Parameters for Bond Refinancing Beyond the 3% Rule

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Parameters for Bond Refinancing Beyond the 3
Rule
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Basic Bond Formulas PV

• Excel PV Function
• PV (rate, nperiod,PMT, FV)
• 30 Year Bonds _at_ 6.0
• 1.0 million Annual Debt Service
• PV (.03, 60, 500,000,0)
• 13,837,781

• HP 12-C PV Function
• How much debt can I afford?

• Terms Semi-Annual
• N 60 periods
• Rate 3.0
• PV ?
• PMT 1.0 million
• FV 0

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Measuring Savings
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Optional Redemption

• Most municipal bonds have an optional call
  feature which allows issuers to repurchase bonds
  at a specified price on certain dates in the
  future
• Call date usually 8-10 years
• Notification typically 30 to 60 days prior to
  call

December 1, 2010 through June 1,
2010 102 December 1, 2011 to June 1,
2011 101 December 1, 2011 and Thereafter 100
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Current Refunding

• Refinancing in which bonds are redeemed within 90
  days of call date
• No limit on of current refundings (2-3 times
  over life of bonds)

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Advance Refunding

• Bonds are redeemed more than 90 days from the
  call date
• IRS allows only 1 advance refunding

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Structuring an Escrow Basic Sizing
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Defeasance

• Legal Defeasance
• Escrow securities backed by full faith credit
  of U.S. government (e.g., U.S.Treasuries / SLGS)
• Requires bond counsel opinion
• Debt removed from books
• Economic Defeasance
• Escrow securities not backed by full faith
  credit of U.S. government (e.g., Corporates
  Agencies)
• Higher yield / Greater savings
• Debt remains on the books

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Defeasance Escrow

• Refunding (Defeasance) Escrow
• A portfolio of eligible securities, as defined
  in the Indenture (U.S. Treasuries / SLGS)
• Cash flows sufficient to pay
• Principal
• Interest
• Call Premium
• to the call date, without reinvestment

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Escrow Requirements
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Escrow Structuring

• Escrow cash flow requirement 8,769,525
• Escrow funding costs 7,631,692
• Escrow can yield the same rate as the arbitrage
  yield on the refunding bonds (e.g., 3.64)
• Perfect escrow would cost 7,493,310

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Negative Carry

• Proceeds invested _at_ the bond rate pays for itself
  carry
• Investment yield (3.01) lower than bond yield
  (3.64)
• Inefficient Escrow increase par value of
  refunding bonds by 2.1
• 138,382 in Negative Carry (negative arbitrage)

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Bond Sizing Requirements
Additional Costs 3.0 to 6.0

• Cost of Issuance .50
  to 1.0
• Underwriters Discount .50 to
  1.0
• Redemption Premium 2.0
  to 3.0
• Bond Insurance (2x
  principal) .50 to 1.0

Current Refunding Bonds 6,580,000
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Advance Refunding
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Bond Sizing Requirements
Bonds Outstanding 6.15 Million
Principal Interest 1.6 Million

• Cost of Issuance .50
  to 1.0
• Underwriters Discount .50 to
  1.0
• Redemption Premium 2.0
  to 3.0
• Bond Insurance (2x
  principal) .50 to 1.0
• Negative Carry 1.0
  to 3.0
• Advance Refunding

Advance Refunding Bonds 8,000,000
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How to Evaluate a Refunding
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Issuer Objectives

• Debt Service Savings
• Cash Flow Structuring
• Consolidation of Debt
• Remove Restrictive Covenants
• Combination (of above)

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Rolling Down the Yield Curve
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Measuring Savings

• 30,000 Avg. Annual Cash Flow Savings
• 440,293 NPV Savings
• 6.9 of Refunded Bonds
• 6.7 of Refunding Bonds

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The Impact of Investments
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Gross vs. Net Refunding

• Must take into account impact of investments
• Gross-to-Gross Refunding
• Comparison solely of gross debt service
• Does not take into account reinvestment of bond
  proceeds
• Net-to-Net Refunding
• Compares Net Debt Services
• Takes into account reinvestment of bond proceeds

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Net-to-Net Refunding

• Net-to-Net Refunding reflects true savings
• May reduce savings level (e.g. 7.1 vs. 4.8)

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Beyond the 3 Rule
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Key Factors in Evaluating a Refunding

• Current vs. Historical Interest Rate Levels
• Maturity-by-Maturity (shape of yield curve)
• Term to maturity (years remaining)
• Absolute level of savings minimum threshold
  (e.g. 1 million)
• Evaluating an advance refunding generally more
  important than current refunding.

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Savings Formula

• Rule of Thumb

Call Premium Issuance Cost
Coupon Spread X of Years

Savings
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Current vs. Historical Interest Rates

• Refunding should be driven by the potential value
  captured
• Refunding undertaken near historical low interest
  levels, may capture most potential savings

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Maturity-by-Maturity Analysis

• Although overall level of savings attractive
• Issuers should begin to evaluate refunding on a
  maturity-by-maturity basis.
• Review shape of Yield curve

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Shape of the Yield Curve

• Shape of the Yield Curve Time to Final Maturity
  
• 3.0 to 10.0 in par value required to issue
  refunding bonds
• spread of 100 bps more significant later years
  
• 3 year 300 bps / 9 years 900 bps

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Adjusted Maturity-by-Maturity

• Adjusted Par Value 7 for each Maturity
• Level debt service solution, places more
  principal in shorter maturities distorts
  savings in back end.

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Value of Call Option

• Measures Efficiency of a Refunding
• Requires complex multi-variable model
• Simple approximation benchmark savings to
  historical low interest rates
• Rates as of June 12, 2003
• Efficiency of Refunding - of potential savings

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Coupon Spread
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Capture Potential Economic Value

• Benchmark to historical low interest rate level
  provides simple gauge of efficiency of refunding

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Absolute Value Other Considerations

• Suit Rule A refunding should generate more
  savings to the issuer than the suits (i.e., bond
  counsel, FA, underwriter, etc.) get paid.
• Minimum X million NPV savings, regardless of
  of par value
• Current Refundings
• Short term to maturity
• Restrictive Covenants
• Debt Service Coverage
• Developer payments

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Use of Swaps Derivatives

• Issuers may realize greater savings by using swap
  derivative instruments
• However, must consider that
• of LIBOR swaps assume tax risk
• Swaps are effectively non-callable
• must measure the option value of the call

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Questions and Discussion