Refunding-Opportunities-Sklaroff - CSMFO
REFUNDING OPPORTUNITIES IN A RISING RATE ENVIRONMENT CALIFORNIA SOCIETY OF MUNICIPAL FINANCE OFFICERS 2016 Conference Anaheim, California Thursday, March 3, 2016 (4:00 – 5:30 p.m.)
Panelists Nadia Sesay, Director of the Office of Public Finance City and County of San Francisco
David Brodsly Financial Advisor KNN Public Finance
Nikolai J. Sklaroff Public Finance Investment Banker Wells Fargo Securities
Refunding Opportunities Panel 1
2016
Refunding Opportunities in a Rising Rate Environment
Introductions Context: The Convergence of Rates Current and Advance Refundings Negative Arbitrage When to Pull the Trigger Competitive vs. Negotiated Refundings Escrows and Investments Assorted Topics Audience Questions Refunding Opportunities Panel 2
2016
CONTEXT: THE CONVERGENCE OF RATES
Refunding Opportunities Panel
3
Rates are Near Lowest Levels in More than a Quarter Century Tax exempt interest rates are again near 25 year lows, prompting interest in whether there are opportunities to refinance outstanding bonds.
%
25 Year History: 30-Year “AAA” MMD (%) 8.00
7.00 6.00 5.00 4.00 3.00
2.00 1.00 0.00 1991
30 Year "AAA" MMD (%) Current 2.68 Average 4.83 Maximum 7.00 Minimum 2.47
1996
2001
2006
2011
2016
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 4
2016
Convergence of Long-Term and Short-Term Interest Rates Over the past year, long term borrowing ratings are trending lower… But as a result of the December Federal Reserve Fed Funds Rate hike, short term taxable rates are higher Although those too have backed off as a result of global economic concerns Yield Curve Movement %
%
Higher Short-Term Rates 1.80
3.50
1.60
3.00
1.40
2.50
1.20
2.00
1.00
1.50
0.80
0.40
December
0.50
0.20 0.00 Feb-15
Today (February 2016)
1.00
0.60
One Year Ago (February 2015)
0.00 Apr-15
Jun-15
2Y UST
Aug-15 3Y UST
Oct-15
Dec-15
1Y
Feb-16
5Y
10Y
15Y
20Y
25Y
30Y
4Y UST
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 5
2016
As a Result Refunding Activity Has Grown Dramatically While refunding activity has long been an important component of bond issuance in our industry, refunding activity grew dramatically in 2015
($ Billions)
Annual Municipal Bond Volume* 450 400 350 300 250 200 150 100 50 0 2003
2004
2005
New Money
2006
2007
2008
2009
Refunding
2010
2011
2012
2013
2014
2015
Annual Average
Source: Bond Buyer: “A Decade of Municipal Bond Finance,” as of December 31, 2015. *Represents longterm issuance; excludes short-term notes and remarketings;
Refunding Opportunities Panel 6
2016
CURRENT AND ADVANCE REFUNDINGS
Refunding Opportunities Panel
7
%
Typical Structure: 30-Year Bonds with 10-Year Call 3.00
10-year Call Date 2.50
2.00
1.50
1.00
0.50
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
0.00
Current "AAA" MMD Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 8
2016
%
At Call Date, “Roll Down” for Corresponding Maturity 3.00
10-year Call Date 2.50
2.00
1.50
Assuming rates unchanged for 10 years
1.00
0.50
Current "AAA" MMD
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
0.00
Yield Curve at the Call Date
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 9
2016
%
With the “Roll Down” Comes Refunding Savings 3.00
10-year Call Date 2.50
2.00
1.50
Potential Debt Service Savings
1.00
0.50
Refunding Savings
Current "AAA" MMD
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
0.00
Yield Curve at the Call Date
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 10
2016
Advance Refunding versus Current Refunding: No Rate Movement If rates do not change, savings are greater waiting until the call date: o Negative Arbitrage o More Roll Down Current Refunding at Call Date
3.00
%
3.00
10-year Call Date
10-year Call Date
2.50
2.50
2.00
2.00
1.50
1.50
1.00
1.00
NPV Savings 2.272%
0.50
NPV Savings 6.116%
0.50
0.00
Refunding Savings
Current "AAA" MMD
Yield Curve at the Call Date
Refunding Savings
Current "AAA" MMD
Yield Curve at the Call Date
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 11
2016
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2020
2019
2018
2017
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
0.00
2021
%
Advance Refunding Two Years Prior to the Call Date
Advance Refunding versus Current Refunding: 100 bps Increase Alas rates are dynamic and movements in rates can erode (or increase) savings Current Refunding at Call Date (Interest Rates Increase 100 bps) %
4.50
4.50
10-year Call Date
10-year Call Date
4.00
4.00
3.50
3.50
3.00
3.00
2.50
2.50
2.00
2.00
1.50
1.50
1.00
1.00
NPV Savings 2.272%
0.50
NPV Savings 1.354%
0.50
0.00
Refunding Savings
Current "AAA" MMD
Yield Curve at the Call Date
Refunding Savings
Current "AAA" MMD
Yield Curve at the Call Date
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 12
2016
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
0.00
2017
%
Advance Refunding Two Years Prior to the Call Date
NEGATIVE ARBITRAGE
Refunding Opportunities Panel
13
Negative Arbitrage: A History In advance refunding, the proceeds are escrowed until the bonds are called Negative arbitrage: Cost of paying long term tax exempt rates until the call date but not being able to recover the rate in escrow earnings %
Borrowing Rates versus Investment Rates: 25 Years of History 10.00 8.00 6.00 4.00 2.00 0.00 -2.00 -4.00 -6.00 1991
1996
2001 Difference
2006 15yr "AAA" MMD
2011
2016
2yr UST
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 14
2016
Negative Arbitrage in the Context of Refundings Many issuers look at refundings as the relationship between savings and negative arbitrage on a maturity by maturity basis Refunding Efficiency: (Savings) / (Savings + Negative Arbitrage) SAMPLE ISSUER Maturity
Series
Coupon (%)
Refunded Par ($)
Call Date
NPV NPV Negative Savings ($) Savings (%) Arbitrage ($)
Refunding Efficiency
Series 2008 Refunding Savings by Maturity 5/1/2019
2008
4.000%
10,000,000
5/1/2018
54,841
0.548%
79,593
40.74%
5/1/2020
2008
5.000%
10,000,000
5/1/2018
471,579
4.716%
73,465
86.51%
5/1/2021
2008
5.000%
10,000,000
5/1/2018
746,240
7.462%
107,871
87.37%
5/1/2022
2008
5.000%
10,000,000
5/1/2018
973,452
9.735%
150,608
86.60%
5/1/2023
2008
5.000%
10,000,000
5/1/2018
1,144,057
11.441%
195,224
85.42%
5/1/2024
2008
5.000%
10,000,000
5/1/2018
1,291,400
12.914%
231,192
84.82%
5/1/2025
2008
5.000%
10,000,000
5/1/2018
1,416,766
14.168%
264,886
84.25%
5/1/2026
2008
5.000%
10,000,000
5/1/2018
1,523,370
15.234%
294,260
83.81%
5/1/2027
2008
5.000%
10,000,000
5/1/2018
1,437,909
14.379%
315,177
82.02%
5/1/2028
2008
5.000%
10,000,000
5/1/2018
1,373,186
13.732%
331,874
80.54%
5/1/2029
2008
5.000%
10,000,000
5/1/2018
1,298,658
12.987%
350,636
78.74%
5/1/2030
2008
5.000%
10,000,000
5/1/2018
1,239,275
12.393%
365,182
77.24%
5/1/2031
2008
5.000%
10,000,000
5/1/2018
1,164,412
11.644%
383,844
75.21%
5/1/2032
2008
5.000%
10,000,000
5/1/2018
1,106,226
11.062%
398,346
73.52%
5/1/2033
2008
5.000%
10,000,000
5/1/2018
1,065,858
10.659%
408,689
72.28%
5/1/2034
2008
5.000%
10,000,000
5/1/2018
1,024,727
10.247%
419,004
70.98%
5/1/2035
2008
5.000%
10,000,000
5/1/2018
983,196
9.832%
429,314
69.61%
5/1/2036
2008
5.000%
10,000,000
5/1/2018
940,616
9.406%
439,617
68.15%
5/1/2037
2008
5.000%
10,000,000
5/1/2018
898,229
8.982%
449,914
66.63%
5/1/2038
2008
5.000%
10,000,000
5/1/2018
835,381
8.354%
460,183
64.48%
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 15
2016
WHEN TO PULL THE TRIGGER
Refunding Opportunities Panel
16
Interest Rate Expectations – A Year Ago Last summer, the market was awaiting the Fed to raise rates for the first time in many years, and was expected a long term trend of rising rates as reflecting the 50 economic forecasts tracked by Bloomberg.
Federal Funds Rate Projections
30yr UST Rate Projections
6.0%
6.0%
5.0%
5.0%
4.0%
4.0%
3.0%
3.0%
2.0%
2.0%
1.0%
1.0%
0.0%
0.0% 1Q 2015
2Q 2015
3Q 2015
4Q 2015
Median
1Q 2016
2Q 2016
1Q 2015
Wells Fargo
2Q 2015 Median
3Q 2015
4Q 2015
1Q 2016
2Q 2016
Wells Fargo
Source: Thompson Financial/Securities Data; as of February 9, 2015.
Refunding Opportunities Panel 17
2016
Interest Rate Expectations – Today (“A Whole New World”) While the Fed increase did result in rising short term taxable rates, global concerns about the world economy have dramatically transformed rate expectations Now economists expect short term rates to rise more steeply, while long term rates rise more modestly Federal Funds Rate Projections
30yr UST Rate Projections
6.0%
6.0%
5.0%
5.0%
4.0%
4.0%
3.0%
3.0%
2.0%
2.0%
1.0%
1.0%
0.0%
0.0% 1Q2016
2Q2016
Median
3Q2016
4Q2016
High
1Q2017
Low
2Q2017
1Q2016
Wells Fargo
2Q2016
Median
3Q2016 High
4Q2016 Low
1Q2017
2Q2017
Wells Fargo
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 18
2016
Policy vs. Expectations: When to Pull the Trigger Using San Francisco’s Debt Policies as an example. How to apply policy thresholds to dynamic markets? When to proceed with refunding?
Source: Debt Policy of the City and County of San Francisco, Controller’s Office of Public Finance, Last Update: June 2013
Refunding Opportunities Panel 19
2016
COMPETITIVE VS. NEGOTIATED REFUNDING
Refunding Opportunities Panel
20
The Great Competitive vs. Negotiated Sale Debate
Refunding Opportunities Panel 21
2016
California Trends: Competitive vs. Negotiated Most California City and County bonds are sold on a negotiated basis, but the the percentage has typically been even higher for refunding bonds, with nearly 80-90% of such bonds sold negotiated in the last four years. Why consider one or the other? New Money Financings
Refunding Financings
100%
100%
90%
90%
80%
80%
70%
70%
60%
60%
50%
50%
40%
40%
30%
30%
20%
20%
10%
10%
0%
0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Negotiated
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Competitive
Negotiated
Competitive
Source: Thompson Reuters; revenue bonds issued by California City and County entities; as of December 31, 2015.
Refunding Opportunities Panel 22
2016
What’s New About This Debate? 2015 characterized by extreme volatility due to low supply, changing demand and interest rate expectations and global events – timing matters!
%
“AAA” MMD Volatility during 2015 3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 1.50 Jan-15
Feb-15
Mar-15
Apr-15
May-15
Jun-15
10yr "AAA" MMD
Jul-15
Aug-15
20yr "AAA" MMD
Sep-15
Oct-15
Nov-15
Dec-15
Jan-16
30yr "AAA" MMD
Source: Bloomberg; as of December 31, 2016
Refunding Opportunities Panel 23
2016
What’s New About This Debate? Volatility, means risk to bidders. Competitive underwriting fees sometimes higher than negotiated fees, as desks build in risk premium and numbers of bidders more limited Average Annual Gross Spread (1995 – Present)* $9.00
Competitive
$8.50
Negotiated
$8.00 $7.50 $7.00 $6.50 $6.00 $5.50 $5.00 $4.50 $4.00 $3.50
Source: Source: The Bond Buyer, "2015 in Statistics ,Midyear Review" & "2014 in Statistics, Annual Review“ *Represents underwriting spreads for competitive and negotiated municipal new issues issued from 1/1/1995 - 6/30/2015
Refunding Opportunities Panel 24
2016
Negotiated vs. Competitive Limited number of firms able to bid sizeable competitive sales o According to Thomson Reuter’s, 2/3 of competitive bonds were purchased by only six firms in the first half of this year
o Many larger bids only get 4 to 6 bidders Competitive underwriting fees sometimes higher than negotiated fees, as desks build in risk premium and numbers of bidders more limited
o According to the Bond Buyer, Competitive Sale underwriting fees have been higher than negotiated fees in four of the past five years*
While RFPs often focus on fees, they translate into a fraction of a basis point of cost for most long term sales – the key is rates… Source: The Bond Buyer, "2015 in Statistics ,Midyear Review" & "2014 in Statistics, Annual Review“; Rankins sourced to Thomson Reuters *Represents underwriting spreads for competitive and negotiated municipal new issues issued from 1/1/2011 - 6/30/2015 (YTD)
Refunding Opportunities Panel 25
2016
Considerations Greater flexibility in pricing date; ability to accelerate or delay as conditions warrant
Greater ability to manage couponing/structure and explore optimal options with buyers
Ability to pre-market bonds Ability to target buyers – for example through Retail Order Periods, Priority of Orders, Designation Policies
Ability to move orders to different maturities, re-size based on demand, manage premium
Manage “Call Optionality” through managing coupons
Refunding Opportunities Panel 26
2016
ESCROWS AND INVESTMENTS
Refunding Opportunities Panel
27
Escrows and Investments State and Local Government Series (“SLGS”) Open Market Securities (“OMS”) Cash Bidding
Refunding Opportunities Panel 28
2016
ASSORTED REFUNDING TOPICS
Refunding Opportunities Panel
29
Debt Service Reserve Funds The Disappearing Debt Service Reserve Fund o Rating Agency Transparency o Investor Appetite o The “Drag” of Negative Arbitrage
o Reserve fund “alternatives” But if a DSRF is Needed… o Handling DSRF Sureties from “Fallen” Insurers o Using New Sureties vs. Cash Funding a Reserve
Refunding Opportunities Panel 30
2016
Other Topics Budgeting and Refunding Decisions Debt Policies and Savings Thresholds Build America Bonds / Taxable Bonds Issues Unique To:
o General Obligation Bonds o Lease Revenue Bonds and COPS o Revenue Enterprise Bonds o Mello Roos and Assessment Bonds o Tax Allocation Bonds Refunding Opportunities Panel 31
2016
AUDIENCE QUESTIONS
Refunding Opportunities Panel
32
Continue the Dialogue… Nadia Sesay, City and County of San Francisco (415) 554-5956 [email protected]
David Brodsly, KNN Public Finance (510) 208-8205 [email protected]
Nikolai J. Sklaroff, Wells Fargo Securities (415) 371-2648 [email protected]
Refunding Opportunities Panel 33
2016
Disclosure This communication is for informational purposes only, is not an offer, solicitation, recommendation or commitment for any transaction or to buy or sell any security or other financial product; and is not intended as investment. The information contained herein is (i) derived from sources that Wells Fargo Securities ("WFS") in good faith considers reliable, however WFS does not guarantee the accuracy, reliability or completeness of this information and makes no warranty, express or implied, with respect thereto; and is (ii) subject to change without notice. WFS accepts no liability for its use or to update or keep it current. Products shown are subject to change and availability. WFS and/or one or more of its affiliates may provide advice or may from time to time have proprietary positions in, or trade as principal in, securities that may be mentioned herein or other securities issued by issuers reflected herein; or in derivatives related thereto. Wells Fargo Securities is the trade name for certain securitiesrelated capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including Wells Fargo Securities, LLC, member NYSE, FINRA, NFA, and SIPC, and Wells Fargo Bank, N.A. (“WFBNA”). Municipal Derivatives solutions are provided by WFBNA. This communication is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations and does not constitute advice within the meaning of Section 15B of the Securities Exchange Act of 1934. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment, and other aspects of this communication. Neither WFS nor any person providing this communication is acting as a municipal advisor or fiduciary with respect to any transaction described or contemplated therein unless expressly agreed to in a written financial advisory or similar agreement.
Refunding Opportunities Panel
34
Panelists Nadia Sesay, Director of the Office of Public Finance City and County of San Francisco
David Brodsly Financial Advisor KNN Public Finance
Nikolai J. Sklaroff Public Finance Investment Banker Wells Fargo Securities
Refunding Opportunities Panel 1
2016
Refunding Opportunities in a Rising Rate Environment
Introductions Context: The Convergence of Rates Current and Advance Refundings Negative Arbitrage When to Pull the Trigger Competitive vs. Negotiated Refundings Escrows and Investments Assorted Topics Audience Questions Refunding Opportunities Panel 2
2016
CONTEXT: THE CONVERGENCE OF RATES
Refunding Opportunities Panel
3
Rates are Near Lowest Levels in More than a Quarter Century Tax exempt interest rates are again near 25 year lows, prompting interest in whether there are opportunities to refinance outstanding bonds.
%
25 Year History: 30-Year “AAA” MMD (%) 8.00
7.00 6.00 5.00 4.00 3.00
2.00 1.00 0.00 1991
30 Year "AAA" MMD (%) Current 2.68 Average 4.83 Maximum 7.00 Minimum 2.47
1996
2001
2006
2011
2016
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 4
2016
Convergence of Long-Term and Short-Term Interest Rates Over the past year, long term borrowing ratings are trending lower… But as a result of the December Federal Reserve Fed Funds Rate hike, short term taxable rates are higher Although those too have backed off as a result of global economic concerns Yield Curve Movement %
%
Higher Short-Term Rates 1.80
3.50
1.60
3.00
1.40
2.50
1.20
2.00
1.00
1.50
0.80
0.40
December
0.50
0.20 0.00 Feb-15
Today (February 2016)
1.00
0.60
One Year Ago (February 2015)
0.00 Apr-15
Jun-15
2Y UST
Aug-15 3Y UST
Oct-15
Dec-15
1Y
Feb-16
5Y
10Y
15Y
20Y
25Y
30Y
4Y UST
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 5
2016
As a Result Refunding Activity Has Grown Dramatically While refunding activity has long been an important component of bond issuance in our industry, refunding activity grew dramatically in 2015
($ Billions)
Annual Municipal Bond Volume* 450 400 350 300 250 200 150 100 50 0 2003
2004
2005
New Money
2006
2007
2008
2009
Refunding
2010
2011
2012
2013
2014
2015
Annual Average
Source: Bond Buyer: “A Decade of Municipal Bond Finance,” as of December 31, 2015. *Represents longterm issuance; excludes short-term notes and remarketings;
Refunding Opportunities Panel 6
2016
CURRENT AND ADVANCE REFUNDINGS
Refunding Opportunities Panel
7
%
Typical Structure: 30-Year Bonds with 10-Year Call 3.00
10-year Call Date 2.50
2.00
1.50
1.00
0.50
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
0.00
Current "AAA" MMD Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 8
2016
%
At Call Date, “Roll Down” for Corresponding Maturity 3.00
10-year Call Date 2.50
2.00
1.50
Assuming rates unchanged for 10 years
1.00
0.50
Current "AAA" MMD
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
0.00
Yield Curve at the Call Date
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 9
2016
%
With the “Roll Down” Comes Refunding Savings 3.00
10-year Call Date 2.50
2.00
1.50
Potential Debt Service Savings
1.00
0.50
Refunding Savings
Current "AAA" MMD
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
0.00
Yield Curve at the Call Date
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 10
2016
Advance Refunding versus Current Refunding: No Rate Movement If rates do not change, savings are greater waiting until the call date: o Negative Arbitrage o More Roll Down Current Refunding at Call Date
3.00
%
3.00
10-year Call Date
10-year Call Date
2.50
2.50
2.00
2.00
1.50
1.50
1.00
1.00
NPV Savings 2.272%
0.50
NPV Savings 6.116%
0.50
0.00
Refunding Savings
Current "AAA" MMD
Yield Curve at the Call Date
Refunding Savings
Current "AAA" MMD
Yield Curve at the Call Date
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 11
2016
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2020
2019
2018
2017
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
0.00
2021
%
Advance Refunding Two Years Prior to the Call Date
Advance Refunding versus Current Refunding: 100 bps Increase Alas rates are dynamic and movements in rates can erode (or increase) savings Current Refunding at Call Date (Interest Rates Increase 100 bps) %
4.50
4.50
10-year Call Date
10-year Call Date
4.00
4.00
3.50
3.50
3.00
3.00
2.50
2.50
2.00
2.00
1.50
1.50
1.00
1.00
NPV Savings 2.272%
0.50
NPV Savings 1.354%
0.50
0.00
Refunding Savings
Current "AAA" MMD
Yield Curve at the Call Date
Refunding Savings
Current "AAA" MMD
Yield Curve at the Call Date
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 12
2016
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2046
2045
2044
2043
2042
2041
2040
2039
2038
2037
2036
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
0.00
2017
%
Advance Refunding Two Years Prior to the Call Date
NEGATIVE ARBITRAGE
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Negative Arbitrage: A History In advance refunding, the proceeds are escrowed until the bonds are called Negative arbitrage: Cost of paying long term tax exempt rates until the call date but not being able to recover the rate in escrow earnings %
Borrowing Rates versus Investment Rates: 25 Years of History 10.00 8.00 6.00 4.00 2.00 0.00 -2.00 -4.00 -6.00 1991
1996
2001 Difference
2006 15yr "AAA" MMD
2011
2016
2yr UST
Source: Thompson Financial/Securities Data; as of February 10, 2016.
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2016
Negative Arbitrage in the Context of Refundings Many issuers look at refundings as the relationship between savings and negative arbitrage on a maturity by maturity basis Refunding Efficiency: (Savings) / (Savings + Negative Arbitrage) SAMPLE ISSUER Maturity
Series
Coupon (%)
Refunded Par ($)
Call Date
NPV NPV Negative Savings ($) Savings (%) Arbitrage ($)
Refunding Efficiency
Series 2008 Refunding Savings by Maturity 5/1/2019
2008
4.000%
10,000,000
5/1/2018
54,841
0.548%
79,593
40.74%
5/1/2020
2008
5.000%
10,000,000
5/1/2018
471,579
4.716%
73,465
86.51%
5/1/2021
2008
5.000%
10,000,000
5/1/2018
746,240
7.462%
107,871
87.37%
5/1/2022
2008
5.000%
10,000,000
5/1/2018
973,452
9.735%
150,608
86.60%
5/1/2023
2008
5.000%
10,000,000
5/1/2018
1,144,057
11.441%
195,224
85.42%
5/1/2024
2008
5.000%
10,000,000
5/1/2018
1,291,400
12.914%
231,192
84.82%
5/1/2025
2008
5.000%
10,000,000
5/1/2018
1,416,766
14.168%
264,886
84.25%
5/1/2026
2008
5.000%
10,000,000
5/1/2018
1,523,370
15.234%
294,260
83.81%
5/1/2027
2008
5.000%
10,000,000
5/1/2018
1,437,909
14.379%
315,177
82.02%
5/1/2028
2008
5.000%
10,000,000
5/1/2018
1,373,186
13.732%
331,874
80.54%
5/1/2029
2008
5.000%
10,000,000
5/1/2018
1,298,658
12.987%
350,636
78.74%
5/1/2030
2008
5.000%
10,000,000
5/1/2018
1,239,275
12.393%
365,182
77.24%
5/1/2031
2008
5.000%
10,000,000
5/1/2018
1,164,412
11.644%
383,844
75.21%
5/1/2032
2008
5.000%
10,000,000
5/1/2018
1,106,226
11.062%
398,346
73.52%
5/1/2033
2008
5.000%
10,000,000
5/1/2018
1,065,858
10.659%
408,689
72.28%
5/1/2034
2008
5.000%
10,000,000
5/1/2018
1,024,727
10.247%
419,004
70.98%
5/1/2035
2008
5.000%
10,000,000
5/1/2018
983,196
9.832%
429,314
69.61%
5/1/2036
2008
5.000%
10,000,000
5/1/2018
940,616
9.406%
439,617
68.15%
5/1/2037
2008
5.000%
10,000,000
5/1/2018
898,229
8.982%
449,914
66.63%
5/1/2038
2008
5.000%
10,000,000
5/1/2018
835,381
8.354%
460,183
64.48%
Source: Thompson Financial/Securities Data; as of February 10, 2016.
Refunding Opportunities Panel 15
2016
WHEN TO PULL THE TRIGGER
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Interest Rate Expectations – A Year Ago Last summer, the market was awaiting the Fed to raise rates for the first time in many years, and was expected a long term trend of rising rates as reflecting the 50 economic forecasts tracked by Bloomberg.
Federal Funds Rate Projections
30yr UST Rate Projections
6.0%
6.0%
5.0%
5.0%
4.0%
4.0%
3.0%
3.0%
2.0%
2.0%
1.0%
1.0%
0.0%
0.0% 1Q 2015
2Q 2015
3Q 2015
4Q 2015
Median
1Q 2016
2Q 2016
1Q 2015
Wells Fargo
2Q 2015 Median
3Q 2015
4Q 2015
1Q 2016
2Q 2016
Wells Fargo
Source: Thompson Financial/Securities Data; as of February 9, 2015.
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2016
Interest Rate Expectations – Today (“A Whole New World”) While the Fed increase did result in rising short term taxable rates, global concerns about the world economy have dramatically transformed rate expectations Now economists expect short term rates to rise more steeply, while long term rates rise more modestly Federal Funds Rate Projections
30yr UST Rate Projections
6.0%
6.0%
5.0%
5.0%
4.0%
4.0%
3.0%
3.0%
2.0%
2.0%
1.0%
1.0%
0.0%
0.0% 1Q2016
2Q2016
Median
3Q2016
4Q2016
High
1Q2017
Low
2Q2017
1Q2016
Wells Fargo
2Q2016
Median
3Q2016 High
4Q2016 Low
1Q2017
2Q2017
Wells Fargo
Source: Thompson Financial/Securities Data; as of February 10, 2016.
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2016
Policy vs. Expectations: When to Pull the Trigger Using San Francisco’s Debt Policies as an example. How to apply policy thresholds to dynamic markets? When to proceed with refunding?
Source: Debt Policy of the City and County of San Francisco, Controller’s Office of Public Finance, Last Update: June 2013
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2016
COMPETITIVE VS. NEGOTIATED REFUNDING
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The Great Competitive vs. Negotiated Sale Debate
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2016
California Trends: Competitive vs. Negotiated Most California City and County bonds are sold on a negotiated basis, but the the percentage has typically been even higher for refunding bonds, with nearly 80-90% of such bonds sold negotiated in the last four years. Why consider one or the other? New Money Financings
Refunding Financings
100%
100%
90%
90%
80%
80%
70%
70%
60%
60%
50%
50%
40%
40%
30%
30%
20%
20%
10%
10%
0%
0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Negotiated
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Competitive
Negotiated
Competitive
Source: Thompson Reuters; revenue bonds issued by California City and County entities; as of December 31, 2015.
Refunding Opportunities Panel 22
2016
What’s New About This Debate? 2015 characterized by extreme volatility due to low supply, changing demand and interest rate expectations and global events – timing matters!
%
“AAA” MMD Volatility during 2015 3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 1.50 Jan-15
Feb-15
Mar-15
Apr-15
May-15
Jun-15
10yr "AAA" MMD
Jul-15
Aug-15
20yr "AAA" MMD
Sep-15
Oct-15
Nov-15
Dec-15
Jan-16
30yr "AAA" MMD
Source: Bloomberg; as of December 31, 2016
Refunding Opportunities Panel 23
2016
What’s New About This Debate? Volatility, means risk to bidders. Competitive underwriting fees sometimes higher than negotiated fees, as desks build in risk premium and numbers of bidders more limited Average Annual Gross Spread (1995 – Present)* $9.00
Competitive
$8.50
Negotiated
$8.00 $7.50 $7.00 $6.50 $6.00 $5.50 $5.00 $4.50 $4.00 $3.50
Source: Source: The Bond Buyer, "2015 in Statistics ,Midyear Review" & "2014 in Statistics, Annual Review“ *Represents underwriting spreads for competitive and negotiated municipal new issues issued from 1/1/1995 - 6/30/2015
Refunding Opportunities Panel 24
2016
Negotiated vs. Competitive Limited number of firms able to bid sizeable competitive sales o According to Thomson Reuter’s, 2/3 of competitive bonds were purchased by only six firms in the first half of this year
o Many larger bids only get 4 to 6 bidders Competitive underwriting fees sometimes higher than negotiated fees, as desks build in risk premium and numbers of bidders more limited
o According to the Bond Buyer, Competitive Sale underwriting fees have been higher than negotiated fees in four of the past five years*
While RFPs often focus on fees, they translate into a fraction of a basis point of cost for most long term sales – the key is rates… Source: The Bond Buyer, "2015 in Statistics ,Midyear Review" & "2014 in Statistics, Annual Review“; Rankins sourced to Thomson Reuters *Represents underwriting spreads for competitive and negotiated municipal new issues issued from 1/1/2011 - 6/30/2015 (YTD)
Refunding Opportunities Panel 25
2016
Considerations Greater flexibility in pricing date; ability to accelerate or delay as conditions warrant
Greater ability to manage couponing/structure and explore optimal options with buyers
Ability to pre-market bonds Ability to target buyers – for example through Retail Order Periods, Priority of Orders, Designation Policies
Ability to move orders to different maturities, re-size based on demand, manage premium
Manage “Call Optionality” through managing coupons
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2016
ESCROWS AND INVESTMENTS
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Escrows and Investments State and Local Government Series (“SLGS”) Open Market Securities (“OMS”) Cash Bidding
Refunding Opportunities Panel 28
2016
ASSORTED REFUNDING TOPICS
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Debt Service Reserve Funds The Disappearing Debt Service Reserve Fund o Rating Agency Transparency o Investor Appetite o The “Drag” of Negative Arbitrage
o Reserve fund “alternatives” But if a DSRF is Needed… o Handling DSRF Sureties from “Fallen” Insurers o Using New Sureties vs. Cash Funding a Reserve
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2016
Other Topics Budgeting and Refunding Decisions Debt Policies and Savings Thresholds Build America Bonds / Taxable Bonds Issues Unique To:
o General Obligation Bonds o Lease Revenue Bonds and COPS o Revenue Enterprise Bonds o Mello Roos and Assessment Bonds o Tax Allocation Bonds Refunding Opportunities Panel 31
2016
AUDIENCE QUESTIONS
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Continue the Dialogue… Nadia Sesay, City and County of San Francisco (415) 554-5956 [email protected]
David Brodsly, KNN Public Finance (510) 208-8205 [email protected]
Nikolai J. Sklaroff, Wells Fargo Securities (415) 371-2648 [email protected]
Refunding Opportunities Panel 33
2016
Disclosure This communication is for informational purposes only, is not an offer, solicitation, recommendation or commitment for any transaction or to buy or sell any security or other financial product; and is not intended as investment. The information contained herein is (i) derived from sources that Wells Fargo Securities ("WFS") in good faith considers reliable, however WFS does not guarantee the accuracy, reliability or completeness of this information and makes no warranty, express or implied, with respect thereto; and is (ii) subject to change without notice. WFS accepts no liability for its use or to update or keep it current. Products shown are subject to change and availability. WFS and/or one or more of its affiliates may provide advice or may from time to time have proprietary positions in, or trade as principal in, securities that may be mentioned herein or other securities issued by issuers reflected herein; or in derivatives related thereto. Wells Fargo Securities is the trade name for certain securitiesrelated capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including Wells Fargo Securities, LLC, member NYSE, FINRA, NFA, and SIPC, and Wells Fargo Bank, N.A. (“WFBNA”). Municipal Derivatives solutions are provided by WFBNA. This communication is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations and does not constitute advice within the meaning of Section 15B of the Securities Exchange Act of 1934. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment, and other aspects of this communication. Neither WFS nor any person providing this communication is acting as a municipal advisor or fiduciary with respect to any transaction described or contemplated therein unless expressly agreed to in a written financial advisory or similar agreement.
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