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Presentation to IASBO Members – The Truth About Premium Bonds, Debt Limit, and Cost Effective Finance Plans. May 18, 2006. Tammie Beckwith Schallmo UBS Investment Bank Tom Chapman Raymond James & Associates
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Presentation to IASBO Members –The Truth About Premium Bonds, Debt Limit, and Cost Effective Finance Plans May 18, 2006 Tammie Beckwith Schallmo UBS Investment Bank Tom Chapman Raymond James & Associates Wendy Flaherty First Trust Portfolios, LP Lynda Given Chapman and Cutler LLP Todd Krzyskowski JP Morgan Securities Inc.
Table of Contents • Goals of the Presentation • Background and History • Types of Debt Structures • Market Impact and Cost of Different Structures • E. Managing the Media • Tab
Many Different Perspectives All Bond Structures for Illinois Public Schools Must be Viewed and Understood from Many Different Perspectives Board of Education District Administration (Superintendent and Business Manager) Bond Counsel (e.g. Chapman and Cutler) Debt Structure, Tax Rate Impact, Types of Bonds Used Financial Expert and Underwriter (Capital & Operating Knowledge) Community Member The Media (Newspaper and TV) Citizens Groups and Referendum Committees And then, there’s the Investor……
What Will We Accomplish Today? • A Historical Perspective on Bonds and Debt Limits for Illinois Schools • Types of Debt Structures – Developing a Debt Structure that Meets Community Needs • True Costs of Different Debt Structures – Market Impact and Investor Acceptance • Handling Media Coverage and Reaction to Referendum Plan
Background and History • History of debt limits • 1870 Constitution • 1970 Constitution • Personal Property Tax • Examples • Construction Bonds • Working Cash Fund Bonds • Funding Bonds
Background and History • How Borrowers Can Address These Limitations • Obtain additional authority from voters • Exploding enrollment • 2/3 voter approval • Change limitation by legislation • Issue in series • Staleness • Costs • Adjust bond components
Types of Debt Structures • Level Debt Service • Level Tax Rate • Use of Capital Appreciation Bonds (CABs) • Use of Premium Bonds
Debt Structure Considerations • Growing or stable school district and EAV? • Impact of Tax Cap on total tax rate • Other referenda in the community • Palatability to the taxpayer • Average life of debt versus new facilities • Preventive maintenance needs and/or Capital Improvement Plan • Planning for the Future • Debt Limit availability • Debt Policy
Debt Service Approach • Level debt is common in Districts where the EAV is stable • Level tax rate typical in Districts with significant growth projected • A level rate/level debt approach is often used (when growth is expected to slow or stop) • Level tax rate usually results in a higher total debt service cost for the district but a lower initial impact on the tax rate
Capital Improvement Plan • District should maintain multi-year (3-5 years) Capital Improvement Plans for all of its facilities • Enables Districts to prioritize needs, identify Life Safety projects and potentially spread out costs to make projects more affordable • The development of a Capital Improvement Plan (CIP) enables a District to get a handle on any financing needs • Preventive maintenance is a critical component of a Capital Improvement Plan
Confusion Recently, the Media has Very Effectively Confused the “Coupon Rate” on a Bond with its Effective “Yield” or Cost to a School District • Coupon Rate – The stated interest rate printed on a bond (e.g. 9%) that is payable semi-annually for an outstanding bond • Yield or “Current Yield” – The rate of return on a bond to an investor (or cost to a School District) based on the ratio of the coupon income to the purchase price. For example, a $1,000 par value bond with a coupon of 9% pays $90 annually in coupon income, but if the $1,000 par value bond is bought at $1,700 the current yield (or cost to the School District) is only 5.29%! • Important Notes – Effective costs on different types bonds are best determined by comparing yields not coupon rates. The only time a coupon rate equals the yield on a bond is when the bond is purchased at par (i.e. $1,000). If you don’t CLEARLY distinguish between coupon rate and yield, negative assumptions about financing costs will arise!
What Does “Premium” Mean? “Premium” does not automatically mean the School District is paying a higher financing cost Par Bond – Coupon rate equals yield and investor pays exactly 100 cents on the dollar for the bond Discount Bond – Coupon rate is lower than bond yield and investor pays less than 100 cents on the dollar for the bond Premium Bond – Coupon rate is higher than bond yield and investor pays more than 100 cents on the dollar for the bond In fact, all three types of bonds could have the same yield or financing cost to the District………………………….
Calculating the Yield $60.00 $47.50 Coupon Rate $50.00 5% 5% Current Yield 5% = = = = Price $1,000 $950 $1,200 The Yield (or cost to a School District) on a Bond is a function of Both Coupon Rate and Price Par Bond Coupon = 5% Discount Bond Coupon = 4.75% Premium Bond Coupon = 6% Thus if Prices Decrease, Yields Increase and Vice Versa
Debt Service Comparison Par, Premium and Discount Bonds Interesting to note that a premium bond generating the same amount of proceeds as a discount or par bond actually has lower cumulative debt service!!!
Capital Appreciation Bonds (CABs) Zero Coupon or Capital Appreciation Bonds (CABs) Can Also Be Sold with an Implicit “premium” to Raise Additional Bond Proceeds and/or Preserve Debt Limit • Zero Coupon or “Capital Appreciation” Bond (CAB) – A Bond that is issued at a deep discount and which bears no stated rate of interest (i.e. 0%), only compounded interest is paid at maturity. Such bonds are bought at a discount price that implies a stated yield (i.e. rate of return) calculated on the basis of the bond being payable at par (or face value) at maturity. • Premium Capital Appreciation Bond (PCAB) – A type of CAB that has a stated yield or accretion rate that is higher than its actual current yield to investors. This difference results in a lower initial stated par amount which preserves debt capacity. • Important Note – A CAB and a PCAB of the same amount and with the same maturity and same yield to maturity cost exactly the same. However, the components of the initial cost (par amount and premium) are different. The primary benefits to a School District from using these bonds is to; (1) raise additional proceeds, (2) preserve debt limit, and (3) help reach tax rate targets.
Bond Investors Investor Purchase Different Types of Municipal Bonds for Various Reasons • Where Bonds Best Fit Into a Portfolio – Portfolio Swaps • Capital Appreciation and Capital Gains • High Current Income – Retirees or Portfolio Managers • Defensive Couponing Strategies – Recent Strong Preference for Premium Bonds with at least a 5% coupon rate. Portfolio managers were positioning for upturn in interest rates that is currently materializing. • Non-Callability – assurance that a bond cannot be redeemed in advance of its final maturity. Provides more overall yield and capital appreciation stability for a portfolio over a longer period of time.
Effective Interest Rates – CIBs Versus CABs Effective interest rates (i.e. yields) on Current Interest Bonds are slightly lower (.50 to.70%) than interest rates (i.e. yields) on Zero Coupon Bonds (Capital Appreciation Bonds) Yield Curve Comparison
Cost of CABs The Additional Cost of Using Capital Appreciation Bonds Can Be Measured by Comparing CAB Debt Service to Conventional Current Interest Bond Debt Service and Reviewing the Present Value Difference • A District cannot issue $18 million of Interest Bearing Bonds in 2006 because of Debt Limit Constraints. • Current Interest Bonds would result in District exceeding its 24-cent tax rate target • Capital Appreciation Bond Yields are Assumed to be .50% Higher than Conventional Current Interest Bond Yields.
Communicating Debt Policy with the Public Managing the Media
Recent Headlines Broken Bonds Big Money, unspoken practices: The costly word of school loans On February 5, 2006 the Daily Herald ran the first of a series of articles uncovering Illinois school district borrowing. • “A typical home loan will cost you twice what you borrowed when it’s paid off with interest.” • “School districts get better interest rates – 30% lower.” • “However, in an analysis of 206 Illinois suburban school district loans, taxpayers pay MORE than what a typical homeowner would pay on their own loan.
Ouch! • Are 206 Illinois schools taking advantage of the innocent taxpayers? • “Cash bonuses” – are school administrators getting some type of kickback at taxpayers’ expense? • “Backloading” – is this something out of a Sopranos episode?
What Can We Learn? • There is mounting concern over how Illinois school districts are managed. A lack of trust. • School districts are on obvious target – instead of libraries, park districts, or municipalities? • The facts were pulled out of context and manipulated in a negative way.
Why is This Happening? • “No comment!” • Assumptions that reporters understand school district funding issues • Constant transition • Lack of early and effective communication
What Can We Do Going Forward? Be Proactive Rather Than Reactive
What Can We Do Going Forward? The first step to being proactive is to RESPOND • Respond when other districts will not. Regularly saying “no comment” or being “unavailable” is ineffective and potentially damaging because: • Media regards itself as the public’s eyes and ears • They will continue to do a story WITHOUT your input • They will gather “information” from anyone that offers it • Assume nothing • Understand and accept the media’s role • Take leadership, control and responsibility
Fostering Relationships Why do districts need to foster a positive relationship with the media? • To develop and maintain credibility for the Board of Education and your administration • To educate and influence taxpayers to support you at the polls when additional funding is needed • To inform and involve your community with the ever-changing educational process • To improve the community’s understanding of district goals, initiatives, programs and operations • To promote community pride in student, team and district accomplishments and honors
Key Messages You need key messages…and to know how to use them • Develop and articulate key messages • Remember 3 + 3 • 3 key messages, plus 3 facts to support each • Use powerful facts to stay on message • News = people + actions + local interest • News is immediate, timely, right now
Successful Media Relations Strategies • Be the primary, trusted source for information • Be prepared by brainstorming the “must answer” questions you expect to be asked • Be creative and pitch story ideas to them instead of just waiting for their call • Respond, respond, respond!
