Chapter 8: Municipal Bonds, Local Government Debt Securities

General Obligation Bonds (GO)

Backed by the full faith. credit, and taxing power of a municipality

• Used to fund non-revenue producing projects like schools, libraries, emergency services

• They require voter approval once the municipality has hit its debt limit

Factors effecting the Marketability of a Municipal Bond

Quality (rating): Higher Credit rating = More Marketable

Block size: Larger initial offering makes it more marketable

Dollar Price: All else qual a lower dollar price makes it more marketable

Issuer’s reputation: A strong record of on-time payment makes it more marketable

Insurance: Insured bonds are safer and more marketable

Municipality current debt: Existing debt levels

Tax base: Higher property values/sales tax base makes the bond more marketable and safer

Net overall debt

Direct debt + overlapping debt (the share of debt owned by larger government units such as the state or country)

• The less net overall debt the more marketable a security

Revenue Bond

Bonds that fund revenue producing facilities such as toll roads, airports, hospitals, and utilities

• Does not require voter approval but needs feasibility study before issuance

Industrial development bond (IDR)

Funds a facility for a private corporation moving into the municipality

• It is backed by the corporation’s lease payments (and so rating is based on the company’s credit)

  • This is the riskiest type of municipal bond

Rate covenant

Promise to charge enough user fees to cover expenses and debt service

Maintenance covenant

Promise to properly maintain the facility so that it can keep earning revenue

Insurance covenant

A promise to adequately insure the facility

Components of Bringing Municipal Bonds to Market

Notice of sale: Published invitation (in the Daily Bond Buyer) for underwriters to bid on a competitive offering

Good-faith deposit: Deposit submitted by bidding underwriters to show their serious

Spread: The difference between what the underwriter pays the issuer and what it resells the bonds for to the public

Municipal adviser

A firm that advises state and local governments on bond sales and other financing decisions

Allocation of orders

MSRB required prioty order for filling customer orders:

1) Presale orders

2) Syndicate orders

3) designated orders

4) member orders

Additional components of selling

Date of sale: When bids are due (for competitive offerings) or when the syndicate signs the final contract (for negotiated offerings)

Order period: Time set by the syndicate during which members solicit customer orders

Underwriting period: Runs from the first order/purchase from the issuer until the syndicate sells all the bonds

Special tax bonds

Bonds backed by a specific tax other than property tax (example: fuel tax, tobacco tax, or business license tax)

Special assessment (special district) bonds

These bonds funds local improvements such as sidewalks and sewers

• They are backed only by the taxes of properties that directly benefit

Double barreled bonds

Combine revenue bonds and GO bonds

• The tax base revenue covers any gap if the facility revenue is not enough

Limited tax general obligation bond (LTGO)

A GO bond where the property tax that can be used to pay off the bond is capped

Public housing authority bond (PHA/NHA)

Bonds that funds low income housing and is backed by US government subsidies

• It is among the safer unicipal bonds

Moral obligation bond

A bond backed by a pledge from the state to cover the municipality in case of shortfall

• It requires legislative approval but the pledge is not legally binding

Building America Bonds (BABs)

A taxable municipal bond created in 2009 to fund infrastructure

Tax Credit BAB: Investors receive a tax credit equal to 35% of the coupon rate

Direct Payment BAB: The muncipality receives 35% of coupon reimbursment from the US treasury

Tax Anticipation Notes (TANs)

Finance current operations when waiting for future tax collections

Revenue Anticipation Notes (RANs)

Finance current operations while waiting for future (non-tax) revenue

Tax and revenue anticipation notes (TRANs)

Combination of TANs and RANs

Grant Anticipation Notes (GANs)

These notes provide financing while a municipality is waiting for a grant from the US government

• The notes are paid off from the grant funds

Bond anticipation notes (BANs)

These notes provide interim financing for municipality while its waiting for long-term bonds to be issued

Construction loan notes (CLN)

These notes provide interim financing for the construction of housing projects

• They are typically paid back from the money the issuer receives from issuing longer-term bonds

Tax-exempt commerical paper

These short term notes are usually used by organizations like universities with the permission of the government

• They help the organization cover its short term liabilities

Variable rate demand note

These notes have variable interest rate and have a put option (allowing the noteholder to sell back to the issuer periodically)

Municipal fund securities

Are exempt from the Investment Company Act of 1940

Section 529 Savings Plan

Tax advantaged saving account for education

• Contribution limits vary by state

• Money contributed buys units in a state trust

• Unused funds can rollover to another family member

• Account owner keeps control even after the beneficiary turns 18

ABLE account

Tax-advantaged account for people with disabilty used to cover disability related expenses

LGIP (Local Government Investment Pool)

A short term investment vehicle states set up for other government entities

• SEC registration exempt by requires disclosure documents

Taxable Equivalent Yield (TEY)

What a muncipal bond’s yield would be if it were taxable

TEY = [Municipal Yield / (100%-Investor’s tax bracket)]

Triple tax-free bonds

are municipal bonds exempt from federal, state, and local tax

• This automatically true for bonds from US Territories and Washington DC

Capital gains on municipal bonds

Capital gains on municipal bonds are taxable

• Federal tax exemption applies only to interest income

Rule G-17

Broker dealers must act fair, no deception and dishonesty

Rule G-30

Pricing and comissions on municipal trades must be fair and reasonable

Rule G-45

Requires reporting on 529/ABLE programs