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BONDS FOR BEGINNERS National Association of Local Housing Finance Agencies WELCOME!!
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Transcript of BONDS FOR BEGINNERS National Association of Local Housing Finance Agencies WELCOME!!
BONDS FORBEGINNERS
National Association of Local Housing Finance Agencies
PART I - Bonds & Yields
PART II - Credit Worthiness
PART III - Issuing Bonds
PART IV - Getting Best Rates
BONDS FORBEGINNERS
Think of an object that helps you describe your impression of the housing bond business.
What you will learn What is a bond? How a bond differs from a note? Why are securities heavily
regulated? Why tax-exempt bonds are
attractive to investors? What is the difference between
interest and yield? How to measure interest & yield.
Bonds are debt instruments like Notes Compare a bond with a note and
identify the key components. Principal or Face Value (1) Interest Rate or Coupon Rate (2) Term or Maturity Date (3) Payment Schedule (4) Prepayment Clause or
Redemption (‘Call’) Provision (5) Legal Authentication (6)
Similarities betweenBonds & Notes
Both notes & bonds are
debt instruments
Both have face values, coupon rates, maturity dates, payment schedules & ‘call’ dates.
Differences between Bonds & Notes
Bond issues can have multiple interest rates & maturity dates.
Interest on notes are taxable, but interest on bonds may be tax-exempt.
Bonds & Notes are also Regulated Securities
A “security” evidencing a debt Securities can be bought or sold
and are therefore “negotiable”. Negotiable Securities
stocks bonds notes checks currency
Who Regulates Securities?
1929 Market Crash
Congress regulates securities to insure the integrity & efficiency of commerce. [Commerce Clause]
The issuance, trade, evaluation and tax treatment of bonds are regulated by the SEC, Fed & IRS.
A Balance of Public Interests ‘Safety & Soundness’ Rules
80% LTV Limitation Total lending limited by deposits Monitoring loan loss risk
Promote the ‘American Dream’ Democracy in America FHA (1934) Fannie Mae (1938), GNMA (1968),
Freddie Mac (1970)
Why are bonds attractive to investors? Safety
Risk of financial loss is low Predictable revenue stream
Interest is paid semi-annually Tailored bond mix
Different types of maturities & interest rates to meet bond purchasers needs
Yield Interest earned can be tax-exempt
Taxable vs. Tax-exempt Yields
EFFECT OF FEDERAL INCOME TAXES ON YIELDSOF TAX-EXEMPT AND TAXABLE INSTRUMENTS
5% Tax-exempt 7.5% Taxable
Bond InvestmentCash investment $30,000 $30,000
Interest $1,500 $2,250
Federal Income Tax in the36% marginal tax bracket 0 $810
Net return $1,500 $1,440
Yield on investmentafter taxes 5.00% 4.80%
Measuring Interest & Yield by Basis Point The basis point is one hundredth of
one percent. 100 basis points = 1% = .01 75 basis points = .75% = .0075 50 basis points = .50% = .0050 25 basis points = .25% = .0025 15 basis points = .15% = .0015
What we have learned What is a bond? How a bond differs from a note? Why are securities heavily
regulated? Why tax-exempt bonds are
attractive to investors? What is the difference between
interest and yield? How to measure interest & yield.
What you will learn
What is credit worthiness & underwriting?
How to use the 5 C’s of credit worthiness analysis for a mortgage loan and for issuing bonds.
What are the key tools to enhance credit worthiness?
Credit Worthiness
Issuing bonds is taking out a loan for a public purpose.
Ever wonder how lenders decide on approval or denial of a loan?
Evaluating Credit Worthiness for a Loan
Character
Capacity
Credit
Collateral
Cash
Loan Application
Income Ratios
Credit Reports
Appraisal
Downpayment & Closing Costs
Evaluating Credit Worthiness for a Bond
Character
Capacity
Reputation of Issuer market history,
management, issuer & bond counsel opinions
Cash Flows worst cast tests
on origination, prepayments
Evaluating Credit Worthiness for a Bond
(continued) Credit
Collateral
Cash
Bond Rating Moody’s/
Standard & Poors
Pledge of revenues mortgages &
MBS Cost of Issuance
Underwriting & marketing fees
Enhancement of Credit Worthiness Purpose is to get a lower coupon
(interest) rate
Credit Enhancement tools mortgage-backed security bond insurance bank letter of credit guarantee
What you have learned
What is underwriting? What are the 5 C’s of credit
worthiness? How do underwriters make sure
the bond issue is credit worthy? What are the key tools to enhance
credit worthiness?
What you will learn
What is the difference between a GO bond and a revenue bond?
What is the private activity volume cap?
How does a public agency issue & sell bonds?
Who are the key professionals used to issue bonds?
What is the basic Flow of Funds?
Key types of Tax-Exempt Bonds GO Bonds & Revenue bonds Bondholders of ‘general obligation’
bonds are paid back by the full faith & credit of the agency of government.
Bondholders of ‘revenue’ bonds are paid back from a particular revenue stream.
The revenue stream is the monthly note payments from the mortgage.
Who can issue tax-exempt bonds?
Agencies of government, but only for a public purpose
Issuance of tax-exempt bonds is limited by Congress through the private activity volume cap
Limited annually to the greater of $95 per capita or $278 million
‘Private activity’ means 10% private use, ownership or security
Cooking with Bonds
Due Diligence
Testing the Ingredients
Professionals
Associate Chefs
Legal Actions
Shaking & Baking
Market Bonds
Adding Seasoning
How to issue & sell bonds Identify public purpose Hire quality bond counsel & financial
advisor Hire quality underwriters Review & test bond structure Conduct public hearings Acquire volume cap allocation Acquire lender participation Authorize issuance & sale of bonds
How to issue & sell bonds (continued)
Hire Trustee, bond insurer & GIC Acquire credit enhancement Acquire bond rating Execute Bond Closing Documents Monitor the origination of loan and
repayment of principal & interest to bondholders
Perform continuing SEC disclosure, IRS rebate calculations, and cash flow analysis
Basic Flow of Funds Single Family
(8) Pay Interest & Principal (7) Pass thru Loan (6) Pay Interest & Principal on Bonds thru DTC Payments on Mortgage Loans
BONDOWNERS TRUSTEE SERVICER BORROWERS (4) Fund
Loans (1) Pay for Indenture & Bonds Assignment (2) Bond (5) Additional Security (3) Make Loans Funds
Bond Purchase UNDERWRITER Agreement ISSUER CREDIT ENHANCER LENDER
Basic Flow of Funds Multi-family
(3) Lender Makes Loan
BONDOWNERS TRUSTEE DEVELOPER/OWNER
UNDERWRITER ISSUER CREDIT ENHANCER
(4) TrusteeBuys Loan
(5) Exchange MBSfor Mortgage(2) Gives Bond
Funds to Trustee
Indenture* &Assignment
BondPurchaserAgreement
(1) Pay forBonds
LENDER/SERVICER
What you have learned What is the difference between a
GO bond and a revenue bonds Who can issue tax-exempt bonds? What is the private activity volume
cap? What are key steps to issue & sell
bonds? Who are the key professionals
used to issue bonds? What is the basic Flow of Funds?
BONDS FOR BEGINNERS
National Association of Local Housing Finance Agencies
PART IVSelling Safety & Quality
Adding Seasonings
What you will learn
How to get a better rate by reducing perceived risk.
How to reduce common risk factors Why the Official Statement is so
important. What are the key due diligence
requirements. Needed credit enhancements
What do bond purchasers want?
Bond purchasers want a secure & quality yield.
The lower the perceived risk, the lower the expected return (interest).
What are the common fears of perceived risk? Tax risk
Are the bonds really tax-exempt? Prepayment risk
Am I really going to get my yield to maturity?
Credit risk Is there really a safe & sufficient
revenue stream?
What must be proven to ease fears of risk? Interest on bonds is tax-exempt; The revenue stream is sufficient &
timely to pay debt service; There is sufficient security in place
in the event that the revenue stream is interrupted.
How does the Agency prove bond quality to the bond purchaser?
Credit Enhancement
Due Diligence
Disclosure
Credit Enhancements
Gives investors more comfort
Four important credit enhancements are: bond insurance mortgage-backed securities letters of credit guarantee
Mortgage-backed security Mortgages are pooled by master
servicer; Pool of mortgages are exchanged
for pass-through certificates; The certificates are backed by the
full faith & credit of Fannie Mae, Freddie Mac and/or Ginnie Mae.
The certificates act as additional security for the bondholders.
Due Diligence
Tests the safety & quality of the bond structure
Most common due diligence are: Cash flow analysis Legal structure & integrity analysis Management capacity analysis
Duty to Disclose
The SEC places the responsibility & liability on the Agency for accurate & complete disclosure.
The primary instrument of disclosure is the Official Statement.
The Official Statement
Gives all the information that investors would reasonably need in evaluating the merits, as well as the risks, of buying the Agency’s bonds.
Prepared by the underwriter. Underwriter’s counsel issues SEC
10b-5 opinion. SEC wants approval by issuer.
What’s in the Official Statement ? States yields & offering prices Identifies payment terms Reveals redemption provisions States method of bond registration Describes the Agency & its
management Explains the flow of funds How fund balances will be invested Summarizes the trust indenture
What you have learned
What are the common perceived fears of the bond purchasers?
How are the common fears reduced? Name the key credit enhancements. What are the key due diligence
requirements. Why the Official Statement is so
important.
The Finance Authority of New Orleans
Created by the City Council in 1978 Provide low interest financing for
home purchase & renovation Provide down-payment assistance Issued more than $500 million in
mortgage revenue bonds Helped more than 7000 home
purchasers
Evaluating Credit Worthiness for a Loan
Character
Capacity
Credit
Collateral
Cash
Loan Application
Income Ratios
Credit Reports
Appraisal
Downpayment & Closing Costs
Evaluating Credit Worthiness for a Bond
Character
Capacity
Reputation of Issuer market history,
management, issuer & bond counsel opinions
Cash Flows origination,
prepayment & worst case tests
Evaluating Credit Worthiness for a Bond
(continued) Credit
Collateral
Cash
Bond Rating Moody’s/
Standard & Poors
Pledge of revenues mortgages &
MBS Cost of Issuance
Underwriting & marketing fees
Enhancement of Credit Worthiness Purpose is to get a lower coupon
(interest) rate
Credit Enhancement tools bank letter of credit mortgage-backed security bond insurance guarantee
BONDS FOR BEGINNERS
The Finance Authority
of New Orleans
PART IVSelling Safety & Quality
Adding Seasonings