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Proposed Response for A5 Compliance – Refunding Debt Which Provides 3% Net Present Value Savings

Proving compliance with the A5 requirement that all outstanding debt that can be refunded to generate 3% net present value savings is a little more difficult then it seems.  Changing market conditions  (this week you can get 3%; next week you can’t); the significant lead-up time it takes to get ready to do a refunding (Local Finance Board application, preparing the prospectus etc), and structuring your refundings to achieve the maximum savings  possible (this sometimes means waiting until you can refund a significant portion of bonds, rather than just a few, or waiting until you can sell them on a bank qualified basis which can provide an additional 10-20 basis points in savings but which requires that you can’t issue more than $10 million in debt in that calendar year, are all factors that need to be considered.

CFA has prepared a tentative model to analyze a Board of Education’s outstanding debt, which examines these factors and provides a written analysis to substantiate A5 compliance.  The cover letter template for a typical district would look much like the following:

In response to the requirements of 18A:55-3(e), which requires that as a condition of receiving State aid, a school district shall refinance all outstanding debt for which a 3% net present value savings is achievable, an evaluation was completed as of 6/30/07 which analyzed refunding results of all callable issues for the Colts Neck Board of Education, (the “Board”) based on current market conditions.

Callable Bonds:

Based on market conditions as of June 1, 2007, our projections indicate the following, based on an annual level savings pattern:

Bond Series: 1998 Refunding Bonds Only

Bond Series: 2002 Bonds Only

Bond Series: Partial BQ refunding of 1998 Refunding and 2002 Bonds

 (Current Best Case Option)

Beyond interest rate movement, there are other factors that may improve the efficiency of a refunding:

1. Call date – The call date for the 2002 bond series is 2019.  Because the 2002 bond series has not previously been refunded, the callable bonds can be refunded well in advance of the call date, if the spread between existing rates on the bonds and current rates is sufficiently wide to generate 3% net present value savings.  However, as the call date gets closer, achieving this level of savings should become easier, as less money will need to be borrowed in order to pay off the refunded bonds and interest due thereon.  The call date for the 1998 bond series is 2008. However, because the 1998 bond series has previously been refunded, the callable bonds cannot be refunded until 3 months prior to the call date, or as a forward refunding up to approximately one year prior to the call date, with a premium included in the rates.   
2. Full or partial refunding – the Board can opt to only partially refund the above listed bond series  in order to have the bonds “bank qualified” and/or refund only those callable bonds that provide the 3% savings threshold. “Bank qualification” applies to municipal bond sold by issuers who do not expect to issue more than $10 Million in debt in the calendar year in which the bonds are sold.  Bank qualification provides tax deductions to banks purchasing the bonds, making rates bid 10-20 basis points less than for non-bank qualified issues.  Issuing bank qualified bonds sometimes mean a Board of Education must wait until after the end of the calendar year, in order to enhance savings from a potential refunding; similarly, pursuing a partial rather than a full refunding may enhance savings, but depending on the maturities selected, may diminish future refunding opportunities for the balance of the callable bonds.
3. Composite issue versus stand-alone refunding – If the Board intends to hold a referendum for new projects within the near future, a refunding could be completed more efficiently as a combined bond sale.  Such a sale would spread issuance costs over both the “new” and refunding proceeds, and reduce the costs associated with the refinancing. 

Conclusion:

Neither a full refunding or a partial refunding of the above listed series, will, at this point in time, generate 3% net present value savings.  The best case option which would be a bank qualified partial refunding of the 1998 and 2002 bond series is 30 basis points away from “working”.  We will monitor market conditions and alert the Board when conditions change sufficiently to warrant taking those steps necessary to implement such a refunding.