Transcript 1) US Municipal Bond Market - FGV

Aula 7: Política e
Financiamento Municipal
(Material apresentado durante o seminário:
Nova Gestão Pública e Finanças
New Public Management & Finance)
Seminário Especial
FGV-EAESP
Jeffrey Leifer
Kurt von Mettenheim
5–9 Junho 2006
Rua Itapeva 474 Sala 4002
13:00 – 16:00
Lecture Topics
1)
Introduction: US Municipal Bond Market
2)
Diagnosis 1: Achilles Heel of Brazilian Development =
Local Government Finance
3)
Diagnosis 2: Economic & Financial Reforms make
Brazilian Municipal Bond Market viable
4)
Diagnosis 3: Recommendations from Successful Muni
Markets in Emerging Economies (& Calif. Model)
5)
Proposal: BMBMwg (Brazilian Municipal Bond Market
working group) 2nd Semester 2006  CVMM,
Comissão de Valores Mobiliários Municipais
1) US Municipal Bond Market
“Municipal bonds have been issued by US local
government since 1812” Fahim, Mayraj.
Infrastructure in the United States is generally financed
through municipal bonds
(all sub-national governments, agencies, quasi-public
“special districts”).
1st paper: General obligation bond, i.e. backed by taxing
power and revenues of issuer.
“…without the ability of state and local governments to
issue debt … today’s America, as we know it, would
cease to exist.”
2005 Market Value = 2.0 Trillion US$ = 15% US GDP
History of US “Muni” Bond Market
1902 = 2.1 billion or $27 per capita.
1927 = 14.9 billion or $125 per capita.
Downturn From WWI  Great Depression  WWII
1945+ “Pent up demand” for infrastructure (urbanization…)
1960 = 66.0 billion
1981 = 361.0 billion
1998 = 1.3 trillion.
If 1/3 per capita US mkt,
Brazilian Municipal Bond
Market = R$ 6.5 billion
Types of US Municipal Bonds
1)
2)
3)
General obligation bonds secured by pledge of
government taxing power;
Revenue bonds secured by pledge of project revenues.
Hyrids…
General Obligation Bonds = early bonds
Current Market = Bonds with revenue stream of a
particular
entity (user fees
and service charges) and
Bonds issued by special districts.
Before 1957 most revenue bonds = utility projects or local
public housing projects.
1960 + = Revenue Bonds replace general obligation bonds
Legal Framework
Origin = financial ruin brought about by the unregulated
and uninhibited issuance of municipal debt.
19th Century = 3 Depressions cause = over- issuance of
Munis: 1837-43  1873-79  1893-99
Constitutional restrictions imposed on state and local
government spending.
Federal System  State Level Regulation
1940  1999 HIGHEST DEFAULT RATE = 1.1%
Default History
1839  1969 = 6,195 defaults (4,770 1929-1935)
1940s = 79 municipal defaults
1950s = 112
1960s = 300
Transition from “Institutional Investors” to
Credit and Risk Analysis & Individual Investors
History = From “Boom & Bust” to stable market,
Today = flight to quality...
Bartley & Zorn. “The Evolution of the State and
Local Government Municipal Debt Market over
the Past Quarter Century.” Public Budgeting &
Finance, December 2005
1986 Tax Reform Act
innovations in the market (changing
economic and social conditions)
Increase in disclosure requirements
Credit enhancements & efficacy of
municipal securities for US state and local
governments.
Innovations 1986 +
Revenue Bonds & Custom Solutions > long-term, fixed-coupon general
obligation (GO) bonds.
Creative ways to avoid debt limits and procedural hurdles
Lease financing (Certificates of Participation (COPs),
Tax increment financing (TIF),
Bond banks,
Revolving loan funds.
Issuers protect investors via letter of credit (LOC)
Reset securities, or floating rate debt
Interest rate exposure mitigated via swaps and derivatives.
All above increase liability risks… Simpler instruments needed?
TOPIC 2:
Diagnosis: Achilles Heel of Brazilian
Development = Local Government Finance
Sequence of Fiscal, Monetary, Banking, and Financial
Market reforms
1982 Dual Fiscal & Debt Crises
1994 Plano Real, 1999 Inflation Targeting,
Fiscal Adjustment, Flexible FOREX
 Financial Deepening without Local Government Finance
 Repressed Demand = HUGE MARGINS  Easy Start
 Desafio da Presidência da FGV (2003 SAP)
How to grow Brazilian economy @ 8%
Savings & Growth, 1948-2000
(% private/public/foreign + GDP
growth)
40,00
35,00
30,00
25,00
Private
20,00
Public
15,00
Foreign
10,00
GDP Growth
5,00
0,00
-5,00
1996
1992
1988
1984
1980
1976
1972
1968
1964
1960
1956
1952
1948
-10,00
Capital Formation & Growth 1948-2000
(% Private, Public + GDP growth)
25,00
20,00
15,00
10,00
5,00
Private
Public
Other
GDP Growth
0,00
(5,00)
(10,00)
1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996
Bond Markets = Achilles Heel of Brazilian
Development
(BIS report, The Development of Bond Markets
in Emerging Economies)
Bond Markets %
GDP
2000
2001
2002
2003
Buenos Aires
Total
Private
Government
Foreign
21.1
2.0
19.2
0.0
19.2
2.5
14.1
2.6
31.4
1.3
27.7
2.4
46.9
1.8
42.4
2.7
São Paulo
Total
Private
Government
Foreign
0.0
0.0
0.0
0.0
0.4
0.4
0.0
0.0
1.0
1.0
0.0
0.0
1.9
1.9
0.0
0.0
Achilles Heel... %GDP Finance
Bond Issues
Foreign Banks
Domestic Banks
1995 2000
1995 2000
1995 2000
------------------------------------------------------------------------------------------------------26
15
6
10
125
88
China
29
23
5
5
27
23
India
11
1
14
14
12
8
Russia
Indonesia
Korea
Philippines
Thailand
53
51
39
98
21
74
45
86
Asia
24
17
11
55
27
14
22
23
2
44
3
4
7
73
18
10
Latin America
25
10
17
13
23
20
Argentina
7
1
16
10
30
31
Brazil
11
1
26
21
67
53
Chile
8
1
15
11
19
18
Colombia
16
12
10
26
12
37
Mexico
0
0
13
9
26
16
Peru
9
4
11
15
10
9
Venezuela
-------------------------------------------------------------------------------------------------------
Diagnosis 2: Economic & Financial
Reforms make Brazilian Municipal
Bond Market viable
1) World Class Transparency & Govt–Market Relations
2) Risk Analysis/IT/Finance: FGV-EAESP Tradition
3) Recentralization = Fiscal Mantra 1990s
Decentralization = Financial Mantra of 2000s
4) Market Confidence  Municipal Finance
* New Public Management = Transparency, Advocacy,
Education & Training, Public & Private collaboration...
* Old Public Management  Hi Cost of Capital, Slow
Economic Growth, Social Exclusion...
Macro-Forecasts & Viability of
Brazilian Municipal Bond Market
1) BCB FOCUS (FGV Brazil Forecast)
3-5 Year Forecasts (Econ/Politics/Govt)
Consensus: Macro-Fundamentals  Foreign
& Domestic Debt Structure Improve...
2) 15-50 year forecasts
a) US Govt National Intelligence Study
b) Goldman Sachs BRIC´s Study
c) Deutsche Bank Scenarios
Long-Term: Brazil & Globalization
US NIC Study:
* NAFTA = north, South America new geopolitical zone
* Global Firms must build emerging market presence /
platforms
Goldman Sachs “Dreaming with the BRICS”
* BRIC GDP > G8 Countries in 2040
Deutsche Bank: 2020 projections
* @ 2.8 % growth, not so soon…
Diagnosis 3: Recommendations from
Successful Muni Markets in
Emerging Economies
(& California Model Sale)
1) Preconditions:
(Recommendations  Brazilian Situation & Viability)
2) Market Structure:
(Recommendations  Brazilian Situation & Viability)
Bahl, Roy & Sally Wallace. “Public Financing in Developing and
Transition Countries” Public Budgeting & Finance. Jan 2005
Pre-Conditions for Muni Market
Recommendation

Brazil Situation
------------------------------------------------------------------------------------1. Devolution of sufficient

Clear Intragovernmental
revenues to encourage
Budget Flows, but myth? of
payment.
no repayment (00s vs 90s)
------------------------------------------------------------------------------------2. Devolution of authority

Yes > % Budget = Mun. Govt.
for budgeting.
(orçamento participativo...)
-------------------------------------------------------------------------------------3. Borrowing authority

NO
to issue short- & long-term debt.
------------------------------------------------------------------------------------4. Provision of public uses

Repressed Demand
of borrowing.
Low Capacity
-------------------------------------------------------------------------------------5. Limits on sources

LRF: Fed. Ministry of Finance
of borrowed funds.
(Sec. Treasury & CAE Senate)
Pre-Conditions for Muni Market
Recommendation

Brazil Situation
------------------------------------------------------------------------------------6. Requirement that debt

Must Design Frame:
approximates economic life
Cost/Benefit Analysis...
asset or project.
Revenue Stream
------------------------------------------------------------------------------------7. Transparent and reasonable 
Transparent YES
debt limits % total spending
Reasonable NO (2%RLC)
on past budget of future.
------------------------------------------------------------------------------------8. Provision for payment

Who? 1) Insurance co´s
debt service arrears & default.
2) Govt., 3) Bond Bank
------------------------------------------------------------------------------------9. Budget law distinguishes

NO? Accounting culture:
capital from recurrent expenditures.
From “debt”  “capital”
Market Structure
Recommendation

Brazil Prospects
------------------------------------------------------------------------------------1. Yields priced for risk.

Primary Market Launches...
------------------------------------------------------------------------------------2. Instruments placed in

Underwriter? Insurance Co´s
Market with private parties
Bond Bank
as underwriters or lenders.
Consortia
----------------------------------------------------------------------------------3. Risk assessed by institutions, 
Must Adapt Credit Analysis
banks, insurance, pension,
to Municipal Finance/Budget
securities firms.
------------------------------------------------------------------------------------4. Criteria for grants &

Policy Discretion for Gov´t.
subsidized market loans clear
& classified from low to high risk.
Manage Market
Recommendation

Brazil Prospects
-------------------------------------------------------------------------------------1. Accounting systems that

Low Capacity
support local liability management.
(asset management systems>).
-------------------------------------------------------------------------------------2. Regular reports to compare

Hi Capacity Budget
planned-to-actual expenditures and
Lo experience finance
track budget progress (debt schedule).
-------------------------------------------------------------------------------------3. Projects evaluated individually and

Low Capacity
according to economic criteria.
Local units have professional capital
programming, budget systems, and
apply cost/benefit and net present value techniques.
Tips
Recommendation

Brazil Situation
------------------------------------------------------------------------------------Uncertainty stunts market growth.

Hi Market Confidence
-------------------------------------------------------------------------------------Political commitment critical.

Legislative Alliances
-------------------------------------------------------------------------------------1st focus = municipal borrowing

Outlawed in LRF
framework (municipal credit markets)
--------------------------------------------------------------------------------------Example: Mexico via provisions for

Who? Fed Govt
Collateral & Debt Security
Insurance co´s
Bond Bank/Consortia
-------------------------------------------------------------------------------------Remedies for nonrepayment

Adapt LRF/ Market
Premium?
Tips, cont.
Recommendation

Brazil Situation
-------------------------------------------------------------------------------------Central government guarantee

NO
-------------------------------------------------------------------------------------Devolution of authority to borrow

NO
-------------------------------------------------------------------------------------Tighter reporting requirements

Tight as Stand in
on commitments and capital expenditures.
Budget/Fical Law
--------------------------------------------------------------------------------------National governments and donor

BIG ADVANTAGE
requirements can direct institutional
savings into domestic investments.
-------------------------------------------------------------------------------------Can provide subsidies to certain

BIG ADVANTAGE
actors and reduce them over time.
Politics & Brazil Muni Market
2007 = New Federal and São Paulo State Governments
 “Supercoalitions” after Mensalão
Problem: Link Federal  State & Local Politics
(partial) Solution: Municipal Bond Market :
* Transform Zero-Sum Budget Disputes into
Positive-Sum collaboration via access to capital
markets
* Executive-Legislative-Judiciary + market discipline
* Risk Ratings to Reward 7 years fiscal adjustment
< Cost of Capital + Deepen Financial System
Diagnosis 3: Lessons from
Emerging Market Experiences with
Municipal Bond Markets
Success: South Africa / Mexico / Poland
(failure Indonesia)
Proposed/Started: China / Philippines / Hungary
Explanatory Variables:
“Legal & Regulatory Borrowing Framework”
“Allocation of Credit by Risk”
California Model
Sale
County of Stanislaus 2004 Certificates of Participation,
Series 2004 A & B
$15,340,000 Series A COPs
$27,455,000 Series B COPs.
A= construction of Gallo Center for the Arts.
B = 12th Street Parking Garage and Office Building,
and acquisition and renovation of Salida Regional
Library and Community Center.
Security A = pledge Gallo Center for the Arts
Security B = pledge of County assets,
(former City Hall building, unencumbered portions of the
downtown County jail, Parking Garage to be constructed,
and Salida Library).
Bond insurance = commitment from AMBAC,
Assurance Corporation.
AAA Moody´s = saved County $667,000 debt
service compared to uninsured COPs ‘A3.’
Capitalize Interest of 1st 2 years, 20 term.
Complex Pricing
(i) multiple bond series, one (tax purposes) as
501(c)(3) bonds, 2% cost of issuance limit,
(ii) no underlying ratings for either series
(iii) lesser essential asset in the Performing Arts
Center,
(iv) complicated private use tax issues and
restrictions
(v) a very difficult market for California paper.
County saved $1.9m 26/3/04 vs two
weeks later. Bond Buyer 20-Bond Index
(avg. yield 20 GO bonds 20-year “A”)
New Public Management and
Finance
Decentralization, Democratization, Transparency,
Accountability
Capitalization of Public Sector
Issuer-Driven Investor Outreach
 Non-Transactional Services
• Debt Affordability Analyses
• Debt Policies
• Municipal Finance Educational Workshops
 Integrity and Accountability
Principles of Prudent Municipal Debt
Management
Independent FA
(No conflicts)
Informed
Decision
Making
Debt
Affordability
Investor
Outreach
Competitive
Sale
Due Diligence and
Enhanced Disclosure
4) Proposal: Brazilian Municipal
Bond Market working group
Working Group  Creation of Muni Debt
Authority(ies)
?= CVMM, Comissão de Valores Mobiliários
Municipais (MBA, Municipal Bond Authority)
Challenge: Write Strategic Plan for Municipal Bond
Market (December 2006)
Challenge: Attract Membership: Academic, Public,
Private Sector Leaders
Critical Juncture
1) Brazil = Successful Sequence of Economic Reforms, but loosing out
on international capital movements & confidence among
international investors.
2) Brazil = World Class IT / Risk / Accounting practices.
* Private Sector  Public Sector
* New Public Management = Debt Capacity Analysis / CostBenefit / IT / Capital Planning / Cash Management /
 New Public-Private dynamic...
3) Can Build Virtual Cycle via Positive Sum:
* Lower Cost of Capital (Hi spreads  Hi marginal returns).
* Increase Transparency / Accountability / Democratization
* Reverse Brain Drain to Private Sector
* Develop Bank Capacity & Market Differentiation
4) “Relational Financial Management” = Pre-Sale  Post-Sale,
education / training  < cost of capital  new issues  education
/ training  < cost of capital... INVESTMENT GRADE...
From Vision to Market
BMBMwg Monthly Meetings, 2nd ½ 2006
Market Design, 2007
Primary Market Launches, 2007 & 2008
Secondary Market 2009+
2007
a=investor
relations
2008
b=federal
govt. tasks
2009-10
c=local govt
tasks
BMBMwg: Tasks / Schedule
June 5-9: Seminar  Today´s PPT = Test Baloon...
June 24: List of Projects for “Pearl” launches, test market,
build confidence, demonstration effect (47 São Paulo
State Strategic Projects? Package Refinance existing?)
August 31: Presentation & Discussion: Market Design
September 30: Approve Draft Memorandum: Market Design
October 28: Roundtable and Discussion: Veto/Amend
Market Design
November 25: Present Proposal to FGV Presidency, Public
Opinion, Fed & State Finance Authorities 2007+
Thank You
* GVpesquisa, Prof. Peter Spink
* FGV-EAESP CDAPG, Coordenador, Fernando Abrucio
& Research Groups
Transformação do Estado e Políticas Públicas
(Prof´s Bresser- Pereira, Pacheco, Abrucio, Loureiro, Martes,
B.Taschner)
Finanças Públicas (Prof´s Arvate, Biderman, Avelino)
* FGV-SP : EAESP EDSP EESP
(professors, students, staff...)
* Jeffrey Leifer; Financial Advocate of California Municipalities
 Best Practices
* Antonio Roberto Bono Olenscki, CDAPG & New Public Management
 São Paulo State Government