Investment Strategies for Investing Bond Proceeds Chris M. DeBow Managing Director
Investing Bond Proceeds Municipal Advisor Regulations I.R.S. Regulations Arbitrage Regulations Safe Harbor Bidding Investment Options Guaranteed Investment Contracts (GIC s) Investment Portfolios Liquidity Vehicles Bank products Investment Pools Investment Securities This presentation does not constitute legal, tax, arbitrage or investment recommendations. 2
Dodd Frank Dodd Frank amended the Exchange Act of 1934 to add a new requirement that Municipal Advisors register with the SEC (October 2010) Delayed Effectiveness till July 1, 2014 Final rules provided for interpretations of regulations of what constitutes a Municipal Advisor and any exemptions therein. Ultimately, anyone providing advice on the issuance or investment of tax exempt bond proceeds must act in a fiduciary capacity. Financial Advisors Broker Dealers Investment Advisors Others 3
Exemptions from Registering as Municipal Advisors Underwriters Underwriters now primarily debt advice to the entities Financial Advisors Attorneys Engineers Accountants Public Officials Duty to the public Investment Advisors Registered with the S.E.C. Held to Fiduciary Standard within the Investment Advisors Act of 1940 Others 4
I.R.S. Regulations Arbitrage Related Arbitrage Ability to borrow at tax exempt rates and invest at higher rates without incurring any additional risk. Governed by Section 148(a) of the Internal Revenue Code. Regulations were created to prevent issuers from: Issuing more bonds than needed. Issuing bonds sooner than needed. Leaving bonds outstanding longer than necessary. Determining an Arbitrage Rate Derived from the cost of funds from the original bond issue Fixed rate bond deals are simpler Variable rate bond deals are more difficult to track. 5
Arbitrage Continued Section 148 does allow for some general exceptions for rebate. Spending exceptions Small issuer exceptions Others Six Month Exception Eighteen Month Two Year Exception Exception 100% 15% in 6 months 10% in 6 months Includes 5% de minimus amount 60% in 12 months 45% in 12 months 100% in 18 months 75% in 18 months 100% in 24 months 6
Is Arbitrage a Bad Thing? Paying arbitrage rebate is generally a good thing! Technically means that investment earnings were maximized within the confines of the regulations. Excess interest must be rebated to the I.R.S. IF arbitrage is owed, payments must be received within 60 days of the 5 year anniversary of the issuance of the Bonds. How do you know if you owe rebate? Have an expert conduct either a review or actual calculation. Make sure you hire a reputable firm. What happens if I don t do a calculation or do not make any required arbitrage payments? Could lose your tax exempt status on bonds Significant financial penalties 7
Bond Proceeds 101 Depending on the type of issuer, the following fund types may be created: Construction or project funds Debt service funds Debt service reserve funds Capitalize interest funds Others 8
Investment of Bond Proceeds Guaranteed Investment Contracts Contracts with a counterparty guaranteeing a rate of return for a specified period of time. In Texas, this generally comes in the form of a Repurchase Agreement Eligible under Texas Public Fund Investment Act. Specifically 2256.011 Repurchase Agreement must Have a defined termination date Is secured by obligations within 2256.009(a) Collateral must be held in public entities name Other requirements 9
GIC Bidding and Other Regulations I.R.S. has very specific regulations for bidding GIC s. 148 Internal revenue code Must have 3 bids Must be conducted in a reasonably competitive environment No last looks New regulations from Dodd Frank require the bidding agent be registered as a Municipal Advisor. Investment Advisors, cannot claim an S.E.C. exemption to execute a GIC. Bidding is done by issuing bid documents. These documents should be heavily customized to your preferences. Bond Counsel should review these prior to the bidding agent releasing to potential bidders. 10
Potential Investment Options for GIC s Construction Funds Public entity can receive a guaranteed rate for a specified period of time for the construction funds. Very simple Known rate Easy to allocate interest across various sub accounts. Debt service reserve funds If the issuer is able to lock up an investment yield equivalent or greater than the arbitrage yield, this may be a great option for earning the maximum arbitrage yield over the life of the debt service reserve funds. Debt service funds Would allow issuer to earn interest while sinking their 1/6 th or 1/12 th payments. Drawbacks If you execute a GIC for DSF s or DSRF s and you refund outstanding bonds, there may be penalties to unwind transaction. 11
Fee s on GIC s Ultimately, the counterparty that is providing the investment rate to the public entity is attempting to earn a spread on the transaction. This is really the cost of the counterparty guaranteeing the public entity a rate and taking a hedging position in the investment marketplace The bidding agent can charge and bidding fee I.R.S. defines what constitutes a qualified administrative cost These costs are deductible against the arbitrage yield. This is good for the issuer Bidding fees have been indexed for inflation. Limits on bond series Limits on overall bond issue Limits on how much yield maybe taken/discounted 12
Investment Portfolios Investment portfolios allow for a highly customized investment solution tailored to your construction program. Can be executed either by issuer or by outside Investment Advisors Be mindful of municipal advisor regulations. Investment Advisors registered with S.E.C. are exempt from registering as Municipal Advisors If the issuer invests the funds directly, the issuer must conduct a bidding or RFP process with their approved brokers. Investment portfolios can include a wide variety of eligible securities as defined by the PFIA. Even though its eligible under statute or your Investment Policy, does not mean that it may be suitable for your portfolio. 13
Creating an Investment Solution/Portfolio Governing Document Review Investment Policy Investment Strategies State Statutes/Other Draw Schedule Review Review Budgeted Draws Project(s) Completion Date(s) Investment Options Review Investment Marketplace for Eligible Securities and Investment Rates Investment Solution 14
Sample Solution Sample Draw Schedule $10,000,000 1.20% $9,000,000 $8,000,000 1.00% $7,000,000 0.80% Draw Amounts $6,000,000 $5,000,000 0.60% Interest Rates $4,000,000 $3,000,000 0.40% $2,000,000 0.20% $1,000,000 $0 0.00% Bank or LGIP U.S. Treasuries U.S. Gov. Agencies AA Municipals Blended Yield Illustrates a sample construction draw schedule. Public Trust has provided a sample assets allocation for this hypothetical draw schedule. Rates are shown as Gross of Fees for all draws except Bank or LGIP draws which are shown Net of Fees. Blended Yield represents the yield at each draw based upon the asset allocation. For illustrative purposes only. Not guaranteed. Source: Bloomberg. 1/11/2016 15
Sample Investment Portfolio Sample Metrics Sample Portfolio Metrics 9.80% 17.00% 10.45% Weighted Average Maturity 1.1 years Gross Portfolio Yield* 0.72% Sample Interest Income Analysis Sample Investment Solution $698,935.33 Bank/LGIP Only Solution $395,333.33 62.75% GIC Investment Solution $485,034.28 Bank or LGIP U.S. Gov. Agencies U.S. Treasuries AA Municipals *Rates are shown as Gross of Fees for all draws except Bank or LGIP draws which are shown Net of Fees.Source: Bloomberg. 1/11/2016. Sample Interest Income Analysis assumes time weighted calculation of sample draw schedule. Figures are not guaranteed. 16
Investment Portfolios Various Fund Types Construction Funds The upward sloping yield curve allows for the inclusion of: Bank checking accounts/investment Pools for liquidity options Individual securities provides increased interest income for longer term construction funds. Debt service reserve funds Investment portfolios allow for enhanced interest income. Debt service funds Given the short term nature of these funds, at this time, funds are likely better suited in bank checking accounts or Investment Pools. 17
Summary Issuing bonds presents opportunities for reinvestment Put a plan in place to safely invest the proceeds Don t be afraid to reach out to an expert. Bond counsel Arbitrage experts Investment Advisors/Municipal Advisors Others 18
Contact Information Chris DeBow Managing Director Public Trust Advisors Chris.debow@publictrustadvisors.com 513.252.3830 Chris has more than 15 years of investment experience assisting public clients nationwide with their investment management needs. He has a broad knowledge base of state statutes governing public funds investing and regularly works with clients to create unique investment solutions for a wide array of funds including operating; construction; reserve; capitalized interest; debt service; sinking and selfinsurance funds, among others. Chris also specializes in assisting underlying issuers who implement conduit issue financings, complex investment solutions typically governed by state statutes; trust indentures; bond covenants and IRS safe harbor regulations. In addition to his experience as an investment advisor, he has assisted a number of entities with such financial complexities as their escrow defeasance portfolios; flexible repurchase agreements; guaranteed investment contracts and forward delivery agreements. Prior to joining Public Trust in 2013, Chris served as Director of Institutional Services for Seasongood Asset Management (SAM), a $2 billion public funds specialty firm. He was responsible for the daily sales efforts for public funds clients in Ohio, Kentucky and Indiana. After RBC Global Asset Management U.S., Inc. acquired SAM, Chris was named Managing Director of Public Fund Services, managing public fund sales and servicing nationwide. Chris has a Bachelor of Arts (BA) in Economics from the University of Rio Grande and earned a Master of Business Administration (MBA) degree in Finance from Xavier University. He previously held NASD licenses Series 6, 3, 30, and 65. 19
Additional Disclosure This presentation is for informational purposes only. All information is assumed to be correct but the accuracy has not been confirmed and therefore is not guaranteed to be correct. Information is obtained from third party sources that may or may not be verified. The information presented should not be used in making any investment decisions and is not a recommendation to buy, sell, implement or change any securities or investment strategy, function or process. Any financial and/or investment decision should be made only after considerable research, consideration and involvement with an experienced professional engaged for the specific purpose. All comments and discussion presented are purely based on opinion and assumptions, not fact, and these assumptions may or may not be correct based on foreseen and unforeseen events. All calculations and results presented and are for discussion purposes only and should not be used for making calculations and/or decisions. The investment advisor providing these services is Public Trust Advisors, LLC (Public Trust), an investment adviser registered with the U.S. Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940, as amended. Registration with the SEC does not imply a certain level of skill or training. The data in this presentation is unaudited. Performance comparisons will be affected by changes in interest rates. Investment returns fluctuate due to changes in market conditions. Investment involves risk, including the possible loss of principal. No assurance can be given that the performance objectives of a given strategy will be achieved. Past Performance is no guarantee of future results. Any financial and/or investment decision may incur losses. 20