Introduction to Municipal Bonds

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1 2011 Fall Leadership Summit Marriott, Columbia, South Carolina September 27-28, 2011 Introduction to Municipal Bonds A. Reid Cavnar Senior Vice President This document has been prepared by Merchant Capital, LLC for informational purposes only. This document shall not constitute an underwriting commitment, an offer of financing, an offer to sell, or the solicitation of an offer to buy any securities described herein. Merchant Capital, LLC does not guarantee the accuracy or completeness of information which is contained in this document and which is stated to have been obtained from or is based upon trade and statistical services or other third party sources. No one may reproduce or disseminate the information contained in these materials without the prior written consent of Merchant Capital, LLC.

2 What is a Municipal Bond? A debt security issued by a state, municipality, or county to finance capital expenditures. Municipal bonds are exempt from federal taxes and from most state taxes, especially if you live in the state in which the bond is issued Concept of the taxable yield equivalent. Because municipal bonds are generally tax-exempt, investors are willing to accept lower rates on tax-exempt debt Example: 3.65% tax-exempt interest = 5.62% equivalent taxable yield for an investor in a 35% tax bracket There are five (5) basic types of municipal bonds: 1) General Obligation Bonds, 2) Revenue Bonds, 3) Lease Revenue Bonds, 4) Tax Allocation Bonds and 5) Special Tax and Assessment Bonds Slide 2

3 Who Issues Municipal Bonds? State & Local Governments Cities, counties, states, special districts, schools, etc. Conduit issuers: economic development authorities (ex. JEDA) Non-Profit Organizations Universities, charter schools, hospitals, affordable housing Nonfinancial Corporate Business Industrial development bonds (IDB) SOURCE: Bloomberg. As of 1Q 2011 Slide 3

4 The Size of the Municipal Bond Market. ($MM) $500,000,000 $450,000,000 $400,000,000 $350,000,000 14,401 15,503 13,614 13,959 12,766 12,659 10,830 11,721 13,826 $300,000,000 $250,000,000 $200,000,000 $150,000,000 6,527 $100,000,000 $50,000,000 $0 (1) SOURCE: Bloomberg. Please note yellow box indicates total number of issues (1) Reflects market conditions as of September 1, 2011 Slide 4

5 Who Buys Municipal Bonds? Retail Investors High net-worth individuals Institutional Investors Mutual Funds 37% Mutual Funds Investment advisors Commercial banks Bank trust departments Insurance companies Retail 37% Other 6% Banks 9% Insurance Co. 16% SOURCE: Bloomberg. As of 1Q 2011 Slide 5

6 Credit Ratings Rating Agencies Standard & Poor s, Moody s and Fitch Ratings Analyze credit quality of bonds and assign a rating Purpose of Ratings Assess issuer s ability to repay bonds through maturity Rating timing Initially determined prior to bond issuance Continuously renewed (annually) to help investors determine bond value May be amended over time to reflect changes in the credit quality of the debt Slide 6

7 Bond Ratings / Credit Quality Moody s Standard & Poor s Fitch Ratings Aaa AAA AAA Investment Grade Aa1,Aa2,Aa3 AA+,AA,AA- AA+,AA,AA- A1,A2,A3 A+,A,A- A+,A,A- Baa1,Baa2,Baa3 BBB+,BBB,BBB- BBB+,BBB,BBB- Non Investment Grade Ba1,Ba2,Ba3 BB+,BB,BB- BB+,BB,BB- B1,B2,B3 B+,B,B- B+,B,B- Caa1,Caa2,Caa3 CCC+,CCC,CCC- CCC+,CCC,CCC- Most charter schools are rated in the triple-b category Slide 7

8 Charter School Rating Criteria When analyzing a charter school, rating agencies focus on the following areas: Operating profile Charter school legislation, funding mechanism, charter renewal history, wait list, academic offerings (special focus) Governance Composition of Board of Directors, management company (if applicable) Financial Information Audited financial statements, operating performance, budget practices, financial projections Slide 8

9 Charter School Rating Criteria (continued) Project Scope New construction or acquisition of current facility, location of school (if new construction), construction risk mitigates Covenants and Legal Framework Debt service coverage ratio, days cash on hand, additional bonds test Slide 9

10 Bond Issuance Steps Determine Charter School Objectives Financial Structuring Rating Agency Presentation Marketing & Sale of Bonds Bond Closing Step 1 Determine objective (new construction, acquisition) Step 2 How much can the charter school bond for? Variable or fixed rate? Step 3 Develop credit presentation (enrollment, renewal history, financial audit) Step 4 Bonds are sold to investors using credit rating Step 5 Bond closing and delivery of proceeds Slide 10

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