Nuts and Bolts of Debt Including Arbitrage Ohio Government Finance Officers Association

1
Nuts and Bolts of Debt Including ArbitrageOhio
Government Finance Officers Association

• Presented by
• Raymond C. Headen, Esq.
• Bricker Eckler LLP
• 1375 East Ninth Street, Suite 1500
• Cleveland, OH 44115
• www.bricker.com
• Columbus Cleveland Cincinnati-Dayton

2
Topics Addressed

• Sources of Funding Capital and Operating Expenses
• Overview of Debt Authority
• Types of Debt
• Overview of Debt Limitations and Types of
  Issuers
• Arbitrage
• Other Issues

3
Sources of Funding Capital and Operating Expenses

• Cash
• Property Taxes
• Income Taxes
• Utility Revenues
• Borrowing / Debt Issuance

4
Overview of Debt Authority

• State of Ohio
• Political Subdivisions
• Taxing Districts
• Municipalities, Counties, Townships, School
  Districts, Joint Vocational School Districts,
  etc.
• Special Districts without taxing power

5
State of Ohio

• Article VIII, Section 1 Ohio Constitution
• Ability to borrow for deficit limited to 750,000
• Article VIII, Section 2 Ohio Constitution
• Specific Amendments (approved by voters from time
  to time) to permit issuance of debt for capital
  projects Issue 2 money

6
Political Subdivisions

• Taxing Districts
• Municipalities
• Counties
• Townships
• School Districts
• Joint Vocational School Districts

7
Political Subdivisions

• Special Districts
• Library Districts
• Community College Districts
• Fire Districts
• Hospital Districts
• Water and Sewer Districts
• Recreation Districts
• New Community Districts

8
Types of Debt

• Bonds, Notes, Bond Anticipation Notes
• General Obligations
• Voted vs. Unvoted
• Revenue or Special Obligations
• Non-Debt (i.e., leases, lease-purchase,
  installment purchase), including Certificates of
  Participation (COPs)
• Capital vs. Operating

9
General Obligation Debt

• Full Faith and Credit and general taxing power
  of subdivision is pledged to pay debt service
• May be paid out of General Fund of Issuer
• Priority over operating expenses
• Subject to specific Constitutional and statutory
  limitations

10
General Obligation Debt

• Voted G.O. Debt
• Specifically approved by voters
• Special tax authorized (but not required to be
  levied)
• Unlimited as to rate or amount
• Most secure of all debt

11
General Obligation Debt

• Unvoted G.O. Debt
• First claim against revenues but no special tax
• Includes most special assessment debt

12
Special or Revenue Obligations

• Limited pledge of only a specific revenue stream
  to pay debt service
• Utility revenues (water, sewer, electricity,
  etc.)
• Debt to be paid only from a specific tax (with a
  limited rate or amount to be collected)
• Less secure than G.O. Debt

13
Non-Debt

• Types
• Leases
• Lease-Purchase
• Installment Purchase
• Certificates of Participation
• No debt limitations

14
Capital vs. Operating Expenses

• Limited Authority to Borrow for Operating
  Expenses
• Final judgments or settlements
• Emergencies
• Anticipating a voted tax levy
• Requirement to show a deficit

15
Overview of Debt Limitations and Types of Issuers

• Ten-Mill Limitation (Indirect Debt Limit)

16
Overview of Debt Limitations and Types of Issuers

• Statutory Debt Limitations (Direct Debt Limit)
• Municipalities
• Overall - 10½ of assessed valuation (AV 35
  of true value)
• Unvoted - 5 ½ of AV

17
Overview of Debt Limitations and Types of Issuers

• Statutory Debt Limitations (Direct Debt Limit)
• Counties
• Unvoted 1 of AV
• Example Total Assessed Valuation of County X is
  400,000,000
• Total unvoted 1 Direct Debt Limitation
  is4,000,000.

18
Overview of Debt Limitations and Types of Issuers

• Statutory Debt Limitations(Direct Debt Limit)
• Counties Overall (Unvoted and Voted)
• 1) AV not exceeding 100,000,000, 3 of AV
• 2) AV exceeding 100,000,000 but not exceeding
  300,000,000, 3,000,000 plus 1½ of AV in excess
  of 100,000,000
• 3) AV exceeding 300,000,000, 6,000,000 plus 2½
  of AV in excess of 300,000,000.

19
Overview of Debt Limitations and Types of Issuers

• Statutory Debt Limitations(Direct Debt Limit)
• County Example
• Total Assessed Valuation of County X is
  400,000,000
• Unvoted Debt Limitation is equal to
• 100,000,000 x 3 3,000,000 plus
• 200,000,000 x 1.5 3,000,000 plus
• 100,000,000 x 2.5 2,500,000 equals
• 8,500,000

20
Overview of Debt Limitations and Types of Issuers

• Statutory Debt Limitations(Direct Debt Limit)
• School Districts (including joint vocational)
• Overall 9 except for special needs districts
• Unvoted 1/10 of 1 for most debt
• 9/10 of 1 for energy conservation
  debt

21
Overview of Debt Limitations and Types of Issuers

• Statutory Debt Limitations(Direct Debt Limit)
• Township
• Overall 5
• Exception Home Rule Townships same as
  municipalities

22
Overview of Debt Limitations and Types of Issuers

• Statutory Debt Limitations(Direct Debt Limit)
• Exemptions
• Special Assessment Debt
• Self-Supporting Debt
• Other Special Categories

23
Overview of Debt Limitations and Types of Issuers

• Other Issuers
• Library Districts
• Community College Districts
• Fire Districts
• Joint Hospital Districts
• Conservancy Districts
• Park Districts
• Port Authorities
• Sanitary Districts
• Water and Sewer Districts
• Regional Transit Authorities
• New Community Authorities

24
Tax-Exempt Interest Arbitrage

• Section 103, Internal Revenue Code of 1986, as
  amended
• gross income does not include interest on any
  State or local bond.

25
Arbitrage

• Arbitrage Bond
• A bond is not tax-exempt if it is an arbitrage
  bond under Section 103(b)(2) of the Internal
  Revenue Code
• Arbitrage Bond is any bond issued in which the
  proceeds of such issue are reasonably expected
  (at the time of issuance of the bond) to be used
  directly or indirectly
• To acquire higher yield investments, or
• To replace funds which were used directly or
  indirectly to acquire higher yield investments

26
Exceptions to Arbitrage

• Temporary Period Exception Three Part Test
• Expenditure Test 85 of proceeds must be spent
  within three years of the date of the issue
• Time Test within six months of the date of the
  issue, the issuer must incur a substantial
  binding obligation (5 of debt proceeds)
• Due Diligence Test work on the project must
  proceed with due diligence
• All three parts apply to a reasonable
  expectation at the date of the issue

27
Exceptions to Arbitrage

• Small Issuer Exception
• Counties, Townships, Municipalities
• Must issue less than 5 million of new money in
  any calendar year
• New money means non-refunding (current) issues
• Example
• 2005 - 5 million of new money
• 2006 - 4 million of new money 5 million of
  refunding money
• Result Neither issue is subject to rebate
  (assuming the temporary period exception is met)

28
Exceptions to Arbitrage

• Small Issuer Exception
• School Districts
• Must issue less than 5 million of new money in
  any calendar year, plus
• An additional 10 million of proceeds which are
  allocated to the construction of school
  facilities
• Example
• 5 million on working capital or land acquisition
• 10 million on construction of school
  facilities(bricks mortar)

29
Arbitrage

• Refunding Issues
• Current Refunding Issue
• Refunding which occurs within 90 days of the
  maturity date of the issue which is being
  refunded
• Notes
• Callable bonds
• Unlimited number of current refundings
• Ohio law after five years, issuer must begin to
  pay down principal on notes

30
Arbitrage

• Refunding Issues
• Advance Refunding Issue
• Refunding which occurs outside of 90 days of
  maturity date of the issue which is being
  refunded
• Only one advance refunding is permitted over the
  life of a bond issue
• Subject to rebate (to the extent that proceeds
  from the prior issue have not yet been spent)

31
Arbitrage and Rebate

• Rebate
• Exceptions to Rebate
• Small Issuer Exception
• 6 Month Expenditure Exception
• 18 Month Expenditure Exception(15, 60, 100)
• 24 Month Expenditure Exception(10, 45, 75,
  100)

32
Arbitrage

• Private Business Use (Private Activity Bonds)
• No more than 10 of the bond (or note) proceeds
  are used in the trade or business of any person
  other than a governmental unit, and
• The payment of the principal and interest on
  bonds (or notes) representing more than 10 of
  the total issue is secured by or derived from
  property to be used in the trade or business of
  non-governmental persons

33
Other Issues

• Bank Qualification (10,000,000)
• Certain financial institutions get a deduction
  for 80 of that portion of the financial
  institution's interest expense allocable to
  interest on tax-exempt securities.
• Implications for refunding issues

34
Official Statements

• Offering/disclosure document required by the SEC
  for issues of debt greater than 1,000,000
• Certain Exemptions
• Offered in minimum denominations and
• Term of nine months or less
• Sold to no more than 35 sophisticated investors

35
Continuing Disclosure

• SEC requirement that issuer provides disclosure
  of pertinent financial information each year
  until outstanding bonds are paid
• Information furnished to certain information
  repositories
• Filing of CAFR sufficient

36
Other Issues

• Ratings and Municipal Bond Insurance
• Roles of Professionals
• Investment Bankers
• Financial Advisors
• Paying Agent/Trustee/Registrar
• Bond Counsel

37
Questions?

• Contact Raymond C. Headen
• Bricker Eckler LLP
• 1375 East Ninth Street, Suite 1500
• Cleveland, OH 44115
• 216-523-5471
• rheaden_at_bricker.com
• www.bricker.com
• Columbus Cleveland Cincinnati-Dayton