2011 Fall Leadership Summit Marriott, Columbia, South Carolina September 27-28, 2011 Introduction to Municipal Bonds A. Reid Cavnar Senior Vice President Reid.cavnar@merchantcapital.com This document has been prepared by Merchant Capital, LLC for informational purposes only. This document shall not constitute an underwriting commitment, an offer of financing, an offer to sell, or the solicitation of an offer to buy any securities described herein. Merchant Capital, LLC does not guarantee the accuracy or completeness of information which is contained in this document and which is stated to have been obtained from or is based upon trade and statistical services or other third party sources. No one may reproduce or disseminate the information contained in these materials without the prior written consent of Merchant Capital, LLC.
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 MERCHANT CAPIT AL Slide 2 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
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) – SOURCE: Bloomberg. As of 1Q 2011 MERCHANT CAPIT AL Slide 3 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
The Size of the Municipal Bond Market. ($MM) $500,000,000 13,826 $450,000,000 12,659 11,721 13,959 10,830 12,766 $400,000,000 15,503 13,614 14,401 $350,000,000 $300,000,000 $250,000,000 $200,000,000 6,527 $150,000,000 $100,000,000 $50,000,000 $0 (1) 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 MERCHANT CAPIT AL Slide 4 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
Who Buys Municipal Bonds? ● Retail Investors Mutual Funds High net-worth individuals – 37% ● Institutional Investors Mutual Funds – Banks Investment advisors 9% – Commercial banks Retail – 37% Bank trust departments – Insurance Co. Insurance companies – 16% Other 6% SOURCE: Bloomberg. As of 1Q 2011 MERCHANT CAPIT AL Slide 5 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 – MERCHANT CAPIT AL Slide 6 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 Ratings / Credit Quality Moody’s Standard & Poor’s Fitch Ratings Aaa AAA AAA Aa1,Aa2,Aa3 AA+,AA,AA- AA+,AA,AA- Investment Grade 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- Non Investment B1,B2,B3 B+,B,B- B+,B,B- Grade Caa1,Caa2,Caa3 CCC+,CCC,CCC- CCC+,CCC,CCC- Most charter schools are rated in the triple-B category MERCHANT CAPIT AL Slide 7 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
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 MERCHANT CAPIT AL Slide 8 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
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 MERCHANT CAPIT AL Slide 9 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 1 2 3 4 5 Determine Rating Financial Marketing & Bond Charter School Agency Structuring Closing Sale of Bonds Objectives Presentation ● 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 – MERCHANT CAPIT AL Slide 10 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
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