Tag Archives: Municipal Bonds

Example Bond Issue: April 2011

The basics of a Municipal Bond are straightforward. The City borrows some money, pays interest while using it, and then pays it all back on the due date.

The reality of the bond markets is more complicated. As an example, consider the Bond issue that Hartford did in April of 2011. The City issued $25,000,000 in debt in the first half of 2011.

Page 2 of the Offering Statement showed that the issue was actually a series of 13 bonds. The first 12 were scheduled to come due each April 1st beginning in 2013 and ending in 2024. The face value of those notes was relatively constant each year, and the coupon rate varied between 3.00% and 5.25%.

The final bond was written to be due on April 1, 2031 with a face value of approximately 7 times as high as the others. The final bond also included a mandatory sinking fund provision that forced the principal to be paid off in 7 equal annual installments on April 1 of 2025 through 2031.

Each bond is an individual financial security, with it’s own unique ID called a CUSIP Number. Each bond can be bought and sold independently of the others in the series.

2014-10-31 April 2011 GO Bond Series

Because the coupon rate for most of the individual bonds in the series was above the market interest rate at the time (yield), the proceeds from the overall issue was higher that the $25,000,000 face value of the debt. The proposed Sources and Uses table on page 10 of the Offering Statement (numbered as page 8 in the document) shows that the proceeds totaled $25,609,052.

One way to understand the debt issue is to plot the annual principal and interest due on the series of bonds. Interest is highest in the early years, because interest is due on all of the individual bonds in the series. As time goes on, some of the bonds come due and the City pays off the principal. Paying down the principal causes the annual interest to fall.

2014-10-31 April 2011 Payment Summary

Note that the annual principal payments remain constant throughout because of the mandatory sinking fund provision placed on the bond due in April of 2031.

Principal repayment for the $25,000,000 in debt was to be paid off in roughly equal installments over 19 years.

Intro to Municipal Bonds

Cities and Towns typically do not have enough cash available to pay for large expenses, so they borrow money. Municipal Bonds are the most common way in which the borrowing is structured.

A bond is a type of contract between two parties that specifies legal and financial terms for lending. In this case, the City of Hartford is asking to borrow money and offering to pay it back in the future.

It is traditional in the bond market for the borrower to receive all of the money up front. The borrower then pays interest twice per year at a fixed interest rate for the life of the bond. At some point in the future, when the bond is due, the borrower pays back the entire amount of the bond.

Suppose Hartford borrowed $1,000,000 at 5% for 10 years. The City would receive the $1,000,000 when the deal closed. Every six months, the City would make a “coupon payment” of half of the annual interest:

$1,000,000 * 5% * 1/2 = $25,000

In 10 years, when the bond is due, the City would pay $1,025,000 to cover the final interest payment and the full face value of the note.

Municipal Bonds are a special type of debt contract. Government entities are allowed to issue debt in which the interest income (the coupon payment) is exempt from income taxes.

The effect of this policy is to lower the interest rate for municipal bonds below that of corporate bonds. Municipalities, and therefore their taxpayers, save money by taking advantage of the lower cost of borrowing.