Ohio s History Financing School Construction Projects. Profiting from the Sale of School Bonds

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1 Profiting from the Sale of School Bonds John Adams FIFTH THIRD SECURITIES Ed Cavezza PECK, SHAFFER & WILLIAMS, LLP 21 East State Street, 14th Floor Columbus, Ohio (614) E. State Street, Suite 500 Columbus, Ohio (614) Ohio s History Financing School Construction Projects! No Financial Advisor on Finance Team! Underwriter/Investment Banker trusted to structure and execute entire transaction! Bond Counsel drafts all documents and issues approving opinion! Spotty history of efforts by national and Ohio based advisory firms. Very few instances of Underwriter abuse. 1

2 What Has Changed! Complex Financial Instruments introduced nationwide in public finance! Unexpected downturn in real estate markets, rise of interest rates and failure of wall street firms and bond insurers SWAPS create several unanticipated losses for public and private investors What Has Changed (cont.)! Public sector borrowers not equipped to assess risk of complex financial instruments! Underwriter s revenue incentives encouraged promotion of these products! Underwriter will typically introduce affiliated professional asset manager Impact in Ohio! Despite million dollar losses by individual governmental issuers (PA and WI School Districts) (TN Local Governments), only a handful of newly introduced derivatives sold to Ohio School Districts! Bond Counsels disagreed on legality without specific additional legislation! Underwriters not able to get direct State Legislative approval for conservative, riskadverse Ohio political subdivisions to participate 2

3 Current Climate! Demise of long-established Ohio underwriting firms coupled with fear of recent recession provides opportunity for Ohio based financial advisory firms! Emphasis on protection of the Issuer (School District) Why Might School District Need Protection?! The Bare Bones Transaction is the sale of securities by the School District and purchase of securities by the Underwriter (buyer/seller relationship)! Securities must be structured Rating? Insurance? Call Features? Speed of Principal Repayment State Intercept?! Borrowed funds must be invested Why Might School District Need Protection? (cont.)! Underwriter is purchaser of debt with financial expertise but no fiduciary duty to Issuer 3

4 Potential Conflict and Solution! Pressure because Underwriter has two entities to satisfy: His or her for-profit employer The School District! The Issuer on its own has no way of being sure the structure and pricing of its debt was in all respects in its best interest Potential Conflict and Solution (cont.)! Financial Advisor: Levels the playing field Knows which questions to ask Is familiar with current market conditions Would recognize clearly exorbitant banker or lawyer fees Registration and Regulation! Dodd-Frank Act creates fiduciary duty owed by Municipal Advisors when providing financial advice! Federal Government is now requiring registration of Financial Advisors to assure minimum uniform standards! Partly because some Financial Advisors participated in the risky but profitable sale of complex securities to local governments! Remember not all Financial Advisors are created equal. 4

5 MSRB Mandated to Protect State and Local Governments! MSRB working on establishing minimum professional qualifications for Municipal Advisors! MSRB Municipal Advisor rules put on hold pending SEC determination by rule of who is covered under Municipal Advisor definition Not for Everybody! Some Issuers have experienced exemplary service from the purchaser of their debt! The key is to ask and answer this question: Do we need the help of a trained professional looking out only for us? MSRB Rule G-17! Conduct of Municipal Securities and Municipal Advisory Activities In the conduct of its municipal securities or municipal advisory activities, each broker, dealer, municipal securities dealer, and municipal advisor shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice. 5

6 MSRB Rule G-17 Interpretive Notice Effective 8/2/12! New Required Disclosures (Underwriter to Issuer) Duty to deal fairly with Issuer and investors (basic rule) Purchase of securities in arms-length commercial transaction No fiduciary duty not required to act in Issuer s best interest Duty to purchase securities from Issuer at fair price by/and against duty to sell to investors at fair price Underwriter must not recommend that the Issuer not retain a financial advisor Sample Debt Service Schedules $10,000, $10,000, Sample Debt Service at 3.6% for 30 Years Sample Debt Service at 3.75% for 30 Years Principal Coupon Interest Period Total Principal Coupon Interest Period Total , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , Total 10,000, ,742, ,742, ,000, ,317, ,317, Underwriter Compensation Disclosure! Is it contingent on closing the deal?! Does size matter? More bonds means more compensation! Must compensation be disclosed? 6

7 Disclosure of Conflicts! Payments to third parties! Profit-sharing with investors! SWAP/complex transaction incentive How to Disclose! In writing signed by Issuer representative! To Issuer s representative with authority! Arms-length nature of transaction must be disclosed exactly! All disclosures made when Underwriter engaged! If transaction more sophisticated than Issuer s representative, particulars of proposal must be laid out What to Expect! 450 billion dollars of municipal securities issued annually in U.S.! More regulation, more disclosure, increased transparency/accountability! MSRB charged with federal mandate to protect the local Issuer 7

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