munibonds101
TRANSCRIPT
IRE 2015 | Philadelphia 1
MUNICIPAL BONDS 101Cezary Podkul | @Cezary
6/6/2015
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Link to Class Materials
• Everything you need is in Dropbox:
bit.ly/1ElBGNR
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Roadmap
• What we hope to learn today:1. Muni Bonds: Why Do We Care?2. Taxonomy: Types Of Muni Debt3. Bond Docs: Say Hello To EMMA4. Bond Math: How Much Do We
Owe?5. Benchmarks: View It In Context6. Databases: Where To Get stuff
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Muni Bonds: Why Do We Care?
Part 1
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Why Do We Care?
• Governments borrow to build our essential infrastructure through the $3.6 trillion muni bond market:– Schools, universities–Government buildings–Water and sewer systems–Roads, bridges, highways
. . . and much more
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Why Do We Care?
• It is also how they get in trouble:
- Detroit Free Press, April 5, 1993
- Chicago Tribune, Nov. 1, 2013
- The Bond Buyer, Feb. 12, 2014
- ProPublica, Aug. 7, 2014
- Boston Herald, June 10, 2012
- BenefitsPro Feb. 12, 2015 - USA Today, Dec. 3, 2013
- Wall Street Journal, Jan. 26, 2010
- Voice of San Diego, Aug. 6, 2012
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Taxonomy: Types Of Muni Debt
Part 2
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Types Of Muni Debt
• Government bonds come in three major flavors:–General obligation debt–Revenue-backed bonds–Short-term borrowings
• And indirect ways to borrow:–“Moral obligation bonds”–Bond guarantees
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Types Of Muni Debt
General obligation bonds• Debt backed by the
taxing power of the governments that issue them – aka “full faith and credit”
• Obligation to raise taxes to make up any shortfall
• Lower risk, lower interest rates
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Types Of Muni Debt
Revenue-backed bonds• Debt backed by a
specific revenue source, like tolls from a toll road
• No obligation to raise taxes to make up any shortfall – “non-recourse”
• Higher risk, higher interest rate
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Types Of Muni Debt
Short-term borrowings• Cash management tool:
bridges gap between when government needs cash and when it receives it
• Known as “tax and revenue anticipation notes” or TRANs
• Typically due in less than one year, pay short-term interest rates
• General obligations
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Types Of Muni Debt
“Moral obligation bonds”• Issuer has authority to
ask the government to make appropriation to cover debt service in case of a shortfall
• Government has a “moral obligation” to honor the request
• Not a legal obligation
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Types Of Muni Debt
“Moral obligation bonds”–Surprise! You now owe millions of dollars:
–The advice? Pay up:• “ … the state will be better off honoring its m
oral obligation” – State’s financial advisor, SJ Advisors LLC
- Report on Rhode Island’s Moral Obligation Bonds on the 38 Studios Bonds , May 8, 2014
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Types Of Muni Debt
“Moral obligation bonds”–What happens if the government doesn’t
honor the obligation? Swift punishment:
- The Bond Buyer, Feb. 12, 2014
- The Bond Buyer, Jan. 14, 2014
- The Bond Buyer, Dec. 13, 2013
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Types Of Muni Debt
Bond guarantees• Government promises
to make good on the debt by whatever means necessary to make sure bondholders get repaid in full
• Lowers the risk for the bondholders, taxpayers on the hook to if anything goes wrong
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Types Of Muni Debt
Bond guarantees–The legalese leaves little to imagination:
“Under the City Bond Guaranty, the City has unconditionally guaranteed, for the benefit of the registered owners of the 2003 Bonds, the full and prompt payment of principal and interest on the 2003 Bonds when due according to the terms of the City Bond Guaranty, for which obligation the City has pledged its full faith, credit and taxing power.”
- The Harrisburg Authority, Series 2003 Bonds Official Statement
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Types Of Muni Debt
Bond guarantees–Easy way to end up in bankruptcy court:
- Bloomberg News, Oct. 12, 2011
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Bond Docs: Say Hello To EMMA
Part 3
Best bond website ever
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Say Hello To EMMA
• What is EMMA?– Electronic Municipal Market Access
• Since 2009, the official repository for muni bond offering documents and continuing disclosures
• Run by the Municipal Securities Rulemaking Board (MSRB)
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Say Hello To EMMA
• What’s in EMMA?–Data on more than 1.2 million muni bonds:• Official statements; ongoing financial
disclosures; advance refunding documents; event notices, voluntary disclosures, and more
–Real-time trade data for nearly every municipal bond bought and sold
– Political contribution disclosures (here)–Documents, documents, more documents
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Say Hello To EMMA
• What’s not in EMMA?–No bulk download of data about bond
deals–You will need a third-party data
vendor for this, like Thomson Reuters SDC:
- Thomson Reuters SDC
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Say Hello To EMMA
- EMMA
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Say Hello To EMMA
• What’s an “official statement”?– It’s these documents I keep linking to
all over the place in this presentation!–Think of them as the prospectus for
the bond issue: they’re supposed to tell investors all the key things they need to know before buying the bonds–This is your starting point for
understanding the debt6/6/2015 IRE 2015 | Philadelphia
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Say Hello To EMMA
• Tips for reading official statements– First two to four pages always contain all the
key numbers – amounts sold, when they’re due, interest rates, CUSIPs, key terms and conditions• Some bonds will also contain a “summary” official
statement, which is good to skim also
– Other things you should look for:• “Sources and Uses” table – ALWAYS read this• Security and sources of payment for bonds• Subordination and payment priority• Optional redemption features
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Types Of Muni Debt
What exactly is a ‘bond issue’?• Bonds issues are
chunks of debt sold together
• An issue can have many different tranches with different characteristics
• Each tranche can have multiple bonds, each with its own CUSIP
Issue
Tranche
Bond(CUSIP)
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Say Hello To EMMA
• A word about CUSIPs:–Eight digit identifier for specific
securities–The six digit CUSIP is your best friend:
682745 3T 9
Uniquely identifies the issuer of the security
Uniquely identifies the security
Check digit (ignore)
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Say Hello To EMMA
• Advice: Use documents to back check any third-party data
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Say Hello To EMMA
• Where do I learn more?– Introductory guide for investors:• “Getting to Know EMMA”
–MSRB education center:• “Understanding the Municipal Market”
–MSRB video tutorials on EMMA:• “Educational Videos”
–MSRB glossary for muni market terms:• “Glossary of Municipal Securities Terms”
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Bond Math: How Much Do We Owe?
Part 4
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How Much Do We Owe?
• The two equations you need to know for most bond math:
Yield =
Coupon = Interest Rate x
PrincipalAmount
Coupon Cost basis
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How Much Do We Owe?
• Open the “Bond_Math_Examples” Excel file in Dropbox for a demo:–Use this California GO bond issue:• CUSIP: 13063A7D0
–Enter in the inputs values to calculate the coupon, initial yield and market yield–Use data from official statement and
the latest trade available on EMMA6/6/2015 IRE 2015 | Philadelphia
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How Much Do We Owe?
• There are two ways bonds repay interest to bondholders:–Current interest bonds –Capital appreciation bonds
(aka “zero coupon bonds”)
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How Much Do We Owe?
Current interest bonds• Bonds that make
periodic cash interest payments to bondholders over the life of the bonds
• The interest rate sets the coupon, or how much investors get each period
• This is how most bonds are sold in muni market
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How Much Do We Owe?
Current interest bonds–Calculate the annual debt service for
the California GO bond we looked at before:• CUSIP: 13063A7D0
–Hint 1: Look at the official statement, pay close attention to first two pages!–Hint 2: Check the official statement
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How Much Do We Owe?
Current interest bonds• Here is what the debt service
looks like:
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How Much Do We Owe?
Capital appreciation bonds• Capital appreciation bonds
do not pay annual cash interest
• Instead, interest grows on the original principal and accumulating balance until it comes due, often decades in the future
• Can easily turn small sums borrowed into hundreds of millions, or even billions owed
• Get the cash now, let future generations worry about paying it back
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Capital appreciation bonds• The power of compound interest – take
Ohio’s tobacco CABs as an example:– Series 2007B: $191.3m borrowed,
$3.2bn due at maturity in 2047. • Interest accrues at 7.25% interest rate
– Series 2007C: $128.2m borrowed, $3.4bn due at maturity in 2052. • Interest accrues at 7.5% interest rate
How Much Do We Owe?
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Capital appreciation bonds• Ohio’s Series 2007B debt burden over
time
How Much Do We Owe?
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Capital appreciation bonds• Ohio’s Series 2007C debt burden over
time
How Much Do We Owe?
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How Much Do We Owe?
Capital appreciation bonds • What officials are saying:
• New Jersey’s way of undoing a CAB deal:
• “Behind New Jersey’s Tobacco Bond Bailout, A Hedge Fund’s $100 Million Payday”
“CABs are – for good reason – known as a distinctly horrible means of public finance. They are bad policy. Everybody knew it then, everybody knows it now. But that's the situation that we've inherited.” - Andrew Sidamon-Eristoff, New Jersey State Treasurer, April 1, 2014
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How Much Do We Owe?
• When do investors get repaid?–Bondholders don’t always have to wait
until maturity to get their money back– Issuers typically reserve right to “call” the
bonds ahead of their final maturity• Repay bondholders today at a specified price,
usually above or below par value
–Beneficial to issuers – like having ability to refinance mortgage when interest rates fall:• http://www.sec.gov/answers/callablebonds.ht
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How Much Do We Owe?
• What exactly is ‘par value’?–Generally speaking, it’s the amount due at
maturity – i.e. when principal is due
• So is ‘par value’ same as principal?–Not always.• Capital appreciation bonds are sold at a discount to par value and earn interest (“accrete”) until they grow into the par amount• Current interest bonds are typically sold at par value, so principal and par will be the same
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Benchmarks: View It In Context
Part 5
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View It In Context
• The importance of benchmarking– How much interest is more than the norm?
Well, it depends:• What time horizon are we talking about?• How creditworthy is the issuer?
– So what you need are:• The term (“tenor”) of the bonds you’re looking at• The credit ratings (“AAA”, “BBB+” etc.) of the
issuer
– These allow you to make an apples-to-apples comparison against a benchmark borrowing rate
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View It In Context
• What benchmark should I use?–MMD curves are a good one
• What are they?–Generic yield curves that represent
borrowing costs for issuers based on tenor and credit quality
• What do they look like?–Open up the Excel file “MMDCurves”
in the Dropbox folder6/6/2015 IRE 2015 | Philadelphia
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View It In Context
• How does it work?– Simple example: How much more does it cost
you to borrow if you’re Illinois vs. Texas:
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View It In Context
• What does this look like in print?–Here is an example of how I used MMD curves to
benchmark borrowing costs in one story:
“Buried in Appendix G of the 416-page bond prospectus was the amount due at maturity: $6.8 billion, including $593 million for Niagara's bonds. The hefty payoff was made possible by interest rates that ranged from 6 to 7.85 percent for the riskiest CABs, due in 2060. The top rate was nearly double that for long-term, taxpayer-backed municipal debt at the time, according to Thomson Reuters data.”- ProPublica, “How One New York County Fell Into the Tobacco Debt Trap,” Oct. 23, 20146/6/2015 IRE 2015 | Philadelphia
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Databases: Where To Get Stuff
Part 6
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Where To Get Stuff
• Useful sources for muni bond data:What You Want
Where to Get it Website
Bond documents
EMMA www.emma.msrb.org
Bond ownership data
Lipper, Morningstar(mostly mutual funds)
www.lipperweb.comwww.morningstar.com
Bond issuance data
Thomson Reuters (SDC Platinum)
www.thomsonreuters.com
Bond reference prices
S&P Capital IQ (J.J. Kenny)
www.capitaliq.com
Issuance calendar
Ipreo www.ipreo.com
Bond ratings S&P, Moody’s, Fitch
Available upon request
Yield curves TM3 www.tm3.com
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