Palm Beach County School District
Synthetic Refunding Opportunities
July 6, 2005 presented by Public Financial Management
300 South Orange Avenue Suite 1170 Orlando, FL 32801 407 648-2208
PFM
Table of Contents
I.
Refunding Opportunities/Savings
II.
Synthetic Fixed Rate Debt and Swaption Mechanics
III.
Market Conditions and Risk Considerations
PFM
Summary of Refunding Opportunities
Citigroup has monitored the following refunding candidates. Market
conditions are such that the District can obtain upfront savings by selling
to Citigroup the option to enter into swap(s) to partially refund the
following outstanding COPs on their respective call dates:
Certificates of Participation, Series 2001A
− Par amount of refunded COPs: $73,010,000
− Callable 8/1/11 @ 101% (Advance Refundable)
Certificates of Participation, Series 2001B
− Par amount of refunded COPs: $160,465,000
− Callable 8/1/11 @ 101% (Not Advance Refundable)
Certificates of Participation, Series 2002C
− Par amount of refunded COPs: $105,300,000
− Callable 8/1/12 @ 100% (Advance Refundable)
Certificates of Participation, Series 2002D
− Par amount of refunded COPs: $115,710,000
5 PFM
Refunding Opportunities
Comparison of Advance Refunding and BMA Swaption
Negative arbitrage reduces savings derived from a traditional advance refunding
Adv Ref BMA*
Upfront NPV Savings: 804,921 3,300,000
% of Refunded Par: 1.10% 4.52%
Negative Arbitrage: (2,324,552)
-Adv Ref BMA*
Upfront NPV Savings: N/A 6,300,000
% of Refunded Par: N/A 3.93%
Negative Arbitrage: N/A
-Adv Ref BMA*
Upfront NPV Savings: 565,272 4,600,000
% of Refunded Par: 0.54% 4.37%
Negative Arbitrage: (3,674,382)
-Adv Ref BMA*
Upfront NPV Savings: 956,745 5,300,000
% of Refunded Par: 0.83% 4.58%
Negative Arbitrage: (3,981,630)
-Certificates of Participation, Series 2001A
Certificates of Participation, Series 2001B
Certificates of Participation, Series 2002C
Certificates of Participation, Series 2002D
*Savings are estimated and will vary over time based on market factors and changes in ongoing costs.
PFM
Summary of Upfront Payment & Savings*
The District can obtain upfront savings in the amounts listed belowassociated with a synthetic fixed rate refunding.
LIBOR based swaption (tax risk) can enhance savings significantly
BMA LIBOR Upfront NPV Savings: 3,300,000 6,600,000 % of Refunded Par: 4.52% 9.04% BMA LIBOR Upfront NPV Savings: 6,300,000 11,300,000 % of Refunded Par: 3.93% 7.04% BMA LIBOR Upfront NPV Savings: 4,600,000 8,800,000 % of Refunded Par: 4.37% 8.36% BMA LIBOR Upfront NPV Savings: 5,300,000 9,800,000 % of Refunded Par: 4.58% 8.47%
Certificates of Participation, Series 2001A
Certificates of Participation, Series 2001B
Certificates of Participation, Series 2002C
Certificates of Participation, Series 2002D
*Savings are estimated and will vary over time based on market factors and changes in ongoing costs.
Synthetic Fixed Rate Debt and
Swaption Mechanics
PFM
Interest Rate Swaps in General
Counterparty A
Counterparty A
Counterparty A Counterparty BCounterparty BCounterparty B
Fixed Payments (Fixed interest rate X notional principal amount)
Floating Payments (Variable interest rate X notional principal amount)
•
An interest rate swap is a contract between two parties (referred to as
“counterparties”) to exchange interest rate payments at specified dates in the
future.
•
The interest rate payments for a given counterparty equal the product of an
interest rate (swap rate) and a notional (principal) amount.
•
Usually, the swap rate for one counterparty is a fixed rate, while the swap rate for
the other counterparty is a variable rate.
•
The principal amount by which the swap rates are multiplied is “notional”. That
is, principal payments are not swapped, paid or exchanged; the notional principal
amount is only a “placeholder” used for calculating swap payments.
9 PFM
Floating-To-Fixed Swap (“Synthetic Fixed”)
A floating-to-fixed interest rate swap allows the District to effectively convert itsvariable (floating) rate debt to a “synthetic” fixed rate
The District becomes a “fixed rate payor,” receiving a floating rate payment from a counterparty and paying a predetermined fixed rate
To the extent the variable rate received by the District offsets the variable rate paid by the District to bondholders, the District’s debt cost equals the fixed swap rate plus any ancillary fees
The District would issue Variable Rate COPs (VRDOs or ARCs) and swap to a fixed rate
The counterparty pays the District BMA or 67% LIBOR and the District pays the counterparty a fixed interest rate
Principal is not exchanged and payments are typically netted semiannually
Variable Bond Rate
Bondholders Bondholders Swap Counterparty Swap Counterparty Ancillary Fees: • Remarketing Fees • Liquidity Fees Ancillary Fees: • Remarketing Fees • Liquidity Fees Variable Swap Rate
Fixed Swap Rate District
PFM
Floating-To-Fixed Interest Rate “Swaption
”
”
The fixed payor rate, variable swap rates, fees and swaption premium are negotiated at the commitment date.
– Swaption strike rate can be set equal to market rate or existing COPs coupon (off-market)
A swaption gives the swaption purchaser (the counterparty) an option (i.e., the right but not the obligation) to compel the District to enter into a pre-negotiated swap agreement at some future date.
For this swaption sale, the counterparty pays the District a premium at the commitment or exercise date.
Call Date
(or up to 90 days prior) Today
Commitment Date:
• Sell Swaption setting terms of prospective forward swap. • Receive Swaption premium. • Pay commitment fees for
swap, bond insurance and other fees.
Forward Delivery (Exercise) Date:
• Begin exchange of net swap payments (Variable) or terminate swap (Fixed)
• Issue Variable or Fixed Rate COPs • Redeem prior COPs with proceeds
Market Conditions and Risk
Considerations
PFM
The Market for Swaps and Derivatives
The Over-the-Counter (OTC) market for swaps, derivatives and hedging products exceeded $183.5 trillion as of December 31, 2004
– The use of swaps and derivatives for financial risk management is becoming widespread in both the public and private sectors
13 PFM
Structure Can Generate Substantial Savings
1 2 Term Non-Call Insured Bonds BMA Swap 67%*LIBOR Swap* 3 Y 2.76% 3.30% 3.01% 5 Y 3.04% 3.40% 3.07% 10 Y 3.53% 3.68% 3.22% 20 Y 4.00% 4.01% 3.39% 30 Y 4.20% 4.09% 3.41% Rates as of 6/28/04; sw ap rates include 25 bps liquidity *Issuer assumes tax/basis risk
2.50% 2.70% 2.90% 3.10% 3.30% 3.50% 3.70% 3.90% 4.10% 4.30%
3-Year 5-Year 10-Year 20-Year 30-Year AAA Insured Bonds BMA Swap 67% LIBOR Swap
The District should compare the all-in cost of traditional non-call fixed-rate debt to synthetic fixed-rate debt (including credit support)
In certain cases it may be cheaper to create synthetic fixed-rate debt
The relationship between tax-exempt (BMA/67% of LIBOR) swap and bond rates drives the types of opportunities available to issuers
Tax-exempt bond rates are currently “rich” (lower than) versus BMA swap rates in years making synthetic fixed less
attractive for BMA swaps 57
PFM
Floating to Fixed Swap Benefits & Risks
Benefits
– Locks in fixed rate for term of financing
– Can be cheaper alternative to cash fixed-rate bond market
– Ability to terminate swap for gain if interest rates rise
– Ability to assume (transfer) tax risk
– Customized structures
Risks
– Credit exposure to swap counterparty
– Potential cost if swap is terminated early
– Letter of Credit/Liquidity renewal risk/increased credit support costs
– Basis risk between VRDO cost and variable-rate swap index
– Tax risk (LIBOR swaps)
– Accounting treatment
15 PFM
Basis and Tax Risk
The floating index selected on the swap will affect the expected savings
associated with a given synthetic refunding transaction
– A BMA-based swap produces lower expected PV savings but with higher certainty
– A % of LIBOR swap produces higher expected PV savings but with lower certainty
Actual, realized savings could be more or less than expected depending
upon how well the swap variable-rate index tracks the variable rate on
the District’s COPs
This potential mismatch between the variable rate on the swap and
COPs is referred to as basis risk
– Basis risk can result from technical factors in the tax-exempt money market, e.g. temporary supply/demand imbalance that distorts the normal
tax-exempt/taxable yield relationship
– Basis risk resulting in a permanent change in the tax-exempt/taxable yield relationship is referred to as tax risk
PFM
Historical Basis Risk
The chart below shows basis risk as measured by the actual difference in basis points between 67% of 1-month LIBOR and the BMA index
– Basis risk is realized when 67% of LIBOR falls below BMA (assuming cost of issuer funds at BMA “flat”).
BMA Index vs 67% of 1-month LIBOR Weekly Data, January 1990 to Present
0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
BMA Index 67.00% of 1-m LIBOR
Averages Since 1990: BMA = 3.06%
PFM
Outstanding Debt/Swap Position
All of the District’s debt is currently fixed rate (either traditional or synthetic)
– 2 swaps are fixed payor (1 BMA and 1 LIBOR)
– 1 swap is a “basis swap” against a traditional fixed rate financing
Series 1995A 12,595,000 Fixed Series 1996A 2,930,000 Fixed Series 1997A 44,555,000 Fixed Series 2001A 82,740,000 Fixed Series 2001B 168,015,000 Fixed Series 2002A 74,910,000 Fixed
Series 2002B 115,350,000 Synthetic Fixed X X Series 2002C 134,930,000 Fixed
Series 2002 QZAB 950,000 Fixed Series 2002E 93,350,000 Fixed
Series 2002D 167,195,000 Fixed w/ basis swap X X Series 2003A 58,705,000 Fixed
Series 2003B 124,295,000 Synthetic Fixed X Series 2004A 103,575,000 Fixed
Series 2004 QZAB 2,923,326 Fixed Series 2005A 124,630,000 Fixed Series 2005B 38,505,000 Fixed
Tax Risk
Series Outstanding Par Interest Mode
Basis Risk Fixed 75% Synthetic Fixed - LIBOR 9% Synthetic Variable -Basis Swap 7% Synthetic Fixed - BMA 9%
19 PFM
PFM Recommendation
– Based on the results of our analysis, PFM recommends that the District consider a synthetic fixed rate forward refunding (swaption) of the
Series 2001B and Series 2002D COPs with Citigroup
– Under current market conditions, this financing would generate expected net present value savings of:
– The 2001B COPs are not advance refundable, as such, PFM
recommends a synthetic refunding of the 2001B COPs through a BMA swaption
– In addition, PFM recommends a synthetic refunding of the 2002D COPs, using a BMA swaption (note: the 2002D COPs already have a basis swap so the net result will be a 67% of LIBOR swap plus the fixed spread)
– Estimated combined savings - $ 11.6 million
$5.3M or 4.58% of refunded par (BMA) $9.8M or 8.47% of refunded par (LIBOR) $6.3M or 3.93% of refunded par (BMA) $11.3M or 7.04% of refunded par (LIBOR) 2002D
PFM
PFM Recommendation – Projected Swap Position
Current Projected Fixed 64% Synthetic Fixed - LIBOR 16% Synthetic Variable -Basis Swap 7% Synthetic Fixed - BMA 13% Fixed 75% Synthetic Fixed - LIBOR 9% Synthetic Variable -Basis Swap 7% Synthetic Fixed - BMA 9%
– 25% of the District’s COPs currently incorporate a swap.
– 9% of the District’s COPs currently have “tax risk.”
– Completing the swaption will increase the total amount of swapped debt to 36% while the tax risk remains the same.
– Further, PFM recommends that the District evaluate the desire to increase the upfront payment received, by assuming more tax risk, and consider a different combination of BMA and LIBOR swaptions based on that conclusion.
21 PFM
Implementation – Steps
At this point in time:
Approve the transaction in concept
Finalize bond insurance and rating review
– Address rating concerns regarding non-recurring revenues
Obtain delegated Board authorization subject to minimum savings thresholds
Finalize swap documents (Staff, Bond Counsel, Citigroup, Swap Counsel and PFM)
Monitor bond market conditions for opportunity to price the swap
When market conditions are right:
Execute swap
Receive upfront payment
Near the call date of the refunded COPs:
Select a Underwriter
Choose the form of variable rate refunding COPs
Develop documents and official statement
Sell variable rate refunding COPs and “refund” the COPs
PFM and Citigroup are prepared to assist the District in the timely implementation of this transaction.