

ole

of T

rust

ees

ULBs

Escrow Debt Reserve Fund

Guarantee by DFIs / MDBs

Counter Guarantee

Municipal Bond Structure in India

Page 7: Municipal Bond

Principal Municipal Interest Bonds Bonds Principal + Interest Project Cash Flows

Investors

AMC

ULBs Loan/Bonds

Escrow Debt Reserve Fund

Guarantee by DFIs/MDBs

Municipal Bonds With AMC as an Intermediary

Page 8: Municipal Bond

Types of Municipal Bonds

General Obligation Bonds

• ‘P’& ‘i’ secured by faith & credit & taxing power of issuer

• Issued by municipal entities to fund variety of expenses

Revenue

Bonds

• ‘P’ & ‘i’ secured by the revenue derived from tolls, charges or rent

• Issued by special authorities created for particular purpose

Issued in minimum denominations of $5000 or multiples of $5000

Page 9: Municipal Bond

Insured bonds• Insured by policies written by commercial insurance

companies• Intended to provide for the insurer to pay P & ‘i’ payment in

the event the issuer defaults• Creditworthiness of both the insurer and the issuer

Taxable municipal bondsInterest is taxable

• Build America Bonds (BABs) ,introduced in 2008 financial crisis

• 35% federal rebate on interest costs • BABs only subsidize an issuer's borrowing cost• No implied backing from the federal government

Page 10: Municipal Bond

Zero-coupon bonds Issued at a discount, with the full value, including accrued interest, paid at maturity.

• Interest income may be reportable annually

Original-issue discount bondsIssued at a price below face value (par) which qualify for special treatment under federal tax law.

Pre-refunded bondsResult from the advance refunding of bonds that are not currently redeemable

• Goal to provide present-value savings to the issuer• The escrow account is most often funded with U.S. Treasuries

considered relatively safe

Page 11: Municipal Bond

Escrowed-to-maturity (ETM) bonds• When the proceeds of a refunding issue are deposited in an

escrow account for investment in an amount sufficient to pay the principal and interest on the issue being refunded.

Housing bonds• Securities backed by mortgages and mortgage loan

repayments. • Can be called at any time from the prepayment of principal on

the underlying mortgages

Page 12: Municipal Bond

Municipal notes• Short-term debt obligations that usually mature within a year

or less• Municipalities issue notes to generate stable cash flow while

they wait for other expected revenues.

Conduit bonds• Revenue bonds issued by state agencies called "conduit

issuers“ that act on behalf of the actual borrowers• Issued for projects such as non-profit hospitals, housing

developments etc.• The third-party, conduit borrower—not the issuing agency—is

responsible for interest payments and principal repayments

Page 13: Municipal Bond

U.S Bond Market1st general obligation bond was issued by the City of New York for a canal in 1812

The US Municipal Bond market is $2.2 trillion strong

Forms nearly more than 12% of the total debt market

One of the highest yielding debt instruments

Urban infrastructural projects are funded through issue of municipal bonds

Secondary market – active with sufficient liquidity

Tax exempt lower the cost of borrowing

The credit rating mechanism is very robust

Page 14: Municipal Bond

Municipal Bond Market In India

How did it start??Bangalore Municipal Corporation was first to issue municipal bonds in 1997

Ahmedabad Municipal Corporation issued these bonds in 1998

Pune Municipal Corporation followed later.

Page 15: Municipal Bond

Current ScenarioRaised merely Rs. 850 Crore since its inception

Forms nearly 10% of the debt market in the US

Only Tamil Nadu and Karnataka have raised funds through pooled finance route.

Municipalities have tapped the bond market only 13 times

Page 16: Municipal Bond

Credit Rating•Finances•Operations

CRISIL

•Finances, Accounting, expenditure, liquidity•Major Revenue heads•Service delivery and funding arrangements

ICRA

•Fiscal profile of the government and its administrative capability•Profile of project•Risk factors

CARE

Credit Ratings for the municipal corporations of 63 JNNURM are released regularly and 40% of them have been rated as investment grade.

Page 17: Municipal Bond
Page 18: Municipal Bond

Need for Municipal Bonds

Increasing Population and Urbanization leading to rising demand for basic amenities

• Jawaharlal Nehru National Urban Renewal Mission estimates an investment of more than Rs. 1.2 trillion

Fiscal deficit control, budgetary allocations to municipal bodies, concessional funding

• Share of local expenditure in total government expenditure about 40-50%

Page 19: Municipal Bond

Concerns …

Municipal Bonds

Page 20: Municipal Bond

• The urban expenditure so far has been financed significantly out of the budgetary support

• Financing needs will be met by Urban local body (ULB) own revenues and the external financing needs through debt financing.

Page 21: Municipal Bond

Potential of Development of bond markets in India

The savings rate in India is high, close to 33%

The household savings are roughly 25%

Over 10% of household savings are invested in gold or currency

An integrated set of actions is required to convert gold/currency based saving into financial saving.

Page 22: Municipal Bond

The Constraints..

Weak balance sheets:• The Urban local bodies depend largely on the transfers from

government.

Page 23: Municipal Bond

Measures to strengthen the own revenues of India’s local bodies:

• a) Empowering ULBs to levy exclusive taxes, most importantly property tax

• b) A more broad based revenue sharing by states with ULBs

• c) Formula based devolution of state revenues based on recommendations of State Finance Commissions.

Page 24: Municipal Bond

Benchmark and yield curve discovery:• Some of the biggest and richest municipal corporations

run a surplus and therefore do not need to access the debt market.

• Mumbai’s BMC, New Delhi Municipal Corporation, or various other big corporations rely on loans or grants.

• Consequently, there are no benchmark securities that may guide the investors regarding the associated risk premiums and against which the smaller municipal corporations may borrow.

Page 25: Municipal Bond

Credit Enhancement:

• Institutional investors (e.g. Pension Funds, Insurance) are stipulated to not invest in bonds below a certain credit rating.

• This calls for specialized credit enhancement institutions

• The Government instituted the Pooled Finance Development Fund with the aim of providing credit enhancement to a pool of ULBs

Page 26: Municipal Bond

Pooled Finance Route• • To attract urban infrastructure investments - pooled

financing mechanism by GOI.

• A Pooled Finance Development Fund (PFDF) of Rs 400 Cr ($100 mn) for the 10th Five Year Plan period - set up to help ULBs finance their investment needs.

• Ratings enhancement facility through a Credit Rating Enhancement Fund (CREF)

• Expected to reduce the costs of capital and encourage ULBs enter the Municipal debt market

Page 27: Municipal Bond

• . Access the market through a State Pooled Finance Entity (SPFE)

• Purchase guarantees from financial institutions willing to underwrite the risk of a cash-flow shortfall.

Credit protection : mitigate the risks lower the cost of capital encourage the growth of Municipal debt market in

India

Page 28: Municipal Bond

• Advantages of Pooled Financing mechanism:

1. Helps risk diversification

2. Less economically viable, but socially useful projects, can bandwagon on the more bankable projects

3. By pooling together a number of projects, it can help finance more projects

Page 29: Municipal Bond

• Measures to enhance disclosures on behalf of borrowers

• Market infrastructure to enhance secondary market liquidity need to be taken.

Page 30: Municipal Bond

Need of the Hour….

State Government

Borrowing restrictions

Prescriptions regarding interest and principal payment

Specification of purposes for bond issue

Page 31: Municipal Bond