Series 7 – Munis

Municipal Securities
 Second in safety of principal only to U.S government and U.S. government agency securities
 Exempt from the filing requirement of the Act of 1933, but subject to antifraud provisions of Act of 1934
 Taxed at the municipal level, not Federal
o If bond channels >10% of proceeds to private parties, it is a private activity bond and not except from tax
 Appropriate for investor in high tax brackets, not suitable for low tax brackets
 Some issuers establish a sinking fund account
 Term bonds are quoted by price and called dollar bonds
 Serial bonds are quoted on YTM (most munis). In-whole call: lower of YTM/YTC
From lowest to higher yield
 G.O. bond
 Revenue bond
 T-Bond
 Corp bond
General Obligation (GO) – Safer than Revenue Bonds
 Backed by municipality taxing power
o Backed by Ad Valorem/property tax (local), income/sales taxes (state), licenses fees, fines and all other sources of
revenue of municipality
o School, roads and park districts may also issue GO bonds backed by property taxes
 Issued for capital improvements that benefit the entire community, projects that do not produce revenue
 Bond resolution is optional (not subject to Trust Ind. Act of ’39)
 Needs voter approval
 Statutory outstanding debt limits: protect tax payers from excessive taxes and makes bonds safer (lower limit = less risk of
excessive borrowing & default)
o Public referendum is needed to go above this limit
o One mill = $1 per $1,000
o Overlapping / coterminous debt: different municipal authorities that tap the same taxpayer wallets. Only occurs in
property taxing/states
Types of GOs
o Limited tax GO: bond that is only backed by a specific tax. Riskier
o Double-barreled GO bonds: double backing (1) revenue from a facility (not ad valorem); (2) municipal/state taxing
power
 Rated and traded as GOs
Revenue Bonds
 Self-supporting debt, ppal and interest payment made exclusively from revenues from the project for which debt was issued
 Issued to finance any municipal facility that generates sufficient income
 Riskier than GOs
o Not backed by municipality’s full faith and credit
o Not affected by statutory debt limitations / vote approval  requires feasibility study
 Sources of revenue are user charges: utilities, housing, airports and toll roads, dorms, student loans, hospitals, retirement
centers, industrial development, pollution control, sports, parks, lease payments under leaseback agreements
 Covenants: rate/price, maintenance, insurance, catastrophe clause (promise to use insurance proceeds to call bonds and repay
bond holders in a calamity call / extraordinary mandatory call), sinking fund, flow of funds, books/records, open-end/closed-end
 Trust indenture/resolution is optional (not subject to Trust Ind. Act of ’39)
 Flow of funds
o Net revenue pledge: ops & mainten first, then debt service
o Gross revenue pledge: first debt service, then ops & mainten.
Types of Revenue Bonds
 Industrial Development Revenue Bonds (IDR/IDB): Private Activity Bond. Municipality issues a bond to construct facility or
purchase equipment then leased to a corporation
o Backed by corporate credit – leaseback
o As a nonpublic purpose bond, interest paid will be taxable to payers subject to AMT Not recommended for UHNW
 Lease rental bonds: finance office construction for itself, its state or community

1
 Series 7 – Munis

o Certificates of Participation: permits investor to participate in a stream of revenue from lease, installment, or loan
payments related to the acquisition/construction of and/equipment/facilities by the municipality. Not viewed as debt
of municipality. Bondholders can foreclose on the equipment/facility that was financed
 Special tax bonds: one or more taxes other than ad valorem (alcohol, tobacco, hotel, business license, excise, gas)
 Special assessment/district bonds: taxes against benefited property (streets, sidewalks, sewers)
 Moral obligation bonds: need legislative authority to appropriate funds and pay bondholders if revenues insufficient
o Moral, not legal, obligation
o Issued in times of financial distress and have increased credit risk
 PHAs/NHAs/Section 8/HUD bonds: backed first by rental revenues, then by full faith and credit of U.S. gov  MOST SECURE OF
ALL MUNIS – AAA rated
o Not considered double-barreled as this is federally backed, not municipality

Don’t require voter approval: school district, moral oblig, double barreled, state issued

Muni Notes - usually <12 months maturity, may range from 3 months to 3 years. Anticipation notes have MIG rating and are
suitable for fiduciaries
 Tax Anticipation Notes (TANs): helps even out CFs between tax collection periods
 Revenue Anticipation Notes (RANs): in anticipation of future revenues from revenue producing projects/facilitates
 Tax & Revenue Anticipation Notes (TRANs): combo of TAN & RAN
 Bond Anticipation Notes (BANs): interim financing before bond issuance
 Grant Anticipation Notes (GANs): in anticipation of gran from federal government
 Tax-exempt commercial paper: in place of BANs and TANs for <270 days
 Construction Loan Notes (CLNs): interim financing for housing projects
 Auction Rate Securities (ARS) / Reset Bonds / Demand Notes / Variable Rate Securities (VRs/VRDOs):
o Floating rate (protects against inflation) tied to ST interest rates
o Clearing Rate / reset rate every 7, 28, 35 days in Dutch auction (bids above clearing rate not fulfilled)
o Interest in the current period based on rate set on prior period
o Usually issued with put option. Price remains stable
o LT (20-30 year maturities)
State and Local Government Securities Series (SLGS)
 Pre-funded bonds invest in escrow in SLGS, a special gov security issued for munis in connection with pre-funding
Build America Bonds (BABs) – NON-TAX EXEMPT!
 Taxable obligation
 Provides federal income tax credits for 35% of interest paid each year; excess credit can be carried forward
 Expired in December 2010, still around in secondary mkt
Insurance
An insured muni would have the same rating than the insurance company. Appears in certificate or separate doc.

Munis Docs
 Bond contract: between municip., underwriters and prospective investors. Includes the trust indenture
 Authorizing resolution: municipality authorizes issue and sale, contains description of issue
 Bond Resolution Indenture: aka protective covenant, includes flow of funds statement
 Official Statement: equivalent of corporate prospectus; signed by issuer; final version must be delivered to every customer
AT/BEFORE SETTLEMENT DATE
o Preliminary OS: missing interest rate and offering price
 Legal Opinion: on every bond certificate (unless it is ex-legal, still good delivery), signed by bond counsel
o Unqualified: counsel found no issues
o Qualified: issue is legal, but some qualification is necessary because of contingencies
Issuing Munis
 Negotiated underwriting: IB is appointed as underwriter, who works with issuer to set interest rate and offering price
 Competitive bidding: bid representing lowest net interest cost to the issuer wins
o Official Notice of Sale: published in Bond Buyer and local newspapers; rating and underwriter not named yet
 All new munis are fully registered or book-entry
Bond Buyer

2
 Series 7 – Munis

 Publishes the 30-day visible supply and the placement/acceptance ratio (sold vs offered)
o Large visible supply  interest rate likely to increase
o High placement ratio  strong muni market

40 Bond Index Rev + GO Daily

20 Bond Index GO >A 20 yrs
11 Bond Index GO >AA Weekly
Revdex 25 Rev >A 30 yrs

 Thomson Muni Market Monitor: current news on secondary munis mkt

 RTRS (Real Time Transaction System): pricing info regarding muni bond transactions, within 15 min of a trade. Seller must
report. Must report to NSCC (Nat Securities Clearing Corp) when between dealers.
Underwriting Syndicate
 Bond years = years to maturity x # of bonds outstanding (in that maturity)
 Avg life = total bond years / total # of bonds
 Syndicate letter: not signed by issuer/counsel/trustee. Includes priority of order allocation. Not binding until bid submission.
o Negotiated underwriting: syndicate contract / agreement among underwriters
o Competitive bid: syndicate letter / agreement
 Type of syndicate accounts (Divide is in the West)
o Western Account: divided account, each one resp for their account
o Eastern Account: after issue has been substantially distributed, each underwater is allocated additional bonds
(proportionate share of unsold bonds)
Establishing the Syndicate Bid
 Writing the scale – assign coupon & yields to arrive to a bid
 Scale/reoffering scale: YTM at which the syndicate will reoffer bonds to the public
 Firm commitment
 Disclosure of fees being paid to clearing agency and syndicate manager
 Awarding the issue
o Net interest cost: common to compare bids
o True interest cost: adjusted for TVM (time value of money)
o Good faith deposit (1-2% of total par value of offering): kept by issuer to ensure syndicate carries out its commitment
 Syndicate Account: created when issue is awarded. Synd. Manager is responsible for keeping books and account. Max length for
syndicate to exist is 30 calendar days from the time the issuer delivers securities to the syndicate
Breakdown of Spread
 Reoffering price/yield: P to the public
 Spread = production – bid
o Production: all proceeds from reoffering price
o Syndicate member received the full spread if he is also syndicate manager
o Other firms may buy from the syndicate at small discount (reallowance), generally 50% of concession
Concession Selling Group They don’t assume financial risk
Underwriting Total Takedown
Additional Takedown Syndicate Member
Spread
Mgmt Fee Syndicate Mgmt. Smaller than total takedown
Order Allocation
 MSRB requires syndicate to establish priority allocation provisions for orders
 Order period: time set by manager during which the syndicate solicits customers for the issue and all orders are allocated
without regard to the sequence in which they are received. Usually runs for an hour on the day following the award of the bid
 Allocation Priorities – Pro Golfers Don’t Miss / Please Send Dave money
Presale Order Before synd. wins the bid. Customer orders w/o knowing final price. Synd. members are not credited with
takedown, it’s split among all synd members according to participation
Group Syndicate After the bid is awarded. Customer’s order receives priority. Takedown is deposited in the synd account and
Net Order split among all synd members according to participation
Designated Order Wish to allocate takedown to certain synd members
Member Order Member orders for inventory/related accts (must disclose to synd mgr). One synd earns entire takedown
 Within 2 business days of sale, synd mgr must send written summary of how orders were allocated
3
 Series 7 – Munis

 Presale: send confirmation with amount, yield, no settlement date (WI when issued)
Payment & Delivery
 On settlement date, issued bonds are delivered to underwriters with final legal op, and the underwriters pay on delivery
 Interest begins accruing on dated date. Investor starts receiving interest on settlement date
Analysis of G.O.
 Demographic data: property values, diversity of industries, population growth
 Debt limits
 Income of municipality
 Official statement: future financial needs, debt statement
Total Debt
- self-supporting debt
- sinking fund
= net direct debt
+ overlapping debt (city’s proportionate share of county & school/park/sanitary district debt
= net total/overall debt
Analysis of Revenue Bonds
Gross Revenue Net Revenue (MOST COMMON)
Debt is paid first from gross Expenses paid first from gross
revenues revenues
Net revenue pledge
 Income from facility is deposited in revenue fund and disbursed as follows:
1. Ops & mainten
2. Debt service acct: pays int and ppal in the current year
3. Debt service reserve fund: holds money for 1 year debt service
4. Reserve maintenance fund
5. Renewal and replacement fund
6. Surplus (sinking fund): for redeeming bonds / paying for improvements
Muni Debt Ratios
 Net Debt to Assessed Valuation: 5% reasonable
 Net Debt to Estimated Valuation: preferred as assessed val varies a lot
 Taxes per capita
 Debt per capita
 Debt trend
 Collection ratio
 Coverage ratio: revenue / debt service (ppal + int)  ratio of 2:1 is good, 5:4 for utilities
 Rating: MIG: only for ST notes. 1 = best quality
Trading & Taxation
 Munis trade OTC
 Round lot: $100 k face amount
 Bona fide / firm quotes: dealer prepared to trade at the specified price
o Muni dealers can make offers to sell securities they don’t own if they know where to obtain the bonds if such offers are
accepted
 Broker’s broker: do not disclose identity of customer, do not maintain inventory, does not participate on new issue
 Anti-reciprocal rule: dealer cannot be selected by a fund because dealer also promises to sell fund shares
 Not suitable for tax-advantaged accts (IRAs/401k)
o If a customer refuses to disclose NW, income or both a recommendation cannot be made
 Dealer may not guarantee customers against loss or share p/l, unless associated person opens a joint acct with a customer and
obtains written permission from the firm (may share in proportion of contributed capital)
 Control relationship of dealer/issuer must be disclosed in writing at/before transaction completion
o Discretionary acct: customer must give express permission for execution
 Confirmation must be provided indicating agent/ppal role, whether securities are called/pre-funded & yield
o Non-callable: YTM
o Callable: lower of YTC/YTM. If in-whole call is announced use that date
o No disclosure: variable rate/reset bonds, defaulted and bonds sold at par
4
 Series 7 – Munis

 Municipal ppal needs to approve in writing for first use any mktg materials, ads, abstract of official statement (not required for
official statement or correspondence). Copies must be kept for 3 years. Copies of advertising are not filed with MSRB.
B/D as Financial Adviser
 Documented in writing before, upon or promptly after inception
 Cannot act as underwriter, only help with Official Statement (must deliver to managing underwriter promptly after award is
made or 2 days before synd mgr delivers securities to synd members
 Can also purchase the bonds from an underwriter for their own or customers (must disclose to client at/before trade
confirmation)
Interest Deductions
 Expenses associated with purchasing / holding (margin) munis are not deductible
 Exception for banks for GO bonds (<$10 mm face amount), they can deduct 80% of the interest carrying cost
MRSB
 Rules require underwriters/dealers to protect investor’s interest, does not regulate issuers (these are regulated by SEC)
 Enforcement
o FINRA: muni dealer
o Comptroller: National Banks
o FRB: non-national banks, FRB members
o FDIC: non-national banks, non-FRB members
 MFP: associated person of a B/D who is engaged in munis activities other than retail sales to individuals, or who solicits munis
business for the B/D or who is in the supervisory chain
Rules
 Research analysts are considered munis dealers and must register with the MSRB
 Anyone who communicates with the public about munis acts as a representative and must pass the Series 52 (53 if they are a
ppal)
o Clerical/ministerial roles excluded (provide trade reports, record/enters orders)
 Requires B/D to maintain blanket fidelity bonds, varies on firm size, banks not affected
 B/D must obtain and keep records of info from associated persons (U-4/U-5 forms)
 Customer complaints must be entered in complaint file and deliver a copy of MSRB’s Investor Brochure to customer
 Uniform practices and good delivery
o Bearer bonds: $1,000 or $5,000 denominations
o Registered bonds: $1,000 multiples, max $100 k in one certificate
o Mutilated certificates need validation from transfer agent. Issuer or commercial bank must endorse
o Coupon bonds must have all unpaid bonds attached
 Nominal/informational quotes need to be identified as such
 Confirmations must be sent or given to customers AT/BEFORE a transaction completion
 Muni B/D must be examined at least once every 2 calendar years
 Dealers must try to get reasonable prices for customers
 Gifts: max $100 per person per year (excl meals, tickets, biz activities, reminder ads)
 Need to have ppal to supervise reps and create/maintain a supervisory procedures manual. He must approve in writing
o New customer accts
o Every muni transaction
o Actions taken on customer complaints
o Correspondence regarding muni trades
 Every B/D (not bank dealers) must have a financial and operations ppal (FinOp) who maintains books and records
 Muni dealer employee must notify employer in writing if he opens an acct with another firm and send duplicate confirmations
 Keep a copy of MSRB regulations, provided to customers upon request
 Official Statement must be given at/before delivery of new issue securities
o Only in negotiated underwriting the spread must be disclosed
 Political contribution: firm banned for 2 years to be negotiated underwriter (competitive bidding is allowed)
o Individual contributions from MFP of up to $250 per election are permitted if they are eligible to vote
 Telemarketing (new clients): prohibited before 8 am or after 9 pm
o Rule does not apply for existing customers or other B/D
 Must establish AML compliance program