Massachusetts Municipal Auditors’ and Accountants’ Association Annual Meeting South Yarmouth, Massachusetts June 11, 2018 Peter Frazier, Managing Director
Bonds and Notes • An interest bearing promise to pay a sum of money on a specific date • Bonds—maturity greater than one year • Notes—maturity one year or less • Typically sold in $1,000 or $5,000 denominations
Types of Bonds and Notes • Differentiated by – Source of repayment – Underlying security
Types of Notes • Bond Anticipation Notes* • State Aid Anticipation Notes • Federal Aid Anticipation Notes • Revenue or Tax Anticipation Notes * BANs can be rolled for 10 years
Legal Factors • What laws govern the borrowing process? – State • Local municipalities derive their powers from the state • Chapter 44, 70B, and Special Acts – debt limits, purposes and terms – Federal • Public Purpose vs. Private Activity – Tax-exempt vs. taxable – 8038G • Disclosure (SEC, MSRB) – Local • Charter and bylaws – authorization procedures, referendum periods,
Chapter 44, Sections 7 & 8 • Describes almost all of the purposes for which a city or town can borrow. • Maximum borrowing term of purposes based on the useful life of the asset financed. DOR provides guidance • Municipal Relief Act (2010) – – Many terms were increased • Municipal Modernization Act (Nov. 2016)- – Borrowing Purposes Consolidated – Treatment of Premiums changed – Surplus Proceeds De Minimus Increased
Chapter 44, Sections 7 & 8 • Chapter 44, Section 7 – Inside the Debt Limit – Limited to a Maximum of 5% of EQV – Tax supported purposes – Building, Land Acquisition, Equipment, Recreation, etc. • Chapter 44, Section 8 – Outside the Debt Limit – Most Limited to a Maximum of 10% of EQV – Revenue supported purposes – Water, Sewer, Electric, Solid Waste, etc
Massachusetts School Building Authority • Chapter 70B replaced old School debt reimbursement program (Ch. 645) • Provides pay-as-you build grants (40% to 80% of eligible project costs) • Collaborative process • 30 Year Maximum Borrowing Term
Community Preservation Act (‘CPA’): Ch.44B • Funds appropriated and spent for: Open Space Historic Restoration Affordable Housing • Requires majority approval of both the local legislative body and voters at the next regular municipal or state election • Primary source of revenue = property tax surcharge (max 3%) • Secondary source = Annual distributions received from the state • Can’t be repealed while bonds are outstanding
Level Debt vs. Level Principal Structures Total Debt Service Comparison $10,000,000 General Obligation Bonds 10 Year Bonds 20 Year Bonds Years Equal Principal Level Debt Equal Principal Level Debt 1 A $1,322,200 $1,221,424 $912,500 $786,710 2 1,309,300 1,219,943 906,050 787,195 3 1,291,200 1,218,653 897,000 790,770 4 1,268,000 1,222,425 885,400 787,302 5 1,239,800 1,220,917 871,300 786,868 6 1,207,900 1,220,133 855,350 789,746 7 1,171,900 1,219,313 837,350 790,526 8 1,132,100 1,223,319 817,450 789,208 9 1,089,700 1,222,739 796,250 786,188 10 1,045,500 1,223,235 774,150 786,740 11 751,400 790,810 12 728,050 788,160 13 704,200 789,072 14 679,900 788,314 15 655,200 790,897 16 630,050 786,471 17 604,500 790,300 18 578,600 786,889 19 552,500 786,654 20 526,300 789,450 $12,077,600 $12,212,099 $14,963,500 $15,768,264 B
Municipal Borrowing Flow Chart Town Determines Capital Project Project Identified Preliminary Modeling Tax Impact Rate Impact
Municipal Borrowing Flow Chart Town Determines Bond Counsel: Capital Project Drafts Vote Important! Bond Counsel should draft or review town meeting articles and votes
Municipal Borrowing Flow Chart Town Determines Bond Counsel: Town Meeting: Votes Capital Project Drafts Vote Authorization Borrowing Authorization requires 2/3 majority Debt Exclusion requires majority vote at regular or special town election
Municipal Borrowing Flow Chart Town Bond Counsel: Provides Determines Bond Counsel: Town Meeting: Votes Legal Requirements Capital Project Drafts Vote Authorization Letter Bond Counsel provides opinion on: Validity of borrowing Tax Exemption
Tax-Exemption Example Interest After- Interest Tax Tax After Tax Security Principal Rate Interest Rate Bill Taxes Yield Taxable Bond $ 1,000 4.41% $ 44 32% $ 14 $ 30 3.00% Tax-Exempt Bond $ 1,000 3.00% $ 30 32% $ - $ 30 3.00% Issuer Benefit $ 14 Fed Govt Cost $ 14
Arbitrage Rebate • Difference Between Tax-Exempt Borrowing Rate and Investment Rate • Profit must be rebated to the Federal Government (IRS enforces and audits) • Get Cashflows by Purpose • Spending Schedules for Bond Counsel • Keep good records on interest earned (co-mingle vs. segregate proceeds)
Arbitrage Rebate - Exceptions, Spending Tests Exceptions – “Small Issuer” (less than $5 million issued per calendar year) • 10% in 6 months, 100% in 3 years – “Six Month Expenditure” (RANs, Acquisition) • 100% in 6 months – “18 Month Expenditure” (less than 75% construction) • 10% in 6 months, 60% in 1 Year, 100% in 18 Months – “Two-Year Construction” (More than 75% construction) • 10% in 6 months, 45% in 1 Year, 75% in 18 Months, 100% in 2 Years
Municipal Borrowing Flow Chart Town Bond Counsel: Provides Determines Bond Counsel: Town Meeting: Votes Legal Requirements Capital Project Drafts Vote Authorization Letter Treasurer: Satisfies Legal Requirements
Municipal Borrowing Flow Chart Town Bond Counsel: Provides Determines Bond Counsel: Town Meeting: Votes Legal Requirements Capital Project Drafts Vote Authorization Letter FA & Treasurer: Determines Terms of Treasurer: Satisfies Legal Bond Issue & Prepares Requirements OS
To borrow short or long term? • Interest rate environment • Size of project • Spending schedule • Budget constraints
Borrowing Alternatives • Massachusetts Clean Water Trust • Massachusetts Water Resources Authority • State House Loan Notes • Rural Development Loans • State Qualified Bond Act
Borrowing Alternatives • Massachusetts Clean Water Trust – For Eligible Water, Sewer and Landfill projects – DEP determines eligibility – Interim loan financing – 20 or 30 year level debt bonds – 2% interest rate
Borrowing Alternatives • State House Loan Notes & Serial Loans – No Legal Opinion – No Credit Rating – Official Statement - Optional – Low Issuance Costs – Less liquidity (higher interest rates) – Excellent for small, infrequent issuers – No dollar limit, same term limits (limited by market demand)
Borrowing Alternatives • Rural Development Loans – Direct Loans from the Department of Agriculture – Lender of last resort – Eligibility for small, less affluent issuers – 40 year maximum term – Prepayable without penalty – No Credit Rating – Low Issuance Costs
State Qualified Bond Act • Debt Service on Bonds paid directly by State – Deducted from quarterly aid payments • Programmatic Rating Aa2 / AA • 10 to 30 year term • Flexible principal structure • Subject to Municipal Finance Oversight Board Approval (MFOB)
How is interest calculated? • Each principal payment needs to be multiplied by the associated coupon rate. • Take the total amount of interest and divide by 2 to obtain the semi-annual interest payment amount.
Municipal Disclosure • History – 1929: Stock Market Crash – 1933-34: Securities Act of 1933 The Securities Exchange Act of 1934 – 1975: New York City Defaults – 1980’s: Washington Public Power Supply System Defaults – 1989: SEC Rule 15(c) 2-12 – Primary Disclosure – 1994: New SEC Rule 15(c) 2-12 – Continuing Disclosure – 2009: Amendments to Rule 15(c) 2-12 - Annual Disclosure for all
Municipal Borrowing Flow Chart Town Bond Counsel: Provides Determines Bond Counsel: Town Meeting: Votes Legal Requirements Capital Project Drafts Vote Authorization Letter FA & Treasurer: Determines Terms of Treasurer: Satisfies Legal Bond Counsel: Bond Issue & Prepares Requirements Reviews OS OS
Municipal Borrowing Flow Chart Town Bond Counsel: Provides Determines Bond Counsel: Town Meeting: Votes Legal Requirements Capital Project Drafts Vote Authorization Letter FA & Treasurer: Rating Agency: Determines Terms of Reviews OS & Final Treasurer: Satisfies Legal Bond Counsel: Bond Issue & Prepares Docs., Assigns Rating Requirements Reviews OS OS
Bond Ratings Moody’s Standard & Poor’s Aaa AAA Aa1 AA+ Aa2 AA Aa3 AA- A1 A+ A2 A A3 A- Baa1 BBB+ Baa2 BBB Baa3 BBB-
Yield Curves By Rating 6 5 Aaa Percent 4 Aa 3 A 2 Baa 1 0 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 Year
Major Credit Factors • Economy & Institutional Framework (40%) • Management (20%) • Finances (30%) • Debt and Contingent Liabilities (10%)
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