Municipal Bonds

Ashish Agarwal Gaurav Shah (A056) Jatinder Bir Singh Tuli (A062) Nikita Malpani (A046) Priya Chhabria (A017) Urvashi Jha

Issued by

Cities Countries School districts

Special-purpose districts
Redevelopment agencies Public utility districts

Publicly owned airports and seaports

Any other governmental entity below the state level

Interest Payment Exempt from the federal income tax Exempt from the State income tax
Yield usually lower than taxable bond
>> NOT ALL MUNICIPAL BONDS ARE TAX-EXEMPT<< Free to trade anytime once they are purchased by the investor Investment in state and local government projects

Working of Municipal Bonds in the West

Governed by an extensive system of laws and regulations, which vary by state Bonds bear interest fixed/ variable rate, subject to a cap known as the maximum legal limit

Issuer

Cash
Promise to Repay Interest & Face value

Investor

Repayment period- few months to 20 or 30 yrs, even longer

Bond proceeds to be spent on one time capital projects within 3-5 yrs of issuance Tax exempt status- investors accept lower interest payments Attractive source of financing for municipal entities as borrowing rate- lower

Municipal Bond Structure in India

Investors

Special Guarantee

Municipal
Bonds

Principal + Interest

ULBs

Guarantee by DFIs / MDBs

Counter Guarantee

Role of Trustees

Project Cash Flows

Escrow

Debt Reserve Fund

Municipal Bonds With AMC as an Intermediary

Investors Principal Interest Municipal Bonds

AMC

Guarantee by DFIs/MDBs

Bonds Principal + Interest ULBs Loan/Bonds Project Cash Flows Escrow Debt Reserve Fund

General Obligation Bonds

P& i secured by faith & credit & taxing power of issuer Issued by municipal entities to fund variety of expenses

Revenue Bonds

P & i secured by the revenue derived from tolls, charges or rent Issued by special authorities created for particular purpose

Issued in minimum denominations of $5000 or multiples of $5000

Insured bonds Insured by policies written by commercial insurance companies Intended to provide for the insurer to pay P & i payment in the event the issuer defaults Creditworthiness of both the insurer and the issuer Taxable municipal bonds Interest is taxable Build America Bonds (BABs) ,introduced in 2008 financial crisis 35% federal rebate on interest costs BABs only subsidize an issuer's borrowing cost No implied backing from the federal government

Zero-coupon bonds Issued at a discount, with the full value, including accrued interest, paid at maturity. Interest income may be reportable annually Original-issue discount bonds Issued at a price below face value (par) which qualify for special treatment under federal tax law. Pre-refunded bonds Result from the advance refunding of bonds that are not currently redeemable Goal to provide present-value savings to the issuer The escrow account is most often funded with U.S. Treasuries considered relatively safe

Escrowed-to-maturity (ETM) bonds When the proceeds of a refunding issue are deposited in an escrow account for investment in an amount sufficient to pay the principal and interest on the issue being refunded. Housing bonds Securities backed by mortgages and mortgage loan repayments. Can be called at any time from the prepayment of principal on the underlying mortgages

Municipal notes Short-term debt obligations that usually mature within a year or less Municipalities issue notes to generate stable cash flow while they wait for other expected revenues. Conduit bonds Revenue bonds issued by state agencies called "conduit issuers that act on behalf of the actual borrowers Issued for projects such as non-profit hospitals, housing developments etc. The third-party, conduit borrowernot the issuing agencyis responsible for interest payments and principal repayments

1st general obligation bond was issued by the City of New York for a canal in 1812 The US Municipal Bond market is $2.2 trillion strong Forms nearly more than 12% of the total debt market

One of the highest yielding debt instruments Urban infrastructural projects are funded through issue of municipal bonds
Secondary market active with sufficient liquidity Tax exempt lower the cost of borrowing The credit rating mechanism is very robust

Municipal Bond Market In India

How did it start??
First Discussed in a National Level seminar in December 1995 and later in the Rakesh Mohan Committee Bangalore Municipal Corporation was first to issue municipal bonds in 1997

Ahmedabad Municipal Corporation issued these bonds in 1998

Pune Municipal Corporation followed later.

Current Scenario
Raised merely Rs. 850 Crore since its inception Forms nearly 10% of the debt market in the US Only Tamil Nadu and Karnataka have raised funds through pooled finance route.

Municipalities have tapped the bond market only 13 times

Credit Rating
CRISIL ICRA
Finances Operations

Finances, Accounting, expenditure, liquidity Major Revenue heads Service delivery and funding arrangements

CARE

Fiscal profile of the government and its administrative capability Profile of project Risk factors

Credit Ratings for the municipal corporations of 63 JNNURM are released regularly and 40% of them have been rated as investment grade.

Need for Municipal Bonds

Increasing Population and Urbanization leading to rising demand for basic amenities Jawaharlal Nehru National Urban Renewal Mission estimates an investment of more than Rs. 1.2 trillion

Fiscal deficit control, budgetary allocations to municipal bodies, concessional funding

Share of local expenditure in total government expenditure about 40-50%

Concerns
Sense of distrust, Corruption, Etc

Absence of Secondary Market

Municipal Bonds

Lack Of Credit Rating

Lack of Information

 The urban expenditure so far has been financed significantly out of the budgetary support
Financing needs will be met by Urban local body (ULB) own revenues and the external financing needs through debt financing.

Potential of Development of bond markets in India

The savings rate in India is high, close to 33%

The household savings are roughly 25%

Over 10% of household savings are invested in gold or currency An integrated set of actions is required to convert gold/currency based saving into financial saving.

The Constraints..
Weak balance sheets: The Urban local bodies depend largely on the transfers from government.

Measures to strengthen the own revenues of Indias local bodies: a) Empowering ULBs to levy exclusive taxes, most importantly property tax b) A more broad based revenue sharing by states with ULBs c) Formula based devolution of state revenues based on recommendations of State Finance Commissions.

Benchmark and yield curve discovery: Some of the biggest and richest municipal corporations run a surplus and therefore do not need to access the debt market. Mumbais BMC, New Delhi Municipal Corporation, or various other big corporations rely on loans or grants. Consequently, there are no benchmark securities that may guide the investors regarding the associated risk premiums and against which the smaller municipal corporations may borrow.

Credit Enhancement: Institutional investors (e.g. Pension Funds, Insurance) are stipulated to not invest in bonds below a certain credit rating.

This calls for specialized credit enhancement institutions

The Government instituted the Pooled Finance Development Fund with the aim of providing credit enhancement to a pool of ULBs

Pooled Finance Route

To attract urban infrastructure investments - pooled financing mechanism by GOI.

A Pooled Finance Development Fund (PFDF) of Rs 400 Cr ($100 mn) for the 10th Five Year Plan period - set up to help ULBs finance their investment needs. Ratings enhancement facility through a Credit Rating Enhancement Fund (CREF) Expected to reduce the costs of capital and encourage ULBs enter the Municipal debt market

 Access the market through a State Pooled Finance .

Entity (SPFE)
Purchase guarantees from financial institutions willing to underwrite the risk of a cash-flow shortfall. Credit protection : mitigate the risks lower the cost of capital encourage the growth of Municipal debt market in India

 Advantages of Pooled Financing mechanism: 1. Helps risk diversification 2. Less economically viable, but socially useful projects, can bandwagon on the more bankable projects 3. By pooling together a number of projects, it can help finance more projects

 Measures to enhance disclosures on behalf of borrowers Market infrastructure to enhance secondary market liquidity need to be taken.

Need of the Hour.

State Government
Borrowing restrictions

Municipal Authorities
Work towards budgeting and accounting systems
Disclosure of information in public and allowing institutional investment in long gestation investments

Prescriptions regarding interest and principal payment Specification of purposes for bond issue

Look for a good credit rating and security of repayment