October 23, 2012
Variations on Refundings
With longer-term interest rates for both taxable and tax-exempt bond issues remaining low,
three topics concerning advance refundings are worth discussing:
1. Advance refundings of bond issues with call dates as late as 2018 are meeting policy
and/or state law requirements. These refundings are usually for bond issues that still
have 12 to 15 years until the final maturity. Some states, such as Minnesota, have laws
that require a minimum 3.00% net present value (NPV) savings test for general
obligation bonds (generally equal to the present value of the savings by divided by the
present value of the refunded debt service), while some issuers have adopted policies
with a 3.00% or 4.00% NPV savings threshold. These savings tests assume no
restructuring of the issue to extend the weighted average maturity. It is important to
discuss the merits of any refunding where proceeds will be placed in escrow. Many
things can happen that would reduce or negate all of the savings between now and 2018.
For example, will any revenues supporting debt service for the issue increase to a point
that would allow full or partial prepayment prior to the call date? Do you have
additional debt plans in the near future that may better be accomplished by combining
the new issue with the refunding issue? We recommend thoughtful discussion on any
advance refunding, but particularly for any in which an escrow lasts more than a few
years. Negative arbitrage is an important factor to measure in an escrow. Even with
very low interest rates on the new bonds (say 2% interest rate) the escrow is usually
earning less than .5%. This 1.5% difference in the rate paid on the bonds and the
investment rate is called negative arbitrage, and it requires that additional bonds be
issued to fully fund the refunding. For advance refundings of bonds with call dates
several years in the future, negative arbitrage can often be more than the total savings
after all costs. Sometimes the best option is to wait and gather more information,
particularly if you are uncertain about future borrowing needs, prepayments, or the
amount of negative arbitrage.
2. Partial refundings to meet a 3.00% savings test, especially on advance refundings. Most
bond issues can be pre-paid in part rather than in whole. Further, most of the savings for
a bond issue are tied to the last several maturities (higher coupons than earlier
maturities). Some issuers have utilized partial refundings to save enough money to meet
minimum savings requirements, which typically involves leaving the shorter-term
maturities in place. A partial refunding is a reasonable strategy as long as an issuer
understands the complications of such a structure. The issuer will need to make two or
potentially three payments on bonds tied to the same project, where there was only one
before. This is an administrative concern to make sure no payments are missed, but it is
also a financial consideration because a paying agent or trustee will charge for each
individual issue.
3. Taxable bonds to effect a second advance refunding. The Internal Revenue Code
dictates that tax-exempt bonds can only be advance refunded a single time on a taxexempt basis. Because the spreads between taxable and tax-exempt rates are historically
narrow at certain points of the yield curve, taxable bonds are an option to provide
savings for a second advance refunding. Taxable bonds have their advantages. Some
(but not all) of the arbitrage limitations, such as the limitation on the amount earned on
the bond fund, are less of a concern with taxable bonds. Taxable rates are more
volatile, which should be factored into the savings estimates presented to a governing
body when calling for a sale. Also, a sensitivity analysis comparing how much higher
tax-exempt rates could be at the call date to generate the same NPV savings versus
issuing taxable refunding bonds now would offer another method for evaluating the
validity of this option for your particular situation.
There is no one “right” way to undertake a refunding. Too often refundings are presented as
risk-free with no disadvantages. Variations on traditional refundings offer opportunity and
additional risks. We recommend you enter into a refunding with your eyes wide open and
understand the advantages and the disadvantages associated with any financial decision.
Rating Agencies Expanding Questions
For many years we have observed that rating agencies focused on the performance of an issuer’s
general fund and did not spend much time on enterprise funds or other tax-supported funds.
However, we have noticed a shift in recent rating agency conference calls. A Aaa-rated issuer
was recently put on negative watch by a rating agency, in part due to concerns about operating
losses for an enterprise fund that does not have any revenue supported debt. It is now more
common for the rating analysts to ask more detailed questions about recreational facilities and
sewer and water utilities. We recommend that issuers prepare for these types of questions
before a call. We also recommend that issuers consider fund balance policies for enterprise
funds to give more direction to the governing body with respect to appropriate levels of cash or
reserves for these funds. Increased emphasis should also be placed on compliance with bond
covenants for revenue debt, such as debt service reserve requirements and debt service coverage
requirements.
Demand Remains High
Interest rates are very stable. Rates are up slightly over the past two weeks – approximately 5
basis points (0.05%) for maturities of 20 years or less. Demand for non-bank qualified and
bank qualified debt remains high, as demonstrated on the attached summary of competitive
sales.
Trends in Municipal Bond Yields
October 5 to October 19, 2012
October 5, 2012
October 19, 2012
Change
AAA Yields*
5 Years
10 Years
20 Years
30 Years
0.62%
1.69%
2.42%
2.86%
0.67%
1.74%
2.46%
2.86%
0.05%
0.05%
0.04%
0.00%
Bond Buyer 20 Bond Index**
3.61%
3.68%
0.07%
Source:
* Thomson Reuters Municipal Market Data
** The Bond Buyer. Average yield on a portfolio of municipal bonds
maturing in 20 years, with an average rating of AA/Aa2.
Competitive Sale Results October 8-October 19, 2012
St
Par Amt
(in
millions)
10/09/12 Waukegan Park District
IL
4.00
GO Refunding Park Bonds (Alt Rev Source)
10/09/12 Waukegan Park District
IL
1.65
GO Limited Refunding Park Bonds
10/09/12 Detroit Lakes, City
MN
2.39
10/09/12 Hutchinson, City
MN
10/09/12 Oakdale, City
10/09/12 Oakdale, City
Credit
Enhanced
Rating
BQ
TIC /
NIC
Maturities
# of
Bidders
Winning Bidder
AA
Y
0.86%
2013-17
10
Fifth Third Securities
AA
Y
0.86%
2013
10
Fifth Third Securities
GO Improvement Refunding Bonds
AA-
Y
1.48%
2015-26
8
United Banker's Bank
2.28
GO Improvement Bonds
AA-
N
2.16%
2014-28
2
Baird
MN
0.55
Taxable GO Housing Bonds
Aa2
N
2.58%
2015-28
4
Northland Securities
MN
0.78
GO Equipment Certificates of Indebtedness
Aa2
Y
0.76%
2013-17
4
BOSC
10/09/12 Oakdale, City
MN
4.49
GO Improvement and Refunding Bonds
Aa2
Y
1.35%
2014-26
10
BOSC
10/09/12 Lakeville Ind. School District No. 194
MN
43.89
GO Refunding Bonds
Aa3
N
1.49%
2014-22
14
BA Merrill Lynch
10/09/12 Oshkosh, City
WI
12.48
GO Corporate Purpose Bonds
Aa2
N
2.41%
2013-31
8
Janney Montgomery
10/09/12 Oshkosh, City
WI
3.66
GO Promissory Notes
Aa2
N
1.34%
2013-21
6
Janney Montgomery
10/09/12 Oshkosh, City
WI
6.81
Storm Water Utility Revenue Bonds
Aa3
N
2.74%
2013-32
3
Baird
10/09/12 Northeast Wisconsin Tech College District
WI
6.00
GO Promissory Notes
Aaa
N
0.55%
2013-16
7
Morgan Stanley
10/09/12 Sparta Area School District
WI
7.57
GO Refunding Bonds
AA-
Y
0.87%
2014-19
9
UMB Bank
Sale Date
Issuer
Issue
Underlying Rating
Y
IL
9.10
GO Bonds
AA
Y
2.18%
2013-32
8
Janney Montgomery
10/10/12 Kanabec County
MN
2.93
GO Refunding Bonds
A+
Y
0.76%
2014-19
8
United Banker's Bank
10/10/12 Kanabec County
MN
2.90
GO Medical Facilities Equipment & Refunding Bonds
A+
Y
1.24%
2013-22
8
UMB Bank
IL
9.91
GO Bonds
Aa2
Y
2.16%
2014-30
3
Stifel Nicolaus
MN
5.64
GO School Building Refunding Bonds
A+
Y
1.23%
2014-23
7
Piper Jaffray
AA+
PNC Capital Markets
10/10/12 New Lenox, Village
10/11/12 DeKalb, City
10/11/12 Osakis Independent School District No. 213
Y
10/11/12 Robbinsdale Area Schools Ind. SD No. 281
MN
24.11
GO School Building Refunding Bonds
N
1.41%
2014-22
8
10/11/12 Three Rivers Park District
MN
3.56
GO Bonds
Aaa/ /AAA
Y
N
0.80%
2014-18
2
Baird
10/11/12 Three Rivers Park District
MN
20.11
GO Refunding Bonds
Aaa/ /AAA
N
1.16%
2014-22
8
Piper Jaffray
10/11/12 Three Rivers Park District
MN
2.72
GO Golf Course Revenue Refunding Bonds
Aaa/ /AAA
N
1.29%
2014-22
3
Baird
10/15/12 Rolla, City
KS
0.56
GO Bonds
NR
Y
1.45%
2013-22
4
First National Bank
10/15/12 Maize Public Bldg Commission
KS
0.30
Improvement Revenue Bonds
NR
Y
1.80%
2013-22
3
Legacy Bank
10/15/12 Centennial Independent School District No. 12
MN
15.11
GO School Building Refunding Bonds
AA+
Y
N
0.64%
2014-17
10
PNC Capital Markets
10/15/12 Randolph Independent School District No. 195
MN
3.47
GO School Building Refunding Bonds
AA+
Y
Y
0.89%
2014-20
6
United Banker's Bank
Y
Y
0.69%
2014-18
6
United Banker's Bank
10/15/12 Janesville-Waldorf-Pemberton Ind. SD No. 2835
MN
3.84
GO School Building Refunding Bonds
AA+
10/15/12 Pine City Independent School District No. 578
MN
6.67
GO School Building and Refunding Bonds
Aa2
Y
Y
2.28%
2014-32
7
Baird
10/15/12 Hancock Independent School District No. 768
MN
1.12
GO School Building Refunding Bonds
Aa2
Y
Y
0.70%
2014-18
6
BOSC
10/15/12 Meeker County
MN
1.15
GO Law Enforcement Center Refunding Bonds
AA
Y
0.68%
2014-18
7
United Banker's Bank
10/15/12 Wales, Village
WI
1.20
GO Refunding Bonds
NR
Y
1.69%
2013-23
4
Bankers' Bank
10/15/12 Wisconsin Indianhead Tech College District
WI
4.98
GO Promissory Notes
Aaa
Y
0.59%
2013-17
7
Raymond James
10/15/12 Racine Unified School District
WI
10.00
Note Anticipation Notes
MIG1
Y
2.72%
2013
4
Jefferies
www.ehlers-inc.com
Offices in Minnesota: (800) 552-1171
Wisconsin: (800) 717-9742
Illinois: (800) 417-1119
Competitive Sale Results October 8-October 19, 2012
Sale Date
Issuer
St
Par Amt
(in
millions)
Issue
Underlying Rating
Credit
Enhanced
Rating
BQ
TIC /
NIC
Maturities
# of
Bidders
Winning Bidder
10/16/12 Glen Ellyn Park District
IL
1.85
GO Limited Tax Park Bonds
AA
Y
0.71%
2013-16
8
BOSC
10/16/12 Wichita, City
KS
21.25
GO Refunding Bonds
Aa1/AA+
N
1.38%
2015-23
8
UBS Financial Services
10/16/12 Wichita, City
KS
2.85
Taxable GO Refunding Bonds
Aa1/AA+
N
1.68%
2015-22
5
Baird
10/16/12 Wichita, City
KS
4.36
GO Refunding Bonds
Aa1/AA+
N
1.39%
2015-22
4
UBS Financial Services
10/16/12 Wichita, City
KS
17.70
GO Sales Tax Bonds
Aa1/AA+
N
1.98%
2013-27
5
UBS Financial Services
10/16/12 Wichita, City
KS
22.87
GO Sales Tax Refunding Bonds
Aa1/AA+
N
1.33%
2015-22
9
UBS Financial Services
10/16/12 Burnsville, City
MN
4.92
GO Tax Increment Bonds
Aaa
Y
1.46%
2014-27
6
Piper Jaffray
10/16/12 Burnsville, City
MN
3.01
GO Utility Revenue Bonds
Aaa
Y
1.55%
2013-27
4
Piper Jaffray
10/16/12 Burnsville, City
MN
1.34
GO Improvement Bonds
Aaa
Y
1.66%
2013-27
2
Baird
10/16/12 Cannon Falls, City
MN
3.09
GO Refunding Bonds
AA-
Y
1.14%
2014-23
6
UMB Bank
10/16/12 Edina, City
MN
10.77
GO Bonds
Aaa / AAA
N
1.60%
2014-29
6
Piper Jaffray
10/16/12 Edina, City
MN
0.82
Taxable GO Bonds
Aaa / AAA
N
1.29%
2014-20
6
United Banker's Bank
10/16/12 Edina, City
MN
2.10
GO Bonds
Aaa / AAA
N
2.61%
2020-33
5
UBS Financial Services
10/16/12 Fridley Independent School District no. 14
MN
10.91
GO School Building Refunding Bonds
Aa2
N
2.16%
2014-26
5
PNC Capital Markets
10/16/12 Wisconsin Rapids, City
WI
3.32
GO Corporate Purpose Bonds
Aa3
Y
1.40%
2013-25
8
UMB Bank
10/16/12 Winnebago County
WI
17.53
Go Promissory Notes
Aa1
N
1.48%
2013-22
8
BMO Capital Markets
10/17/12 Dundee Township Park District
IL
3.16
GO Limited Tax Park Bonds
AA-
Y
0.72%
2013-15
5
Fifth Third Securities
10/17/12 New Lenox Community Park District
IL
0.88
GO Limited Tax Park Bonds
A2
Y
1.21%
2013-17
2
Wintrust Financial Corp.
MN
2.75
GO School Building Refunding Bonds
Aa2
Y
0.74%
2014-18
5
United Banker's Bank
5.46
GO Promissory Notes
Aaa
N
1.32%
2013-22
3
Incapital
GO Promissory Notes
10/17/12 Hayfield Independent School District No. 203
10/17/12 Appleton, City
WI
10/17/12 Gateway Technical College District
WI
1.50
10/17/12 State of Wisconsin
WI
293.07
10/17/12 Paddock Lake, Village
WI
3.63
GO Corporate Purpose Bonds
10/18/12 Moraine Valley Community College Dist. No. 524
IL
5.40
10/18/12 Johnson County Community College
KS
5.14
10/18/12 Rush City Independent School District No. 139
MN
10/18/12 Janesville, City
WI
Aaa
N
1.62%
2015-22
1
Hutchinson Shockey
Aa2/AA/AA
N
2.90%
2022-33
10
Wells Fargo
A2
Y
1.55%
2013-27
5
Baird
Taxable GO Bonds (Alt. Rev. Source)
Aaa
N
1.82%
2015-22
7
Stifel Nicolaus
Student Commons and Parking Sys Refunding Rev Bonds
AA+
Y
1.37%
2013-27
6
Raymond James
2.27
GO School Building Refunding Bonds
AA+
Y
0.71%
2014-18
7
Raymond James
15.25
GO Promissory Notes
AA-
N
1.77%
2013-22
4
Baird
GO Bonds
Y
www.ehlers-inc.com
Offices in Minnesota: (800) 552-1171
Wisconsin: (800) 717-9742
Illinois: (800) 417-1119