Download DEBT FINANCING TERMS AND CONCEPTS and more Slides Law in PDF only on Docsity!
APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS C-
Appendix C
DEBT FINANCING T ERMS AND C ONCEPTS
This appendix is designed to provide definitions drafted in plain English for terms and concepts used in connection with debt issuance. To be consistent with customary industry practice, the term bonds is used to mean either long-term bonds or, more generally, bonds, notes, commercial paper, certificates of participation, and other types of evidence of debt. The index to the California Debt Issuance Primer (Primer) may contain cross-references to terms not defined here in alphabetical order.
ACCELERATION
A remedy provided in many security agreements (including many indentures and bond resolutions) by which the trustee may declare all future payments of principal immediately due and payable after the occurrence of certain specified events—usually called events of default.
In some security agreements the trustee may be required to accelerate upon the occurrence of an event of default. Sometimes acceleration can occur only upon the consent or direction of a credit enhancement provider or only upon the request of the holders of a specified percentage of the bonds (often 25 percent).
Generally, unless the security agreement provides otherwise, acceleration results in available monies being used first to pay interest pro rata on all the bonds and, if interest is fully paid, to pay principal pro rata on all maturities. As a result, all the bonds are placed on an equal footing, regardless of their scheduled maturity.
ACCRUED I NTEREST
In general, interest that has been earned on a bond but not yet paid—usually because it is not yet due.
More specifically, this term is often used to refer to interest earned on a bond from its dated date to the closing date.
ADDITIONAL BONDS
Additional bonds is a term found in indentures, trust agreements, bond resolutions, and other bond issuance documents referring to bonds that may be issued in the future in addition to the bonds being issued under the current document. Almost always, these bonds are on a parity with the bonds being issued initially and may not be issued without meeting certain conditions
C-2 APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS
involving the level of revenues available to repay the initial bonds and additional bonds, maximum amount limitations, and other conditions. These conditions are often referred to as the additional bonds test. See Parity.
AD VALOREM TAXES
An annual tax that is a uniform percentage of the value (or assessed value) of property.
ADVANCE R EFUNDING
See Refunding.
ALL -HOLD RATE OR H OLD RATE
The interest rate on any auction date equal to a percentage of a variable index specified in the indenture or the trust agreement—typically the Bond Market Association (BMA) Index or the London Interbank Offered Rate (LIBOR)—provided such rate does not exceed the maximum auction rate specified in the indenture or the trust agreement.
ALTERNATIVE M INIMUM TAX (AMT)
An income tax based on a separate and alternative method of calculating taxable income and a separate and alternative schedule of rates.
With respect to bonds, the interest on certain types of qualified private activity bonds—not including qualified 501(c)(3) bonds—is included in income for purposes of the individual and corporate alternative minimum tax.
In addition, the interest received by a corporation on all bonds held by it is included in federal corporate adjusted net book income and adjusted current earnings, a portion of which may increase the alternative minimum taxable income of such corporation.
AMORTIZE
To retire the principal of an issue by periodic payments either directly to bondholders, or first to a sinking fund and then to bondholders. Compare to Balloon and Bullet.
ANNUAL R EPORT
The annual report is the report containing annual financial and operating data prepared and filed with the Nationally Recognized Municipal Securities Information Repositories (NRMSIRs) and state information depository (SID)—if any—pursuant to Securities and Exchange Commission (SEC) Rule 15c2-12.
C-4 APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS
AUCTION
An electronic competitive process through which auction rate securities (ARS) are sold at the lowest yield rate (priced at par) at which sufficient bids are received to sell all securities offered. ARS are sold at the clearing yield established by the auction to the investors placing bids at or below the clearing yield. All ARS in a series will bear interest at the clearing auction rate for the next auction period.
AUCTION A GENT
A third-party institution responsible for conducting the auction used in connection with the periodic reset of the interest rate.
AUCTION D ATE
The business day immediately preceding the first day of each auction rate period for an ARS.
AUCTION P ROCEDURES
The process and timing for conducting the auction as set forth in the bond indenture or trust agreement and summarized in the auction agreement.
AUCTION R ATE
The rate of interest per annum resulting from the implementation of the auction, provided such rate does not exceed a maximum rate specified in the bond indenture or trust agreement.
AUCTION R ATE P ERIOD
The initial auction rate period established by the underwriter at the time of issuance of the ARS and, subsequently, each period during which a specific auction rate is in effect as a result of an auction. The auction rate period commences on the business day after the auction date and ends and includes the day preceding the next interest rate reset date.
AUCTION R ATE S ECURITIES
See Chapter 8, Fixed and Variable Interest Rate Structures – Variable Interest Rate Debt – Auction Rate Securities.
AUTHENTICATING AGENT
The agent of the issuer appointed to authenticate bonds (i.e. to sign them as being authentic) upon initial issuance or upon transfer or exchange.
APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS C-
See also Chapter 1, Overview of a Debt Financing – Roles and Responsibilities of Principal Participants – Trustee/Fiscal Agent/Paying Agent/Registrar/Authenticating Agent.
BALLOON
Principal of an issue to be paid in a single final maturity that constitutes a large percentage of the total principal of the issue. See also Bullet.
BANK ELIGIBLE BONDS
Bonds (including certificates of participation or COPs) that are eligible under federal banking law—the Glass-Steagall act—to be underwritten by commercial banks.
Bank eligible bonds generally include bonds that are directly or indirectly the obligations of the general fund of a city, county, or state and bonds for single-family or multifamily housing.
BANK Q UALIFIED BONDS
Tax-exempt bonds that are issued by certain qualified small issuers and which do not need to be taken into account for purposes of determining the portion of certain financial institutions' interest expense, which is disallowed as a deduction for federal tax purposes, because such interest expense is allocable to debt (including deposits) deemed to have been incurred by the financial institution to carry tax-exempt bonds.
BASIS POINT
See Point/Basis Point.
BLIND POOL I SSUE
See Pooling of Debt Issues.
BLUE S KY LAWS/BLUE SKY SURVEY OR M EMORANDUM
Blue Sky laws are the state statutes that regulate the manner of offering and selling of securities, bonds, investment contracts, and stocks.
These statutes are commonly referred to as Blue Sky Laws because their purpose is to prevent, as the U.S. Supreme Court posited in 1917, “speculative schemes which have no more basis than so many feet of blue sky.”
Generally, in a public offering, a memorandum called a Blue Sky Survey is prepared, which summarizes the treatment of the issue under the securities laws of each state and, occasionally, the laws of Puerto Rico, Guam, the District of Columbia, and the U.S. Virgin Islands. The
APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS C-
given the right to accelerate the payment of principal if the insurer is ever required to make a payment.
See also Chapter 1, Overview of a Debt Financing – Roles and Responsibilities of Principal Participants – Credit Enhancement Provider.
BOND PRINTING
The printing of bonds on special paper designed to be difficult to counterfeit.
BOND PURCHASE CONTRACT OR A GREEMENT
In a negotiated sale, the bond purchase contract is an agreement between an issuer and an underwriter or a group of underwriters—a syndicate or a selling group who have agreed to purchase the issue.
A bond purchase contract generally contains the following:
- The purchase price to be paid by the underwriter (including any premium or discount). See also Underwriter's Gross Spread (Underwriter's Discount).
- Certain terms of the bonds, such as interest rates, maturities, redemption provisions, and original issue discount
- The circumstances under which the underwriter may cancel its obligation to purchase the issue (e.g. changes in the tax treatment of the bonds and other events that would make it substantially more difficult for the underwriter to sell the bonds to investors
- The good faith deposit, if any
- The conditions to the closing of the issue, which often include documents, certificates, and opinions that are to be delivered on the closing date
- Any restrictions on the liability of the issuer
Other common terms for a bond purchase contract are contract of purchase or bond purchase agreement.
In a competitive sale, the notice of sale, the underwriter's bid, and the issuer's acceptance of the bid together constitute a bond purchase contract. Generally, these three items taken together contain items similar to those in a negotiated bond purchase contract.
See Chapter 1, Overview of a Debt Financing – Basic Legal Documents.
C-8 APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS
BOND RESOLUTION
See Indenture/Bond Resolution (General, Supplemental, and Series).
BOOK E NTRY O NLY R EGISTRATION
A form of registration of the ownership of registered bonds in which the owners of bonds are not entitled to the receipt of printed bonds. Rather, the terms of the bonds are specified by the indenture or bond resolution or by the form of a single bond delivered to a securities depository, and the beneficial ownership of bonds is determined by entries on the registration books of the registrar or by the records of members of the securities depository.
The sale of a bond issued in book entry form is evidenced by a receipt provided by the broker/dealer to the investor and not by the issuance of a new registered bond with the owner's name.
BROKER/D EALER A GREEMENT
An agreement between the issuer or auction agent and a broker/dealer specifying the procedures for conducting the auction of the ARS and the settlement procedures for the payment and delivery of the ARS.
BULLET
Principal of an issue to be retired in a single final maturity that constitutes the entire principal of the issue.
A bullet issue has no amortization of principal or sinking fund redemption prior to its final maturity. There may, however, be a sinking fund to accumulate the amount necessary to make the final maturity payment.
CALL
To give notice of redemption; to redeem.
CAPITAL APPRECIATION BOND
See Compound Interest Bond.
CAPITALIZED I NTEREST (FUNDED I NTEREST )
Bond proceeds reserved to pay interest on an issue for a period of time early in the term of the issue—also called funded interest. Capitalized interest may also refer to the interest to be so paid.
C-10 APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS
tax law treats the lease obligation as if it were a debt, and, as a result, the interest component of each lease payment may be treated as tax-exempt interest.
See also Chapter 6, Types of Financing Obligations – Financing Leases and Certificates of Participation.
CLEARING RATE
The lowest interest rate bid at which all ARS shares can be sold at par. The rate is paid on the entire issue for the upcoming period.
CLOSING D ATE (DELIVERY DATE)
The date on which an issue is delivered by the issuer to, and paid for by, the original purchaser (often an underwriter). Also called the delivery date.
This may be a different date than the sale date or the dated date.
COMFORT L ETTER
A letter provided by the issuer's (or sometimes in a conduit financing by the nongovernmental borrower's) certified public accountant at the time the bond purchase contract is signed and on the closing date. The letter confirms that specified financial information regarding the borrower contained in the Preliminary Official Statement or final Official Statement is presented in conformity with generally accepted accounting principles and that no changes in the financial position of the borrower since the date of the last audited financial statements, other than those changes disclosed in the comfort letter or in the Official Statement, have occurred.
The comfort letter often contains items of “special comfort,” which generally confirm that financial information presented in the Official Statement (preliminary or final) is accurately presented or calculated. The content of comfort letters is regulated by the American Institute of Certified Public Accountants and, as a result, the content and style differ only minimally among accounting firms.
COMMERCIAL PAPER
Notes of varying very short-term maturities (generally one to ninety days), which are intended to be rolled over in a series of current refundings as portions of the issue mature from time to time.
Generally, the maturity of the commercial paper sold on each rollover is determined by market conditions at the time of rollover. See also Line of Credit and Letter of Credit.
APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS C-
COMPETITIVE SALE
The sale of bonds to the bidder presenting the best sealed bid at the time and place specified in a published notice of sale (also called a public sale).
When bonds are to be sold at a competitive sale, the issuer typically specifies all the terms of the issue other than interest rates and purchase price. When the issue is ready to market, the issuer solicits bids by placing a notice of sale in one or more industry publications such as The Wall Street Journal or The Bond Buyer and, if required by law, in a local newspaper of general circulation. In the notice of sale, the issuer announces that it will accept sealed bids until a certain date and time. Prior to presenting bids the underwriters evaluate the credit quality of the issue and the municipal market and may form syndicates or selling groups. The bonds are awarded to the underwriters presenting the best bid based on the criteria specified in the notice of sale. Possible criteria include the Net Interest Cost (NIC) method or the net effective interest rate or True Interest Cost (TIC) method of comparing the cost to the issuer of the financing. See also Negotiated Sale.
COMPOSITE I SSUE
Two or more issues having substantially identical terms and which are sold and delivered at the same time (by one or more issuers).
Generally, each issue is used to finance a separate project or purpose. The proceeds are not pooled but instead, the issues are pooled into a composite issue for purposes of marketing. A single Official Statement is used to sell the issues. These issues usually require bond insurance or a letter of credit to guarantee each issue so that the credit rating and marketing of the bonds is based on the insurance company or bank. This equalizes unlike credits in the eyes of investors. See also Pooling of Debt Issues.
COMPOUND
To treat accrued interest as if it were principal, so that interest thereafter accrues on the sum of the principal and the compounded interest.
COMPOUND I NTEREST B OND
A bond on which interest is not payable until maturity (or earlier redemption), but compounds periodically to accumulate to a stated maturity amount.
These bonds are also called capital appreciation bonds or CABs and are sometimes misnamed zero coupon bonds.
APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS C-
COUPON B OND
A bond that generally has a number of interest coupons attached to it and which is transferable merely by delivering it to its new owner.
Each coupon is a negotiable instrument representing interest to be paid on the bond for a specified period, usually six months. To receive an interest payment on a coupon bond, the holder must detach the coupon and present it at the office of the trustee or paying agent—or at the holder's own bank if the bank is willing to provide the service of presenting the coupon for payment.
Coupon bonds are sometimes referred to as bearer bonds, since payment may be made to any bearer of the bond or coupon, rather than to a particular registered owner. Coupons that represent less or more than six months’ interest are sometimes referred to as short coupons or long coupons, respectively.
Tax-exempt coupon bonds with maturities longer than one year may no longer be issued. However, the interest rate on a bond is still sometimes referred to as the coupon rate. Compare to Registered Bond.
COVENANTS
Contractual obligations in financing agreements whereby the party making the promises agrees to perform or refrain from performing certain actions or to comply with certain requirements.
Most issuer covenants are found in the indenture or bond resolution pursuant to which the bonds are issued. However, in a conduit financing, the covenants of the nongovernmental borrower are often set forth in a loan agreement. The following covenants are typical issuer covenants:
- Payment of bonds—a covenant that the issuer will punctually pay the principal of and interest on the bonds from the revenues that have been pledged to pay the bonds
- Extension of payment of the bonds—a covenant that the issuer will not extend or consent to the extension of the maturity of the bonds
- Offices for servicing bonds—a covenant that the issuer will maintain a relationship with an agency, such as a paying agent, in a designated location where bonds may be presented for payment, registration, transfer, or exchange
- Further assurances—a covenant, to the extent authorized by law, to comply with reasonable requests of the trustee to perform, execute, or deliver such acts as may be necessary to confirm the pledge under the indenture
C-14 APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS
- Rate covenant—a covenant that the issuer will establish and collect charges with respect to the project or the program loans sufficient to meet expenses and debt service, perhaps with coverage
- Restriction on sale or disposal—a covenant not to sell or lease the project or to sell program loans, except as specifically authorized in the financing documents
- Limitation on operating expenses and other costs—a covenant not to incur operating expenses and other costs in excess of the reasonable and necessary amount of such expenses
- Insurance covenant—a covenant to maintain insurance against various events, such as fire, casualty, flood, earthquake, theft, liability or, in the case of a lending program, mortgage default
- Reconstruction; application of insurance proceeds—a covenant to repair or reconstruct the project with the proceeds of insurance, or if it does not make economic sense to repair or reconstruct the project, insurance proceeds would be applied to the redemption of the bonds
- Payment of taxes and charges—a covenant to pay and discharge all taxes and fees imposed in connection with the project or the program except taxes and fees which are contested by proper legal proceedings
- Tax covenant—a covenant that the issuer will not take any action or consent to any party taking any action that will cause interest on the bonds to be subject to federal income taxation or to cause the bonds to be arbitrage bonds
- Maintenance of the project—a covenant by the issuer to use its best efforts to acquire, construct, and maintain the project with due diligence and in a sound and economic manner
- Additional bonds—a covenant not to issue any bonds whose security is equal to or superior to that of the existing issue unless certain additional bonds tests (often including historical or projected coverage ratios) are satisfied
- Maintenance of books and records—a covenant to maintain financial records relating to project or program revenues and costs in accordance with generally accepted accounting principles
- Noncompetition—a covenant not to operate, and perhaps (to the extent permitted by law) not to permit the operation of, competing enterprises
C-16 APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS
DATED DATE
The first date from which interest is deemed to accrue on a bond.
The dated date is typically printed on the front of the bond and can be before or as of the closing date, but not after the closing date. For fixed rate bonds, the dated date is generally the first day of the calendar month in which the bonds are sold. For variable rate bonds, the dated date is generally the closing date.
DEBT LIMIT
A statutory or constitutional limit on the amount of debt that an issuer may incur or that it may have outstanding at any one time.
The constitutional debt limit for California cities and counties is found in the California Constitution at Article XVI, Section 18, and for the State of California is found at Article XVI, Section 1. See Chapter 4, State Constitutional Limitations – The 1879 Constitution – The Debt Limit****. California statutes also provide debt limits for a number of different entities. See generally, Chapter 6, Types of Financing Obligations.
DEBT S ERVICE
The total of interest, principal, and mandatory sinking fund payments.
DEBT S ERVICE A CCOUNT (BOND ACCOUNT OR P RINCIPAL , I NTEREST , AND REDEMPTION
ACCOUNTS)
The account or accounts into which the issuer makes periodic deposits to assure the timely availability of sufficient monies for the payment of debt service on an issue.
DEBT S ERVICE R ESERVE ACCOUNT
See Reserve Account (Bond Reserve Account or Debt Service Reserve Account).
DEDICATED POOL
See Pooling of Debt Issues.
DEEMED FINAL
Under SEC Rule 15c2-12, prior to bidding for, offering, or selling bonds, an underwriter must obtain and review an Official Statement (usually a Preliminary Official Statement) deemed final as of its date by the issuer.
APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS C-
DEFAULT /E VENT OF DEFAULT
Failure to make prompt payment on a bond or otherwise comply with other covenants in the financing agreements.
Indentures and bond resolutions commonly provide for some short period of time—a cure period—to correct a failure to comply with a covenant before a simple default becomes an event of default that allows acceleration and certain other remedies to be pursued. In conduit financings, a default may also occur if the nongovernmental borrower becomes the subject of bankruptcy proceedings.
DEFEASANCE
The termination of the rights and interests (including the pledge of revenues but not including the right to payment) of the bondholders under the indenture or bond resolution upon final payment or provision for payment of all debt service on the bonds, all in the specific manner required by the indenture or bond resolution.
In an advance refunding, the defeasance of the bonds being refunded is generally accomplished by placing in an escrow sufficient high quality investments to provide for payment of debt service on the bonds to redemption or maturity.
DELIVERY D ATE
See Closing Date (Delivery Date).
DEMAND B OND (PUT B OND OR T ENDER O PTION BOND)
A bond that the holder has the right to sell back to the issuer, a nongovernmental borrower, or another party at specified times and for a specified price (usually par).
Variable rate bonds generally have a demand feature. The demand feature gives the holder investment flexibility and protection against fluctuating market interest rates and other risks. The interest rate rises or falls in step with market rates, and the holder has the option to keep the bond or to demand the purchase of the bond in accordance with the holder's investment needs.
Demand bonds are sometimes referred to as put bonds or tender option bonds because the holder can “put,” or has an option to tender, the bond back to the issuer.
Put bonds that are tendered are customarily remarketed. If not, they may be purchased using monies available for that purpose, including advances under a line of credit or draws under a letter of credit.
APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS C-
than the original price plus allocable OID, the difference may be treated as a loss for federal income tax purposes.
DISSEMINATION AGENT
An agent appointed pursuant to a continuing disclosure agreement for the purpose of filing annual reports and event notices with NRMSIRs and state information depositories. See, generally, Chapter 10, Continuing Disclosure and Investor Relations Programs.
DUE DILIGENCE
The inquiry made to reveal or confirm facts about the issuer, the issue, and the security for the issue that would be material to a prudent investor in making a decision to purchase the issue.
Due diligence inquiries are made by underwriters and lawyers to determine, for example, whether the issue follows the purpose and scope outlined by the enabling legislation, statutes, and resolutions of the issuer and whether all material facts have been accurately disclosed in the Official Statement. Courts have generally concluded that participants who demonstrate that they have conducted reasonable investigations resulting in a reasonable belief in the accuracy and sufficiency of the disclosure document have satisfied their responsibilities under the disclosure laws relating to municipal bonds.
ECONOMIC USEFUL LIFE
The period over which an asset may reasonably be expected to yield economic benefit to its owner.
Because economic factors can render property useless for its intended purpose long before the property deteriorates physically, the economic useful life of an asset is often different from its physical life. The maturity of an issue of bonds generally may not exceed 120 percent of the weighted average useful life of financed facilities if interest on the bonds is to be tax-exempt. In determining the economic useful life for this purpose, a safe harbor is available by reference to periods prescribed by the Internal Revenue Service under its Asset Depreciation Range (ADR) system.
ENTERPRISE
A defined revenue producing set of facilities that are operationally integrated and which have a common service purpose.
An enterprise may consist of all of the facilities of a special district, such as a municipal water district, or may consist of only a portion of the assets of a general purpose governmental entity, such as the water system of a city.
C-20 APPENDIX C: DEBT F INANCING T ERMS AND CONCEPTS
With respect to certain types of revenue bonds, the specification of the extent of the enterprise is important, because it is the revenues of the enterprise that provide the security for the bonds.
ESCROW A GENT
With respect to an advance refunding, the commercial bank or trust company retained to hold the investments purchased with the proceeds of the refunding and, customarily, to use the amounts received as payments on such investments to pay debt service on the refunded bonds.
EVENT NOTICE
A notice delivered to the NRMSIRs and any state information depository in connection with a listed event. See generally, Chapter 10, Continuing Disclosure and Investor Relations Programs.
EXEMPT FACILITIES
As defined in the Internal Revenue Code, airports, docks and wharves, mass commuting facilities, facilities for the furnishing of water, sewage facilities, solid waste disposal facilities, qualified residential rental projects, facilities for the local furnishing of electric energy or gas, local district heating or cooling facilities, and qualified hazardous waste facilities.
Qualified private activity bonds may be issued for exempt facilities.
FAILED AUCTION
An auction that occurs in which, due to a lack of demand for the auction rate securities (ARS) on the auction date, insufficient clearing bids were received. In the event of a failed auction, existing holders maintain their positions (or some pro rata portion) in the ARS at the maximum rate until a subsequent successful auction. Failed auctions are rare and, to the extent they do occur, are usually associated with downgrades in the credit ratings of the issuer or the insurer.
FEASIBILITY CONSULTANT
The person or firm retained, customarily by the issuer, to express an opinion (generally printed as an appendix to the Official Statement) on the economic feasibility of a facility, enterprise, or lending program to be undertaken with the proceeds of an issue.
Feasibility consultants are retained for a wide variety of different types of financings, ranging from large single projects such as a hydroelectric power plant to lending programs such as a multideveloper single-family mortgage revenue program. The objective of a feasibility report is to provide an assessment of one or more aspects of the economic feasibility of the purpose of a
