BONDS 101: WHAT EVERY MUNICIPAL ATTORNEY SHOULD KNOW ABOUT BONDS AND DEBT. Basic Municipal Bond Transaction. Bondholder(s) Issuer

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1 BONDS 101: WHAT EVERY MUNICIPAL ATTORNEY SHOULD KNOW ABOUT BONDS AND DEBT Presentation to: COLORADO MUNICIPAL LEAGUE SEMINAR ON MUNICIPAL LAW October 15, 2011 Dee Wisor Kim Crawford (303) (303) $ Bond Proceeds Basic Municipal Bond Transaction Bondholder(s) Issuer $ Debt Service (evidenced by a bond, note, or other financial obligation) Basic Municipal Bond Transaction Municipalities issue bonds to finance (or refinance) capital improvements. Purchasers of bonds generally include: banks or other financial institutions who purchase bonds for their own benefit (private placements); underwriters who purchase bonds for resale to others (public offerings). Parties Involved In A Bond Issue Financing Participants Underwriter Financial Advisor Attorney Participants Issuer s Counsel Bond Counsel Disclosure Counsel Underwriter s Counsel Borrower s Counsel (conduit) Trustee s Counsel Administrative Participants Paying Agent Registrar Trustee Other Participants Bond Insurers Letter of Credit Providers Rating Agencies Parties Involved In A Bond Issue Underwriter Buys bonds from issuers and resells to investors. Works with the issuer to structure financing (negotiated sales). Markets the bonds. Financial Advisor Independent from Underwriter. Assists issuer in evaluating funding sources/preparing RFPs for underwriter/counsel. Assists in preparing Notice of Sale for public sales. Bond Counsel Law firm specializing in municipal law and tax law. Drafts legal documents. Issues opinion that bonds are validly issued and exempt from state and federal tax. Disclosure Counsel Law firm specializing in federal securities law. Assists the issuer in preparation of Official Statement. Two Main Types of Municipal Bonds Governmental Bonds Conduit Bonds 1

2 General Types of Municipal Borrowings New Projects Cash Flow Needs Refundings Types of Security General Obligation Revenue Pledge Special Assessment Specific Assets Lease-Purchase Agreements or Lease Revenue Bonds (COPS) Credit Enhancement Bond Insurance Letter of Credit Guaranty of Beneficiary Competitive v. Negotiated Sales There are three ways to sell municipal bonds: Negotiated Sale Competitive Sale Private Placement Competitive v. Negotiated Sales Negotiated Sale Most common form of sale. Effective for more complicated or large issues. Underwriter very knowledgeable about deal. Very flexible in terms of timing and structure. Competitive Sale Best used for highly rated deals. Sale date is set in advance. Limited flexibility in changing structure of issue late in process. Difficult to use for refundings. Steps in Issuance of Bonds Election, if necessary. Issuer may adopt Sale and/or Reimbursement Resolution. Underwriter or Financial Advisor together with Issuer and Bond Counsel structure transaction and prepare documents. Ratings and/or insurance obtained. 2

3 Steps in Issuance of Bonds Issuer approves documents. Where delegation is permitted this occurs before sale; otherwise this occurs after sale. Bond Sale Closing Elections In Colorado, elections are required for most borrowings because of TABOR. Exceptions are: Lease-Purchase Agreements (COPs) Refundings at a lower rate Obligations paid within the fiscal year (TANS) Urban Renewal Authority debt Enterprise (water, sewer, golf course, airport, etc) obligations Obligations for which the issuer has current cash to pay all future payments Elections Under TABOR, elections may only be held on certain dates: The general election in November of even numbered years. The first Tuesday in November of odd numbered years. Date of municipality s regular election (statutory town/charter provisions). Debt limits for statutory municipalities apply for general obligation debt (3% of statutory actual value). Elections Question (s) finalized not less than 60 days in advance of election. TABOR notice must be delivered to County 42 days prior to election mailed 30 days prior. Fair Campaign Practices Act limits the use of public funds in an election. Index of Documents In every transaction there will be an index of documents, closing checklist, closing memorandum or other means of identifying those documents required to be executed and delivered at closing. Most of these documents are required as a basis for bond counsel to deliver the approving bond opinion. Index of Documents BASIC DOCUMENTS Election Proceedings Bond Ordinance Registrar and Paying Agent Agreement DTC Blanket Issuer Letter of Representations Sale Certificate DOCUMENTS FURNISHED BY THE CITY Omnibus Certificate Continuing Disclosure Certificate Federal Tax Exemption Certificate Form 8038-G UNDERWRITING DOCUMENTS Preliminary Official Statement Official Statement Bond Purchase Agreement Certificate of Underwriter Rating Letters DOCUMENTS FURNISHED BY REGISTRAR AND PAYING AGENT Certificate of Bank 3

4 Index of Documents MISCELLANEOUS DOCUMENTS Opinion of Bond Counsel Opinion of Special Counsel Opinion of Counsel to the Issuer Accountant s Consent Closing Memorandum Index of Documents Opinion of Municipal Attorney. See Mehaffy, Rider, Windholz & Wilson v. Central Bank Denver, N.A., 892 P.2d 230 (Colo. 1995). But seecentral Bank Denver, N.A., v. Mehaffy, Rider, Windholz & Wilson, 940 P.2d 1097 (Colo.App. 1997). General Issues/Considerations Arbitrage (Federal Tax) Issues. Rebate (Federal Tax) Issues. Private Use and Private Payments (Federal Tax). Federal Securities Law Issues. Continuing Disclosure (SEC/MSRB). Arbitrage Federal tax policy places some limits on the issuance of tax-exempt bonds due to the impact on the federal treasury. In general, an issuer cannot arbitrage by issuing tax-exempt bonds and reinvesting the proceeds in securities with a higher interest rate. There is a three year temporary period where an issuer may invest at a higher yield if the issuer reasonably expects on the date of issuance. To incur a binding legal obligation to a third party within 6 months to spend 5% of the net sale proceeds on capital projects. The completion of capital project being financed will proceed with due diligence to completion. Within 3 years the issuer will spend 85% of the net sale proceeds. Rebate Even though the rules permit certain arbitrage to occur, an issuer in general must rebate to the federal government the amount by which its investment earnings exceed the yield on its bonds. The rebate requirement does not apply to a small issuer. Six Month Test Eighteen Month Test Two Year Test Rebate Exceptions 4

5 Federal Tax Issues If there is too much private business use of a tax-exempt bond financed facility and there is too much private security for payment of the bonds, the tax exemption is lost. Usually the threshold is 10%. Federal Tax Issues The IRS audits state and local governments for compliance with the tax law rules. Sometimes random and sometimes targeted. Federal Tax Issues Bank-qualified bonds Banks can get a tax benefit by investing in tax-exempt bonds of small issuers. A small issuer is one which reasonably expects to issue less than $10,000,000 in bonds in a calendar year. Federal Tax Issues Section 6700 Penalties - The IRS may impose a penalty against any person who, directly or indirectly, organized or assisted in the organization of a bond offering where there is a representation that the interest is excluded from gross income. Securities Law Compliance Municipal bonds are securities which are exempt from registration requirements of Section 3(2) of the Securities Act of Subject to Antifraud provisions Section 10(b) of the Securities Exchange Act of Securities Law Compliance In the Matter of State of New Jersey Admin. Proc. File No (August 18, 2010). First SEC action against a state. Pension issues. Material misstatements in Official Statement. State settled no scienter... In the Matter of City of San Diego, California Admin. Proc. File No (November 14, 2006). First Order with a municipality that required remedial undertakings. First case to impose civil penalties against municipal officials personally. City Officials knew of magnitude of pension problems but failed to disclose - SEC v. Uberuaga, Civil Action No. 08 CV 0621 (S.D. Cal. April ). 5

6 Securities Law Compliance In December 1996, the National League of Cities; the National Association of Counties; the National Association of State Auditors, Controllers and Treasurers; and the Government Finance Officers Association, with input from the SEC, prepared a publication, Questions to Ask Before You Approve a Bond Issue. Continuing Disclosure SEC Rule 15(c)(2)(12) provides that an underwriter may not purchase or sell municipal securities unless the issuer agrees in writing to provide to the Municipal Securities Rulemaking Board at least annually, its audited financial statements as well as an update of the operating information about the issuer included in the official statement for the bonds. The Rule also requires an issuer to provide timely notice (ten business days from the occurrence of the event) to the market of any material events (listed in handouts). Filings are done through Electronic Municipal Market Access ( EMMA ) website at Continuing Disclosure Exemptions Does not apply to an offering with an aggregate principal amount of $1,000,000 or less. An issuer who has less than $10,000,000 in securities outstanding can enter into a more limited undertaking. Securities are exempt if they are sold in denominations of $100,000 or more and are (i) sold to no more than 35 sophisticated investors; and (ii) have a maturity of nine months or less. Municipal Finance Instruments Fixed Rate Most common structure. Serial bonds are a group of bonds with different maturities issued at one time that pay a stated fixed interest payment at regular intervals. Bonds mature at regular intervals, annually or semi-annually. Each separate maturity in the series has a distinct stated interest rate. Variable Rate Generally structured as one maturity, 20 to 30 years. Interest is paid regularly, monthly or quarterly. Rate of interest paid is set periodically depending on reset mode. Daily Weekly Auction Structured Finance Swaps Forward Delivery agreements Investors In Municipal Bonds Obtaining lowest cost of capital is achieved by identifying active buyers creating competition between both institutional and retail investors. Institutional Investors Predominant buyer of tax-exempt bonds. Mutual Funds Insurance Companies Trust Departments Hedge Funds Retail Investors. Questions & Answers 6

7 Thank you! Dee Wisor Kim Crawford (303) (303)