Best Practices in Debt Management: An Overview FGFOA School of Governmental Finance Sarasota County, Florida November 14, 2012

GOVERNMENT FINANCE OFFICERS ASSOCIATION What is the Role of the Finance Officer in Debt Issuance? Four Primary Rating Criteria  Financial Condition  Debt Structure  Economics/Demographics  Management Management = Creditworthiness  Finance Officers responsible for variety of duties  How each is managed impacts the cost of funds when it comes time to issue enter capital markets

GOVERNMENT FINANCE OFFICERS ASSOCIATION Best Practices Five-year capital improvement plan integrating operating costs of new facilities Debt policies and debt affordability reviews Pay-as-you-go capital funding policies Fund balance reserve policy/working capital reserves Contingency planning policies Policies regarding nonrecurring revenue

GOVERNMENT FINANCE OFFICERS ASSOCIATION More Best Practices … Multi-year financial forecasting Monthly or quarterly financial reporting and monitoring Superior debt disclosure practices Financial reporting and budgeting awards Compliance with Governmental Accounting Standards Board standards

GOVERNMENT FINANCE OFFICERS ASSOCIATION The Debt Component of Your Capital Improvement Plan

GOVERNMENT FINANCE OFFICERS ASSOCIATION Debt Issuance Integration with Capital Improvement Plan GFOA recommends that governments adopt comprehensive multi-year capital improvement plans (CIP) to ensure effective management of capital assets CIP should cover at least 3 year period, preferably 5 years or more

GOVERNMENT FINANCE OFFICERS ASSOCIATION Debt Issuance Integration with Capital Improvement Plan Prudent capital plans do the following:  Identify needs Long-term horizon  Determine project costs  Prioritize capital projects New outlays, maintenance, replacement, renewal  Develop financing strategies

GOVERNMENT FINANCE OFFICERS ASSOCIATION Debt Issuance Integration with Capital Improvement Plan Financing strategies  Cash Flow projections  Consider all funding alternatives  Reliability and stability of funding sources  Affordability of strategies, including impact on debt ratios, taxpayers, ratepayers, etc.  Have to consider debt management policy

GOVERNMENT FINANCE OFFICERS ASSOCIATION Debt Issuance Integration with Capital Improvement Plan Debt management policy and CIP  Use policy to establish parameters for issuing debt relative to capital projects  Particularly with respect to objectives to be achieved before and after issuance  Also use for guidance with respect to debt affordability – use debt policy as control points relative to managing CIP

GOVERNMENT FINANCE OFFICERS ASSOCIATION Debt Capacity Considerations Legal Limits Internal Policy Limits Financial Limits

GOVERNMENT FINANCE OFFICERS ASSOCIATION Debt Capacity – Precious Commodity Determining “ capacity ” is an art not a science Debt capacity is limited; make it count  Funds borrowed for project today can ’ t be used for other projects tomorrow  Funds committed for debt repayment today can ’ t be used to fund services tomorrow Long-term capital planning key to managing debt capacity

GOVERNMENT FINANCE OFFICERS ASSOCIATION Developing a Debt Policy

GOVERNMENT FINANCE OFFICERS ASSOCIATION Importance of Developing a Debt Management Policy A debt management policy improves the quality of decisions, provides justification for the structure of debt issuance, identifies policy goals, and demonstrates a commitment to long-term financial planning, including a multi-year capital plan.

GOVERNMENT FINANCE OFFICERS ASSOCIATION Importance of Developing a Debt Management Policy Adherence to a debt management policy signals to rating agencies and the capital markets that a government is well managed and should meet its obligations in a timely manner. An effective debt management policy provides guidelines for a government to manage its debt program in line with available resources.

GOVERNMENT FINANCE OFFICERS ASSOCIATION GFOA Best Practice – Debt Policies Purposes for which debt may be issued Legal debt limitations Types of debt permitted Structural features preferred Credit objectives Methods of sale Methods for selecting outside professionals

GOVERNMENT FINANCE OFFICERS ASSOCIATION Developing Debt Policies Identify Comparable Governments Collect Example Policies and Borrow Ideas Construct Indicators  For Peer Group  For Self / Compare

GOVERNMENT FINANCE OFFICERS ASSOCIATION GFOA Tools Available to Issuers – Publications GFOA Publications  Guide to Preparing a Debt Policy  Benchmarking and Measuring Debt Capacity  Elected Official ’ s Guide to Debt Issuance  Elected Official ’ s Guide to Tax Increment Financing  Budget Practices: A Framework For Improved State and Local Government Budgeting  Capital Project Planning and Evaluation: Expanding the Role of the Finance Officer

GOVERNMENT FINANCE OFFICERS ASSOCIATION Method of Sale: Competitive vs. Negotiated

GOVERNMENT FINANCE OFFICERS ASSOCIATION Competitive vs. Negotiated Sales: The Decision The finance officer’s decision or recommendation regarding the method in which bonds will be sold will be a leading factor in determining the financing cost of the bonds. Method of Sale decision should be addressed in the issuer’s debt or financial policies.

GOVERNMENT FINANCE OFFICERS ASSOCIATION Competitive vs. Negotiated Sales: Definitions Competitive Sale: Bond issue is prepared by the issuer and financial advisor and then offered for sale to underwriters at specified date and time. Bonds are awarded to the firm that offers the lowest True Interest Cost (TIC). Bids usually submitted electronically. Negotiated Sale: The underwriter of the bonds is selected in advance of the sale and the pricing of the bonds (coupons, yields, spread) is negotiated by the underwriter and the issuer (with their financial advisor).

GOVERNMENT FINANCE OFFICERS ASSOCIATION GFOA Best Practice on Selecting the Method of Sale “Method of Sale” Best Practices provides guidance to issuers regarding choosing between a competitive and negotiated sale. Method of Sale Best Practices were the result of sometimes contentious discussions among GFOA Debt Committee members over two years.

GOVERNMENT FINANCE OFFICERS ASSOCIATION Key Components of Method of Sale BP Issuers should select the method of sale most likely to achieve the lowest cost of borrowing. Decision should be based on analysis of the relevant rating, security, structuring and other features of the bond issue. If an issuer does not have dedicated, experienced debt management staff, it should hire a financial advisor to assist in making the method of sale decision.

GOVERNMENT FINANCE OFFICERS ASSOCIATION Key Components of Method of Sale BP Due to the inherent conflict of interest, issuers should not use a potential underwriter to assist in the method of sale decision unless that firm has agreed not to underwrite the bonds. Due to inherent conflicts of interest, a firm acting as an issuer’s financial advisor should not be allowed to resign in order to serve as underwriter for the proposed bonds. MSRB Rule G-23 now prohibits.

GOVERNMENT FINANCE OFFICERS ASSOCIATION Key Components of Method of Sale BP Favors which favor a competitive sale include:  Bond rating of “A” or higher.  Bonds are general obligations of the issuer, or are secured by a strong, known and long-standing revenues stream (e.g. water, sewer, or electric revenues).  The structure of the bonds does not include unusual or new financing features that require extensive explanation to the bond market.

GOVERNMENT FINANCE OFFICERS ASSOCIATION Key Components of Method of Sale BP Favors which favor a negotiated sale include:  Bond rating less than “A”.  Bond insurance or other credit enhancement not available or not cost-effective.  Bond structure has unique features such as pooled bonds, variable rate debt or deferred interest bonds.  The issuer desires to target underwriting participation.  Other factors that the issuer, in consultation with its financial advisor, believes favor the use of negotiation.

GOVERNMENT FINANCE OFFICERS ASSOCIATION Key Components of Method of Sale BP If a negotiated sale is deemed appropriate:  Engage the services of a financial advisor, unless the issuer has extensive in-house bond pricing experience and access to current bond market data.  Select underwriters through a Request for Proposals (RFP).  Remain actively involved in each step of the negotiation and sale process. (BP on “Pricing Bonds in a Negotiated Sale”)  Be aware that the relationship between the issuer and the underwriter is one of common purpose, but also competing objectives, especially at time of bond pricing. YOUR UNDERWRITER IS NOT YOUR FINANCIAL ADVISOR.

GOVERNMENT FINANCE OFFICERS ASSOCIATION Refunding Analysis

GOVERNMENT FINANCE OFFICERS ASSOCIATION Optional Redemption Most tax-exempt 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  Par call is most common (as opposed to premium call – 101% of par)  Notification: typically 30 to 60 days prior to call

GOVERNMENT FINANCE OFFICERS ASSOCIATION Types of Refundings Less than 90 days Call 2002A Bonds September 1, 2012 Bond proceeds used to fund Defeasance Escrow Call Outstanding Bonds Defeasance Escrow Refunding Bonds Current: Refunding bonds sold within 90 days of Call Date of refunded bonds  Escrow Yield unrestricted  No limit to number of current refundings Refunding Bonds June 1, 2012

GOVERNMENT FINANCE OFFICERS ASSOCIATION Types of Refundings Advance: Refunding bonds sold more than 90 days to the 1st Optional Call Date of refunded bonds  Escrow yield restricted to arbitrage yield of refunding bonds  1 Advance Refunding allowed per IRS Regulations. More than 90 days Call 2004A Bonds August 1, 2014 Bond proceeds used to fund Defeasance Escrow Pay Principal & Interest due on Refunded Bonds until the Call Date Call Outstanding Bonds Defeasance Escrow Refunding Bonds Refunding Bonds June 1, 2012

GOVERNMENT FINANCE OFFICERS ASSOCIATION Economics of Refunding Bonds Absolute difference in interest rates on old “ refunded ” bonds vs. new “ refunding ” bonds Remaining term and amount of refunded bonds Length of the escrow period Efficiency of the escrow  Ability to earn the escrow yield limit  Investment dates vs. refunded bond payment dates Cautions:  Negative arbitrage (earnings) in escrow  Extension of call date

GOVERNMENT FINANCE OFFICERS ASSOCIATION Issuer Objectives Meet Savings Threshold  GFOA recommends 3-5% NPV as starting point  Debt Policy should discuss Threshold Savings Cash Flow Structuring Consolidation of Debt Remove Restrictive Covenants Or Combination of Above Objectives

GOVERNMENT FINANCE OFFICERS ASSOCIATION Savings Targets Establish guidelines in debt policy Opportunity cost analysis Different perspective for current and advance refunding Net present value as % of par value (refunding or refunded par) Absolute savings Savings in excess of COI

GOVERNMENT FINANCE OFFICERS ASSOCIATION How to Evaluate a Refundi ng Current vs. Historical Interest Rate Levels Shape of yield curve Term to maturity (years remaining) Absolute level of savings: minimum $ threshold (e.g. $1 million) NPV Savings as % of par Consider future “ opportunities lost ”

GOVERNMENT FINANCE OFFICERS ASSOCIATION Historical & Current Interest Rates are Useful for Understanding Market Trends Historical interest rates provide context to current rates and insight into how rates change  Compare current rates to historical ranges  Identify current trends  Establish how rapidly rates have moved up or down

GOVERNMENT FINANCE OFFICERS ASSOCIATION Continuing Disclosure

GOVERNMENT FINANCE OFFICERS ASSOCIATION SEC Rule 15c2-12 Effective January 1, 1996 Designed to prevent fraudulent, deceptive, or manipulative acts or practices Requires municipal debt issuers to file updated financial information and operating data annually with EMMA (Electronic Municipal Market Access System) by a specified date and file material event notices. Requires underwriters to reasonably determine that the issuer has complied with the rule prior to offering for sale the related securities

GOVERNMENT FINANCE OFFICERS ASSOCIATION The issuer must enter into a written agreement for the benefit of the bond holders to do the following:  Provide through a filing to the Electronic Municipal Market Access (EMMA) and to the appropriate State Information Depository (SID), if any, annual financial information or operating data presented in the Official Statement  Submit audited financial statements to the EMMA system and respective SID when available, if not provided as part of the annual financial information listed above  Submit a notification to the EMMA system and respective SID of any material event occurrence in a timely manner  Submit a notification to the EMMA system and respective SID of failure to comply in a timely manner Requirements

GOVERNMENT FINANCE OFFICERS ASSOCIATION Material events related to bonds issued after 12/1/10, but submit the material event to the EMMA system within 10 business days of the event occurring. Some events need to be disclosed regardless if they are ‘material’ or not:  Principal and interest payment delinquencies  Unscheduled draws on debt service reserves reflecting financial difficulties  Unscheduled draws on credit enhancement reflecting financial difficulties  Substitution of credit or liquidity providers, or their failure to perform  Adverse tax opinions  Defeasances  Rating Changes Material Events

GOVERNMENT FINANCE OFFICERS ASSOCIATION New Material Events Updated in May, 2010: New Material Events  IRS proposed or final determinations of taxability  Tender officers  Bankruptcy, insolvency, receivership, or similar event of the obligated person  Consummation of a merger, consideration, or acquisition, or certain asset ales, involving the obligated person, or entry into or termination of a definitive agreement to the foregoing (if material)  Appointment of a successor or additional trustee or the change of name of a trustee (if material)

GOVERNMENT FINANCE OFFICERS ASSOCIATION If the issuer fails to meet its annual filing requirements, the issuer must:  Submit a notice of failure to comply with EMMA and the appropriate SID  Complete and submit all past due filings prior to issuing debt  Create procedures to ensure the failure to file will not reoccur  Disclose its failure to comply in every Official Statement for 5 years Notice of Failure to Comply

GOVERNMENT FINANCE OFFICERS ASSOCIATION If the issuer fails to meet its annual filing requirements, the ease of selling its securities diminishes  The underwriter is prohibited from bidding on or offering for sale the primary offering  Rating agencies could assign a lower rating if the failed filings were deemed to be caused by poor management  The investors may not show interest in securities where the required disclosure filings are not available  In the event of a default, the investor could argue the required disclosure filings were not available for due diligence review  Higher borrowing costs Risks of Non-Compliance

GOVERNMENT FINANCE OFFICERS ASSOCIATION Exemptions from annual filings and material event notices  Debt issues with a total par amount of $1,000,000 or less  Debt issues authorized in denominations of $100,000 if, Sold to no more than 35 persons who are believed to capable of evaluating risk and who are purchasing the securities for one account Have a maturity of 9 months or less, or May be tendered to the issuer at par value or above every 9 months until maturity Exemptions from annual filings but not material event notices  Debt issues with a maturity 18 months or less Debt Issue Exemptions

GOVERNMENT FINANCE OFFICERS ASSOCIATION Prior to bidding on or offering for sale municipal securities the underwriter must review the preliminary official statement (“POS”) and reasonably determine that issuer has complied with the rule The underwriter must send a POS no later than 1 business day after the request of a potential customer, if available The underwriter must receive the final official statement 7 business days after the purchase agreement and in sufficient time and quantity to accompany any confirmation that requests payment from any customer Issuers may now submit POS documents to EMMA. Requirements on Underwriters

GOVERNMENT FINANCE OFFICERS ASSOCIATION Continuing Responsibilities of the Finance Officer – Post Issuance Compliance

GOVERNMENT FINANCE OFFICERS ASSOCIATION Post Issuance Compliance Post-issuance tax compliance begins with the debt issuance process itself and provides for a continuing focus on investments of bond proceeds and use of bond-financed property. It will require identifying existing policies, the responsible people, the applicable procedures, and the affected population. The National Association of Bond Lawyers and the Government Finance Officers Association have jointly developed a checklist to assist with issuers post issuance compliance matters (found at below website).

GOVERNMENT FINANCE OFFICERS ASSOCIATION Investment of Bond Proceeds Principals of good investment management and understanding of inherent risks in investing bond proceeds critical  Establish good guidelines for permitted investments to reduce credit risk – SAFETY  Good cash flow estimates mitigate market risk – LIQUIDITY  Integration of knowledge of expected and future market conditions with other cash flows to reduce opportunity risk – YIELD

GOVERNMENT FINANCE OFFICERS ASSOCIATION Investment of Bond Proceeds Obtain projected cash flow schedules from project managers Inform internal investment officer of incoming funds Bid Investment Agreements as needed Develop process for monitoring balances in trustee held accounts Actively monitor construction activities Develop procedures for reinvestment of bond proceeds (see handout)

GOVERNMENT FINANCE OFFICERS ASSOCIATION Investment of Bond Proceeds Initial investment – generally the “ easier part ”  Project cash flows  Capitalized Interest  Debt Service Reserve Fund  Cost of Issuance Reinvestment – generally the “ really hard part ”  Develop process to monitor and make reinvestment decisions  Use of cash flow expectations v. reality

GOVERNMENT FINANCE OFFICERS ASSOCIATION Record Retention Establish Record Retention Requirements and Procedures IRS record retention requirements  Term of bonds + 6 years  Types of records IRS Website   FAQ ’ s -- Record Retention Requirements (handout)

GOVERNMENT FINANCE OFFICERS ASSOCIATION What is Arbitrage? Arbitrage is the ability to earn profit by capitalizing in differences between investments or markets. In the case of public finance, Arbitrage refers to ability to profit from investment of tax-exempt bond proceeds in taxable securities. The ability to earn arbitrage depends on the relationship between taxable and tax-exempt rates and the shape of the yield curve. Positive arbitrage represents earnings above the arbitrage yield. Negative arbitrage represents earnings below the arbitrage yield (i.e., “losses”).

GOVERNMENT FINANCE OFFICERS ASSOCIATION Arbitrage Rebate Compliance Activities Internal monitoring of rebate compliance Recommend annual calculations during construction period  Set aside annual rebate liability in Rebate Fund  Get it out of the Construction Fund Paying rebate is not bad, just need to monitor and pay as required Pay attention to requirements in Tax/Arbitrage Certificate

GOVERNMENT FINANCE OFFICERS ASSOCIATION Compliance with Bond Covenants and Agreements Develop internal tickler system from beginning Keep up-to-date Don ’ t reinvent the wheel with every deal; similar reporting requirements are okay and always preferred Keep as simple as possible

GOVERNMENT FINANCE OFFICERS ASSOCIATION Bond Project Monitoring Critical to complete reinvestment activities Active involvement with project staff  Regular conversations  Understanding of current and future capital needs Review project encumbrance and expenditure needs Understand project delays  Implications for timely commencement of debt service  Develop contingency plan if significant project delays

GOVERNMENT FINANCE OFFICERS ASSOCIATION Questions