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Bond Issue Basics: A Debt and PlanCon Primer Against the Backdrop of the Great Recession

Bond Issue Basics: A Debt and PlanCon Primer Against the Backdrop of the Great Recession. By Christopher Brewer, Esq. Dinsmore & Shohl LLP. All Debt is a Loan of Money Returned in Installments at a cost -- of Interest.

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Bond Issue Basics: A Debt and PlanCon Primer Against the Backdrop of the Great Recession

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  1. Bond Issue Basics:A Debt and PlanCon PrimerAgainst the Backdrop of the Great Recession By Christopher Brewer, Esq. Dinsmore & Shohl LLP

  2. All Debt is a Loan of MoneyReturned in Installmentsat a cost -- of Interest

  3. If you have ever taken a home mortgage, then you have experienced all of the elements of any bond issue. The difference is one of amount and the mechanics needed to accommodate large amounts.

  4. Finding Your Lender • Is Financing packaged with Asset? (Xerox, GE Capital, Dell) • Is Amount under $1.5 MM? • Is Term under 5 years?

  5. Survey/Seek Proposals from BanksRecognize Bank’s Own Tax Position/Portfolio Needs • Variable Rate (Under 70% of Taxable) • Rate Reset (3 to 5 years) • Make whole provision on prepayment • Transfer of accounts • Bank Fees If not a Bank Loan, perhaps a Bond Pool?

  6. Uneeda Bond Issue? If so, you need bond investors. How do you find them?

  7. Taxpayers School District Investment Banking Firm Bond Investors

  8. BANK LOAN – Single Creditor, Single Interest Rate, Monthly Cycle, Equal (Level) Payments, Standard Period (Term)PRIVATE OFFERING – Limited Number of Investors, Blend of two AlternativesBOND ISSUE – Multiple Investors, Multiple Interest Rates, Semi-Annual Cycles, Customized Payments, Customized Term

  9. Alternative Methods of Finance

  10. Direct Source vs. Brokered Source

  11. Public Offering of School District Bonds

  12. Home Mortgage Mortgage Application Collateral Co-signer Credit Score Payment Principal Amortization Interest Rate APR Prepayment Penalty Bank Fee Points Title Opinion Servicing Agent Bond Issue Official Statement Security Bond Insurance/Letter of Credit Credit Rating Debt Service Principal Maturity Coupon (Rate) Yield Redemption/Call Premium Discount Original Issue Discount Bond Opinion Paying Agent Terminology Translator

  13. Alternative Amortization Structures • Level Principal • Level Debt Service • Wrap Around Debt Service • Phasing (first 2 to 3 years) • Match Debt to Useful Life; other Capital Needs/Borrowings • Expected Financial Circumstances

  14. Level Annual Debt Service

  15. Wraparound Debt Service

  16. Alternative Credit Structures General Obligations – Taxes Special Obligations – Enterprise Revenues Non-appropriation – Asset Backed

  17. Alternative Issuers • School District Itself • State Public School Building Authority* • Local Authority (Vo-Tech or Swap)* • Local Bond Pool Authority* *School District delivers note/loan agreement

  18. Uses and Sources

  19. Designing Your Bond Issue School District vs. Bond Investor Needs/Abilities/Goals Needs/Abilities/Goals Market Reception Case in Point : BABs in Europe Yield Curve Positioning Case in Point : Short tax-exempts; Long BABs

  20. Alternative Bond Sale Methods Negotiated (Private) Competitive (Public) [Design / Build] [Design / Bid] More Trust by School District Less Trust by School District Less Risk on Banker More Risk on Banker Components of Discount Management (35%) / Underwriting (65%)

  21. Planning for Construction Workbook“PlanCon” Capital Cost Reimbursement is “Pay-As-You-Go” Little to no PDE input to bond structure Payment must be from School District Revenues (Not accrued or capitalized interest) Full Cash by District = Full Cash by PDE (1 year rule) Debt Amortization by District = Debt Service Reimbursement by PDE

  22. Eligible Project Costs ($ x students adjusted by certain costs) Divided By Total Project Costs Project Eligible % x MVAR equals Effective Reimbursement *Not available until receipt of bids (PlanCon G/H), but PDE will reimburse prior payments *Temporary Percentage until Final Accounting (PlanCon J) Net Debt Service Solutions *Watch assumptions *Changes in Project Eligible % or MVAR will distort net debt solutions

  23. PlanCon D – Project Accounting Based on Estimates Fiscal Constraints D-17 25% of Local Revenues D-17 Test for Fiscal Distress D-18 Mills on Market Value (Local vs. Statewide) Problematic for Poorer School Districts Problematic for Debt Free School Districts

  24. PlanCon G – Project Accounting Based on Bids PlanCon H – Financing PlanCon K – Refinancing * “Never-Pay-More” Rule Inclusion of New Money or Increase of Total Debt Service will reduce Project Eligible % * Pure Savings (whether up-front, over time or back-end) will retain Project Eligible % * Cost of Issuance on School District * New debt service schedule may interrupt reimbursement

  25. Act 1 Constraints Act 1 does not limit what you can borrow; it limits whether you can pay for it. • Referendum • Qualified Costs Limitation • Phase-in/Wrap-Around Structures (Capital Appreciation Bonds?) (Creative use of Build America Bonds?)

  26. Local Government Unit Debt ActLimitations Principal Amount Limits Total School District Debt ≤ Last 3 years’ Average Revenues x 2.25 PlanCon Subsidized Debt May be Excluded Pay–Back Limits Capitalized Interest – construction plus 1 year Principal Deferral – 2 years or construction period plus 1 year Final Maturity ≤ Useful Life Total Debt Service – Level or Wrapped to Level (Downward Cascading Permitted)

  27. Local Government Unit Debt ActProcedures • 3 Day Advance Notice • Board Resolution • Covenant to Budget, Appropriate and Pay • “Acceptable” Purchase Proposal • Post Adoption Notice • 15 Calendar day approval cycle • Appeal to Commonwealth Court • Advent of “Parameters” Resolution

  28. Federal Tax Law Interest earned on obligations of a state or local government are excluded from gross income. In 1914, a right of federalism? In 2010, a federal subsidy and privilege IRC Sections 103 and 141 through 150 contain innumerable limits and conditions on the privilege.

  29. Primary Restriction - Arbitrage Arbitrage is the practice of making money by moving an item between markets Marco Polo - tea ; Dutch colonists – beads Local Governments – tax-exempt bond proceeds into taxable investments

  30. Abusive Device – issuing bonds sooner, or in an amount larger, or allowing them to remain outstanding longer, than is necessary to accomplish the governmental purpose.

  31. Three Point “Reasonable Expectations” Test • Substantial Binding Obligation to expend 5% incurred within 6 months • 85% of proceeds expended within 3 years • Proceed with Due Diligence “Reasonable” does not mean possible or promised; it means “likely, as assessed by a third party observer”

  32. Arbitrage Rebate • Small issuer exemption ($5MM or $15MM Construction) • Spending exemption - 6 month - 18 month - 24 month construction

  33. Refundings • Use of proceeds of new issue to prepay previous issue • Keys are Interest Rate and Redemption Period Current Refunding : Old Bonds Paid off within 90 days of issue Advance Refunding : Old Bonds Paid off later than 90 days of issue

  34. Build America Bonds Must meet all regular Tax Exempt Qualifications Interest is Taxable Federal Government will Reimburse 35% of Interest Expense

  35. Qualified School Construction Bonds Primary compensation to investor is a tax credit “Supplemental Coupon” approximately 1.5 to 2.0%

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