What Every Debt Issuer Needs to Know About the New Issue ... · What Every Debt Issuer Needs to...

What Every Debt Issuer Needs to Know About the New Issue Price Regulations

Ellen Evans

Monday ■ MAY 22, 2017 10:30 AM - 12:10 PM

Deputy Treasurer – Debt Management, State of Washington

Steven ApfelbacherPresident, Ehlers & Associates, Inc.

Rebecca LawrenceManaging Director, Associate General Counsel, Piper Jaffray

MODERATOR

SPEAKERS

#GFOA2017

Darren C. McHughShareholder, Stradling Yocca Carlson & Rauth, P.C.

What Every Debt Issuer Needs to Know About the New Issue Price Regulations

NEW REGULATION IMPLEMENTATION DATE: June 7, 2017

Since 2013 the US Treasury Department has tried to change the Issue Pricing Rule

Issue Price is important because it:1. determines the arbitrage yield restriction for rebate compliance

purposes; and2. determines the maximum allowable escrow yield for advance

refunding bonds.

Treasury/IRS Officials believe changing the rule will reduce flipping and reduce the arbitrage limit

Questions for Issuers to Consider for Refunding Bonds

Current rule: Underwriter certifies there is a reasonable expectation that 10% of each maturity will be sold at the stated reoffering price

New rule: The issue price is the first price at which a substantial amount (at least 10%) of each maturity is actually sold to the public. For private placements, the issue price is the price paid by the buyer

Exceptions to the General Rule:

Exception: Competitive Sales. The issue price for qualifying competitive sales can be based on the reasonably expected initial offering price in the winning bid. To meet the requirements of a competitive sale, issuers must make the notice of sale widely available to underwriters, give all bidders an equal opportunity to bid and award the sale to the bidder with the highest price (lowest cost of funds). In addition, and very importantly, issuers must receive bids from at least three underwriters for the exception to apply.

Exception: Hold the Price. The bond’s issue price may be determined based on the initial offering price to the public on the sale date if each underwriter agrees in writing to hold the price of the bonds of a maturity at a price no higher than the initial offering price for up to five business days after the sale date.

Implementation Considerations for Negotiated Sales:

The Bond Purchase Agreement for a negotiated sale should reflect actual sales on the sale date (typically, the date on which the bond purchase agreement is signed).

Provisions of the Bond Purchase Agreement may include reporting requirements should substantial sales not occur on the sale date, or the requirement that the underwriter will hold the price for up to five days after the sale.

Expectations of the entire underwriting syndicate should be reflected in the sale and bond purchase documents.

Implementation Considerations for Competitive Sales:

The general rule standard can be avoided in competitive sales when the issuer receives at least three bids for their bonds.

In the event that the three-bid minimum is not met, the issuer’s Notice of Sale will need to clearly describe how the issue price will be established. At least four options may apply.

Competitive Sales Four Considerations:

1. General Rule. – Issuer states in the Notice of Sale that if 10% of each maturity is not sold on the sale

date, the winning bidder will provide the issuer with ongoing pricing information until 10% of each maturity is sold and the issue price can be established.

2. Hold the Price. – Issuer states in the Notice of Sale that underwriters will be required to “hold the price”

for up to five business days after the sale. This requires underwriters to limit the price of a given maturity to a price no higher than the initial offering price for the lesser of (i) five business days after the sale date, or (ii) date on which at least 10% of that maturity is sold. This option is likely to negatively impact the pricing of the bonds.

3. Hold the Price/Underwriter Cancel the Bid. – Issuer states in the Notice of Sale that underwriters will be required to “hold the price”

for up to five business days after the sale; however, the winning bidder may elect to withdraw the bid.

4. Issuer Cancel the Bid. – Issuers may state in the Notice of Sale that the issuer will cancel the sale if three bids

are not received, and either reschedule the sale date or consider selling the bonds through a different process.

GFOA Alert:

1. Discuss this regulation (early and often) with your financing team2. The initial compliance on these new rules on or shortly after June 7,

2017 should be a consideration as issuers schedule competitive sales of new bond issues.

3. Factors that may affect this analysis include the type of sale, use of proceeds (new money or refunding), issuer’s history of receiving three or more bids, interest rate sensitivity and the timing of when proceeds are needed.

4. Issuers distribute information about each competitive issue widely and build in more time in the pre-sale schedule in order to enhance likelihood of receiving at least three bids.

5. Issuers should be aware that various industry groups have created model documents to implement the regulations, some more favorable to issuers than others.

Issue Price RulesFederal Tax Considerations and Documentation

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Issue Price Rules - Overview

• Issue price has several uses in the tax law• Arbitrage• Private activity bond tests• Others• *Note that the new definition of issue price applies for

arbitrage purposes only

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Issue Price Rules – Overview (cont.)• Establishing issue price

• Overview of corporate vs. municipal debt issuances (serial maturity structure of municipal debt)

• Historical ways of establishing issue price (reasonable expectations, bona fide public offering)

• Policy concerns about offering/expected prices vs. actual sales

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Issue Price Rules – the Final Regulations• Culmination of two different sets of proposed

regulations – 2013 and 2015• Issued as final regulations in December, 2016• Effective June 7, 2017

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Issue Price Rules – the Final Regulations (cont.)• Establishing issue price under the final regulations

• General rule – issue price of a maturity is the first price at which at least 10% of the bonds of the maturity are sold to persons who are not underwriters

• Hold-the-offering-price rule – the initial offering price to the public may be used as the issue price if the underwriter(s) agree that it/they will not sell any of the bonds of the maturity at prices that are higher than the initial offering price during a “holding” period (i.e., five business days following pricing date)

• Competitive sale safe harbor – may use the expected initial offering price to the public if elements of the safe harbor are satisfied (most notably, 3 underwriters with established industry reputations bid to purchase the bonds)

• Private placements – issue price is the price paid by the purchaser

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Issue Price – the Final Regulations (Cont.)• General rule. Issue price of a maturity is the first

price at which at least 10% of the bonds of the maturity are actually sold to purchasers who are not underwriters.

• Sales by underwriters to related parties do not “count” • Who is an underwriter?• Who is the public?

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Issue Price – the Final Regulations (Cont.)• Special rule for using initial offering price to the public

(the “hold-the-offering-price” rule). The issuer may treat the initial offering price of a maturity to the public as the issue price if:

• Underwriter(s) offered the bonds to the public on or before the pricing date at specified initial offering prices (and certify that the offering at those prices actually occurred). UW(s) must provide reasonable supporting documentation (such as a pricing wire)

• Underwriter(s) agree to “hold-the-offering-price” for five business days after the pricing date, or until the general rule is satisfied

• Ability to choose which rule to use• Documentation where more than one rule is used

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Issue Price – the Final Regulations (Cont.)• Competitive sale safe harbor. An issuer may treat the

reasonably expected initial offering price of bonds to the public as the issue price if the bonds are sold in a qualifying competitive sale.

• Must obtain a certificate from the winning bidder of the reasonably expected initial offering prices of the bonds

• Initial offering prices must be the prices upon which winning bidder’s bid was based

• Sale must meet requirements of the definition of “competitive sale” –

• NOS is disseminated in a manner that is reasonably designed to reach potential underwriters;

• Issuer receives three bids from underwriters with established industry reputations for underwriting new issuances of municipal bonds;

• All bidders had an equal opportunity to bid; and• Award is made to the bidder who submits a firm offer to purchase at

lowest interest cost/highest price.

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Issue Price – the Final Regulations (Cont.)• Private placements – issue price is the price paid by

the purchaser of the bonds.• Single purchaser.• Multiple purchasers.• Interaction with general rule.

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Issue Price – Role of the Issuer in the Process• Negotiated sales

• GFOA best practices• Specifically, pre-pricing call with underwriter (or lead)

and bond counsel. Issuer should be aware of whether the underwriter expects that the general rule will be met with respect to each maturity and, if not, whether the underwriter will agree to hold the offering price of unsold/undersold bond maturities

• Who gives what certifications/supporting information?

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Issue Price – Role of the Issuer in the Process• Competitive Sales

• GFOA best practices• Pre-pricing conversation with MA (if involved). Need to

assess early on the risk that 3 bids will not be received. • Coordination of pre-pricing conversations with NOS

provisions. Which of the SIFMA model NOS provisions should be included? Role of MA, bond counsel, and issuer.

• Providing certifications to bond counsel regarding competitive sale process where no MA is involved.

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PIPER JAFFRAY | 21

Questions Underwriters Are Considering…..

…..in applying the 10% test • Creates reporting obligations based on actual sales of bonds to investors until 10% of

each maturity is sold to the public, as opposed to an underwriter’s “reasonable expectations,” leading to compliance burden and potential for liability to issuers and tax authorities.

• Reporting obligations for underwriters (and determination of issue price) could potentially reach beyond the closing, until 10% of each maturity of the bonds is sold to the public.

• The definition of the “public” is greatly expanded to include dealers not part of the syndicate, a huge benefit in complying with the 10% test.

• But “public” excludes “related” parties and distribution agreement counterparties, typically a major source of “public” distribution under the current rules.

• Creates an incentive for underwriters to price or reprice bonds to assure sales of 10% of each maturity to the public on the sale date.

PIPER JAFFRAY | 22

Questions Underwriters Are Considering….

…in applying the hold-the-offering price rule for unsold maturities• Increases potential for internal capital reserve charges to underwriters for unsold bonds

under net capital rules.• Underwriters may buy hedges to hedge interest rate risk for unsold bonds. May not be

able to recover the cost of hedges on unsold bonds subject to the hold-the-offering price rule.

• Does the rule create an incentive for underwriters to price or reprice bonds at a higher rate to avoid unsold bonds?

• On competitive sales, will underwriters bid less aggressively or decline to bid if asked to apply the hold-the-offering price rule?

• Underwriters may assume that issuers do not want to pay a penalty for the certainty of knowing the issue price, but it will take time to determine whether a meaningful pricing impact results.

• Enhanced concerns about the hold-the-offering price rule in competitive sale context because no pre-sales of bonds.

• Difficulty tracking price and reporting restrictions within the underwriting group.

PIPER JAFFRAY | 23

Underwriter Objectives - Implementing the New Issue Price Rules - Generally

• Discuss the new rules early on with your underwriter and bond counsel. Consider structuring considerations, past sales, history in the marketplace.

• Establish clear expectations and procedures with issuers in advance of the sale date.

• Understand whether the transaction is sensitive to issue price. Issuers should consider whether negotiated sales are a better option for issue price sensitive transactions, such as advance refundings.

• Use standard documents to reduce transactional costs and avoid uncertainty

• Many underwriters are approaching the new rules on a transaction by transaction basis, as they see and understand how the rules are playing out

PIPER JAFFRAY | 24

SIFMA Forms – Negotiated Underwriting

Addendums to Agreement Among Underwriters/Selling Group Members • Underwriters will obtain agreements of the members of the syndicate (co-managers and selling group

members) that they will agree to report prices to the senior manager to allow bond counsel and the issuer to determine when the 10% rule has been met.

• Agreements will also provide that if the senior manager so designates, the senior may agree with the issuer to apply the hold-the-offering price rule to select maturities. These agreements are sent in the form of addendums to existing master agreements .

• Underwriters and syndicate members must obtain similar agreements of their retail distribution partners.

Bond Purchase Agreements Inserts• Sets out the agreement between the issuer and the underwriter as to the underwriter’s reporting

requirements and as to whether the hold-the-offering price rule will apply and to which maturities

• Presumes that the 10% rule will apply, with a separate optional paragraph and schedule to be inserted if the underwriter agrees to the hold-the-offering price rule as to any maturities.

• Issuer acknowledges that the underwriter is not liable for the failure of a syndicate member or any retail distribution partner to comply with is agreement to hold the offering price, if that rule is applied.

Should Include a form of the underwriter certificate

PIPER JAFFRAY | 25

SIFMA Forms – Competitive Underwriting

Alternative I - 10% Test to Apply if Competitive Sale Requirements are Not Satisfied

Alternative II - Hold-the-Offering-Price Rule May Apply if Competitive Sale Requirements are Not Satisfied

Alternative III - Bidders Should Expect that the Competitive Sale Requirements Will be Satisfied – Bids Cancelled if Hold-the-Offering-Price Rule to Apply Unless Bidder Confirms its Bid

Alternative IV - Bidders Should Expect that the Competitive Sale Requirements Will be Satisfied – Sale Will be Cancelled if Competitive Sale Requirements Not Satisfied

Municipal Advisor Perspective

Steven ApfelbacherPresidentEhlers & Associates, Inc.

What are we talking about?Example: $100,000 bond due in 1 year: Priced with an investor yield of 1.1% and a 3.0% coupon

Resulting Dollar Price: 101.884 or $101,884 if all $100,000 sold at that priceBond Yield for Arbitrage Purposes: 1.0923801%

Rule Impact: 10% or $10,000 sold at 101.884

Same analysis done for each maturity within the debt issue resulting in one debt arbitrage yield

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The New Rule• The new rule will not change the proceeds paid to

issuers, so none of the options will result in uncertainty concerning construction fund deposits, issue size, costs, capitalized interest, or internal allocations on the day of sale

• Any change due to the reoffering price adjustment will only impact the discount received by the underwriter.

• The greatest concern is if pricing certainty is required for a refunding

• Remember the Hold-the-Offering-Price Rule or 10% Sale Test Rule can be applied on a maturity by maturity basis

• The issuer may select the rule it will use to determine the issue price for the bonds at any time on or before the issue date of the bonds

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Impact of the Rule change?• For a negotiated sale

• Rule addressed as part of negotiations and should not be an issue in addressing

• However, it could be used as an excuse not to take down bonds if certain maturities have not sold

• For competitive sales• Has the potential impact of hurting smaller competitive sales

by issuers• The New Issue Pricing Rule should not be used as an

excuse to further negotiate sales• Per GFOA Best Practices and if you have concerns, hire an

MA, upfront, to seek independent and fiduciary advice on how best for an issuer to address this new requirement

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What to do for Competitive Bid?• Issuer or issuer with their MA must determine which of the four

SIFMA Alternative’s they believe work best for the issuer • General thoughts:

• Alt 1 or the “General Rule” should generally be used if issue price certainty is not needed on the day of sale, or if there is a high degree of confidence the three-bid rule can be established

• Alt 2 or 3 should be used if arbitrage price certainty is needed and there is a possibility of not getting 3 bids. Depending on the facts and circumstances, either option works but Alternative 2 will ensure that any bid provided will provide price certainty for a refunding. Alternative 3 might avoid a risk premium in the bid, but would not ensure a firm bid which could result in the cancellation of the sale/bid rejection

• Alternative 4 has limited application

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Alternative 1 Alternative 2 Alternative 3 Alternative 4Advantages Disadvantages Advantages Disadvantages Advantages Disadvantages Advantages Disadvantages

Issuer will know they have a firm bid for consideration if one or more bids received

Would not provide arb limit on day of sale if 3 bids not received

Issuer will know they have a firm bid for consideration if one or more bids received

In short term, could result in a higher cost of interest and/or discount

Offers maximum flexibility to the underwriter to encourage their bidding

Complex to explain and manage in a credible manner

Easy to explain and manage

Could result in a failed sale so issuer must understand and plan for possibility of failed sale

May result in same interest and/or discount cost as Alt 3

Issuer refundings that use this rule must understand and plan for possibility of no arb limit on sale day

Provides the arb limit on day of sale for a refunding if one or more bids received

Would likely prevent some underwriters from bidding since they would be required to hold their price if 3 bids not received

In short term, could result in a lower cost of interest and/or discount

May not provide arb limit on day of sale if 3 bids not received

May result in lowest cost of interest and/or discount

Bids by 1 or 2 bidders would not be awarded even if they were strong bids



May exclude larger underwriters that hedge their bidding

Added possibilities over Alt 1 to establish an arb limit if 3 bids not received

Could result in a failed sale so issuer must understand and plan for possibility of failed sale

Most similar to current public sale practice

May avoid any Hold-the-Price premium in a bid

Ehlers MA New Issue Pricing Decision Making Matrix

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Determination of the Appropriate Alternative • Should be based on the facts and circumstances

concerning the issuer and related sale• Determine if price certainty or the arbitrage limit is

needed on day of sale• Understand the latest date the issuer will need the

funds• Review issuer credit and past market access to

determine if 3 bids were received in the past• Determine the probability that the Issuer will receive

three bids. (In our recent past, 1 out of 10 sales did not get 3 bids)

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Why Not Three Bids?• There is no one reason for not getting 3 bids • Combination of several factors are present:

– Competition in the market on day of sale– Size of Issue - (Approximately $2 million or less) – Credit Rating - (A-1/A+ or less)– Story Bond or Limited History of Revenues– Length of Issue - (One year maturity or maturities

longer than 10 years)– Call provision - (Shorter calls less than 8 years)– Name recognition/geographic location of Issuer,

primarily a problem state/infrequent issuer– Smaller block sizes upfront– Back-end loaded maturity schedule– 25 out of 27 issues without 3 bids were Bank Qualified

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What to do to enhancing possibility of 3 bids?• Explore purchasing a Credit Enhancement (bond

insurance) to overcome issue concerns for getting 3 bids• Allow for term bonds in notice of sale to provide

underwriters more flexibility to meet 10% Sale Test Rule or Hold-the-Price Rule

• Get OS in the market as soon as possible• Be prepared to move sale once the competitive bid

calendar becomes clear if could impact the number of bidders

• More competitive sales than normal• Bidding late in the day• More issues with similar terms

• Use SIFMA documents so underwriters are clear on what the issuer is requiring

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With June 7 approaching• If the issuer in the past has received 3 bids in a

competitive sale and it appears that there is a strong probability that issuer will continue to get 3 qualified competitive bids, proceed with the sale under Alternative 1 unless price certainty needed.

• If not a strong probability of 3 bids, either delay sale initially to see how the market receives the new rule or with their MA, if retained, determine is an alternative course of action

• Bank placement• Negotiated sale• Leasing

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