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1
Investing Bond Proceeds
April 20, 2004
Lester T. WoodManaging DirectorBond Logistix, LLC
Lauren BrantSenior Managing ConsultantPFM Asset Management LLC
California Municipal Treasurer’s Association
2
Noticing the Obvious
FINISHED FILES ARE THE RE-SULT OF YEARS OF SCIENTIF-IC STUDY COMBINED WITH THE EXPERIENCE OF MANY YEARS
3
Investing Bond Proceeds •Financial Requirement
•P & I Payments
•Earning Assets
•Debt Service
•Reduce Borrowing Costs
•BondProceeds
•Use ofEarnings
•Objective
4
Overview•Who’s Involved in the Decision Making Process?
•Arbitrage Considerations.
•Fun with Funds!
•Mixing and Matching Investments.
•Case Study.
5
Who’s Involved?
Public Agency Consultants
Finance Director Trustee
Treasurer Underwriter
Mayor Financial Advisor
City Manager Investment Advisor
6
Arbitrage Considerations• What is arbitrage?
• Exceptions, Exemptions, Elections
• How does arbitrage factor into the investment strategy for my bonds?
• How will I keep track of the arbitrage of my bond issue?
• Planning Ahead
7
What is Arbitrage?
Bond Yield(tax-exempt)
Investment Yield (taxable)
4.0
5.0
6.0
7.0
8.0
9.0
1993 1994 1995 1996 1997 1998
Positive Arbitrage
Negative Arbitrage
Yie
ld
• 100% tax on earnings in excess of bond yield
8
Loopholes
• Exceptions
─ Project fund spending
• Exemptions
─ Small issuer
• Elections
─ Penalty in lieu of rebate
9
Investment Strategy• Factors to consider prior to issuance:
─ IRS regulations─ Marketplace vs. arbitrage yield─ Interest rate trends
• Ongoing strategy considerations:─ Arbitrage is cumulative from day one,
across all funds
10
Netting Effect
11
How do I Keep Track?Transaction Transaction Transaction Future Value Future Value
Date Days Type Amount Factor Cash Flow--------------- -------------------------- --------------------- ------------------ -----------------------
5/12/98 1800 Deposit 236,491,000.00 1.29199835 305,545,981.15 5/12/98 1800 Withdrawal (39,947,000.00) 1.29199835 (51,611,457.98)6/30/98 1752 Withdrawal (25,949,000.00) 1.28320184 (33,297,804.46)9/30/98 1662 Withdrawal (14,175,000.00) 1.26686948 (17,957,874.92)
12/31/98 1572 Withdrawal (20,475,000.00) 1.25074500 (25,609,003.95)3/31/99 1482 Withdrawal (20,100,000.00) 1.23482575 (24,819,997.66)6/30/99 1392 Withdrawal (19,050,000.00) 1.21910912 (23,224,028.78)9/30/99 1302 Withdrawal (19,050,000.00) 1.20359253 (22,928,437.66)
12/31/99 1212 Withdrawal (19,600,000.00) 1.18827343 (23,290,159.16)3/31/00 1122 Withdrawal (20,650,000.00) 1.17314930 (24,225,533.12)6/30/00 1032 Withdrawal (19,600,000.00) 1.15821768 (22,701,066.49)9/30/00 942 Withdrawal (12,200,000.00) 1.14347610 (13,950,408.41)
12/31/00 852 Withdrawal (5,150,000.00) 1.12892215 (5,813,949.06)3/31/01 762 Withdrawal (1,000,000.00) 1.11455344 (1,114,553.44)
--------------- -------------------------- --------------------- ------------------ -----------------------15,001,706.05
Calculation Date 5/12/03Days Since Inception 1800
Arbitrage Yield 5.190000%Future Value at Earnings of 5.19% $15,001,706.05Future Value at Earnings of 5.60% $16,486,923.58
Arbitrage Rebate Liability 5/12/03 $1,485,217.53
Earnings Yield 5.600000%
12
Planning Ahead At Issuance• Calendar of Important Dates
– Expenditure benchmarks– Yield restriction– 5-year payment date– Filing
• Data Collection– Segregated funds
• Refunding issues– Transferred proceeds
13
Fun with Funds!
• Project (Acquisition/Construction)–Match to Draw Schedule
• Debt Service Reserve– Covenant to Maintain Fixed Amount– Semi-Annual Availability
• Capitalized Interest
14
Fun with Funds!
• Debt Service Principal & Interest
–Capitalized Interest–Cash Flow Thereafter
• Escrows
15
Surety Bonds or L.O.C.
• Insurance with Recourse
• Replace Cash Funded DSR
– Debt Cap Problem at Time of Issuance
– Over Budget on Project Costs After Issuance
16
Cost of Surety or L.O.C.
• Premium Cost
• Lost Ability to Earn Positive
• Current/expected arbitrage position
17
Mixing & Matching Investments• Typical bond proceeds investments:
─ Liquidity Pools
─ Structured Portfolios
─ Investment Agreements
18
Considerations• Liquidity requirements
• Yield objectives (arbitrage yield vs. market)
• Purpose of funds
• Agency’s tolerance for risk
• Bond document investment language (boilerplate)
• Net/Gross funding for construction fund
19
Liquidity Pools
• Money market funds• County pool• Local Agency Investment Fund (LAIF)• Joint powers authority
Features
• Liquidity within restrictions of investments
• Ease in administration
Issues to consider
• Variable investment rate
• No customization to draws
20
Structured Portfolios Features
• Customized investment strategy
– Portfolio initially structured to match expected draw schedule
• Active trading can improve yield
• Portfolio restructured as draw schedule changes and to adjust for market changes
• Ability to lock in higher yield on longer-term funds
Issues to consider
• Can be time consuming to monitor and manage
• Slightly higher transaction costs may be incurred
• Mark-to-market risk for Reserve Fund
• Reduced liquidity
21
Investment Agreements
• Guaranteed Rate
• Withdrawals at Par
• Shift Reinvestment and Market Rate Risks to Provider
• Issuer Assumes Credit Risk on IAs
22
Investment Agreement Providers
• Banks
• Primary Dealers
• Private Placements • Insurance Companies
23
Investment Agreements
• Standard With Collateral Downgrade
• Collateralized
• Puts
• Forward Delivery
24
Uses of Investment Agreements
• Construction / AcquisitionFull flex draws
• Debt Service ReservesSemi-annual draw
• Debt Service Float Monthly window
25
Conclusion1. Consider the risks/rewards of all options.
2. Develop an investment strategy for all proceeds prior to issuance.
3. Revisit each fund’s strategy on a frequent basis.
By doing these things, you increase your chances of reducing your borrowing costs.