Presentation to:
ASSOCIATION OF INDEPENDENT
SCHOOLS IN NEW ENGLAND
April 30, 2014
TAX-EXEMPT FINANCING:
Chuck Procknow
Tom Murphy
Executive Vice President
George K. Baum & Company
303.391.5444
procknow@gkbaum.com
Director of Finance & Operations
Brookwood School
978.525.6222
tmurphy@brookwood.edu
Public Finance Headquarters
1400 Wewatta Street, Suite 800 • Denver, CO 80202 • (800) 722-1670
CONFLICTS OF INTEREST, ETHICS,
AND GOOD GOVERNANCE
Boston Public Finance
10 Tower Office Park, Suite 506 • Woburn, MA 01801 • (781) 937-0973
1
ETHICS:
The
rules of
a system
ofconduct
moral principals
recognized in respect to a
particular class of human
actions or particular group
2
Ethics Applied
Governing
Principals of a
Financing
Transaction
The School’s
Governing Principals
of a Financing
Transaction
Conflicts of Interest
of transaction
participants
Post Issuance Compliance
Debt Policy
Derivatives Policy
Conflict of Interest Policy
3
Principals of A Financing Transaction:
Industry Wide Lawsuits: What’s Going On?
The municipal market has been headlined by several prominent defaults over the past
several years.
Case
Parties Involved
????
Puerto Rico
Jefferson County, Alabama
Biola University
Stockton, CA
????
Department of Justice
(interest rate swap practices)
????
Detroit, MI
4
When Things Go Wrong: Who’s at Fault?
Bond Counsel
Independent FA
Underwriter
Tax-Exempt Opinion
Recommends Transaction
Executes Transaction
Borrower’s Counsel
Borrower’s Opinion
Jefferson County, AL
Underwriter’s Counsel
10b-5 Opinion
Trustee
Rating Agency
Represents Bondholders
Determines Credit Rating
5
6
New SEC Regulations (732 Pages)
7
New SEC Rules: Highlighting Conflicts of Interest

Do any professionals on a tax-exempt financing have a conflict of interest?
Financing Team Member
Bond Underwriter
Bank (direct purchase/swap provider)
Independent (Unregulated) Financial Advisor
Broker Dealer Financial Advisor
Conduit Issuing Authority
Borrower’s Counsel
Bond Counsel

Some conflicts of interest are “resolvable” through additional disclosure – others
are “unresolvable”.
8
The Role of Counsel
Borrower’s Counsel
Borrower’s Opinion
Bond Counsel
Tax-Exempt Opinion
Borrower’s Counsel has a fiduciary relationship
and no conflict of interest with the borrower.
Therefore, they can give unbiased legal advice, but
are not qualified or licensed to provide tax-exempt
financing advice.
Bond Counsel gives the tax opinion for a taxexempt bond financing and thus represents the
rights of bondholders and the issuing authority.
While it does not have a conflict of interest, it does
not represent the rights of the borrower.
9
Bank Direct Purchase: The Role of a Bank
Bank
(Bond Purchaser)
Borrower
No Advisory of Fiduciary Responsibility. In connection with all aspects of the Transactions (including in
connection with any amendment, waiver or other modification hereof or of any other Bond Document), the
Borrower acknowledges and agrees that: (a) (i) the arranging, structuring and other services regarding this
length
commercial
transactions
Agreement provided by the Bank andarm’s
any Bank
Affiliate
are arm’s
length commercial transactions between the
Borrower and its Affiliates on the one hand, and the Bank and any Bank Affiliates on the other hand, (ii) the
Borrower has consulted its own legal, accounting, regulatory and tax advisors to the extent it has deemed
appropriate, and (iii) the Borrower is capable of evaluating, and understands and accepts, the terms, risks, and
conditions of the Transactions; (b) (i) the Bank and each Bank Affiliate is and has been acting solely as a
principal and has not been,
is not,
and will
notadvisor,
be acting
as an
advisor, agent
orBorrower
fiduciary for the Borrower, or
will not
be acting
as an
agent
or fiduciary
for the
any other Person and (ii) neither the Bank nor any Affiliate has any obligation to the Borrower with respect to
the Transactions, except those obligations expressly set forth herein or expressed or implied under applicable
law; and (c) the Bank and each Bank Affiliate may be engaged in a broad range of transactions that involve
interests that differ from those of the Borrower, and neither the Bank nor any Bank Affiliate has any
obligations to disclose anyMay
of such
interestsintoa the
Borrower.
the fullest extent
permitted by applicable laws,
be engaged
broad
range ofTo
transactions
that involve
the Borrower hereby waives andinterests
releasesthat
any differ
claimsfrom
thatthose
it mayofhave
against the Bank and each Bank Affiliate
the Borrower
with respect to any breach or alleged breach of agency or fiduciary duty in connection with any aspect of any
Transaction.
10
Direct Purchase: Non-Broker Dealer Financial Advisor
Independent
Financial Advisor
Bank
(Bond Purchaser)
Borrower
Independent (Unregulated) Financial Advisors historically have not been subject to Federal regulations – by
FINRA, MSRB, or the SEC.
have not been subject to Federal regulations – by FINRA, MSRB, or the SEC.
Are not broker dealers –need
hence
notundisclosed
have the internal
resources
to obtain
public
market data, interest rate
to do
form
alliances
with broker
dealers
to obtain
swap intelligence, or remarketing desks for variable rate bonds. Independent (non broker dealer) financial
investor/market
based
information
forobtain
their clients
advisors need to form non-disclosed
alliances with
broker
dealers to
this information for their clients
11
Direct Purchase: Broker-Dealer Financial Advisor
Broker-Dealer
Financial Advisor
Bank
(Bond Purchaser)
Borrower
Broker-Dealers, acting in the capacity
financialby
advisor,
regulated
by SEC.
FINRA, MSRB, and the SEC.
are of
regulated
FINRA,are
MSRB,
and the
By accepting a fiduciary role, the Broker-Dealer Financial Advisor has a duty of fair dealing, duty of loyalty, and
a duty of care.
duty of fair dealing, duty of loyalty, and a duty of care
12
Two Types of FAs: One Regulated, One Not
FINRA Exams
SEC Minimum Standards
for Advisory Relationships
Financial Advisor
Non-Broker Dealer
(Unregulated)
Financial Advisor
Broker Dealer
(Regulated)
Subject to Series 7 and/or Series
52 Exams (Starting 2010)
Subject to Series 7 and
Series 52 Exams
- Operates with standard of “fair
dealing”
- Have to be fair in all aspects
- Can’t charge unfair fee
- Can’t knowingly recommend an
inappropriate transaction
N/A
N/A
Satisfy professional and
educational standards: Initial and
ongoing
SEC Rules on Campaign
Contributions
N/A
Can’t “pay to play” – can’t
contribute gifts to borrower or
make election campaign
contributions
SEC Required Disclosures
N/A
Required to disclose any and all
conflicts of interest
SEC Continuing Education
Requirements
–
13
Comparing Financial Advisors
Bond Purchasers
Bond Purchasers
Bond Purchasers
Borrower
Broker Dealer
Financial Advisor
Independent
Financial Advisor
14
Bank
(Bond Purchaser)
What Does the SEC Have to Say?
New SEC rules and regulations have been established to clarify the giving of “advice”
and to highlight “unresolvable” conflicts of interest. These new rules, known as the
Municipal Advisory Rules, amend the regulatory framework imposed on broker dealers
(SEC Act of 1934).
→ New ruleseffective
promulgated January
and
effective10,
January
10, 2014
effective
January
10,2014
2014
→ New rulesas
suspended
as of
1:30ET
pm on
ET onJanuary
January 10, 10,
2014 2014
suspended
of 1:30
pm
→ New rules as
expected
to be reinstated
1, 2014 10, 2014
suspended
of 1:30
pm ET on
onJulyJanuary
reinstated on July 1, 2014
reinstated on July 1, 2014
15
The New Regulation is a Monumental Task
22,000 Unregulated
Financial Advisors
20 Broker-Dealers
(85% Market Share)
16
What Does This Mean for Your School?

It is important to understand the role each professional plays in your financing
transaction. Are they are a fiduciary? Do they have a conflict of interest with the
School’s interests?
 Trust, in any tax-exempt bond transaction, should be your primary concern. If you
don’t trust your transaction professionals, don’t use them.

If you find them working in their own interest at the detriment of your School, then
you shouldn’t use them.
 The new Municipal Advisory rules require historically unregulated nonbroker dealer financial advisors to adhere to the same regulatory guidelines
as broker dealers.

Ultimately the School wants its advisor to put the School’s interests above its own.

The fiduciary relationship assumes:
1. Duty of Fair Dealing 2. Duty of Loyalty 3. Duty of Care
17
What do the New Rules Say?
 If you give advice to a municipal tax-exempt bond/loan issuer, then you are
a Municipal Advisor.
 As a Municipal Advisor, you must put the interests of the borrower above
your own.
 The approximately 22,000 independent (non-broker dealer) financial
advisors will now become subject to the same regulation as broker dealers.
 Each transaction participant must disclose any inherent conflicts of interest
18
Why is All of This Important?
The bank direct purchase:
lowest interest rate
lots of covenants and imbedded risk
Public Market vs. Bank Direct Purchase
6.00%
5.00%
4.00%
Interest
Rate
3.00%
2.00%
Public
Market
Public
Market
1.00%
Bank
Direct
Purchase
Bank
Direct
Purchase
0.00%
1
5
10
Term of Commitment
19
20
30
Understanding the Differences
in Financing Options….Is Complex
Up to $10.0 Million Credit Facility
$750,000
BBVA Compass - 12 yr SFR 1 yr Fwd
BBVA Compass - 12 yr SFR
$700,000
BBVA Compass - 5 yr SFR 1 yr Fwd
Average Annual Debt Service
BBVA Compass - 5 yr SFR
$650,000
Umpqua Bank - 10 yr FR
Comerica Bank - 10 yr - SFR
California Bank & Trust - 10 yr FR
$600,000
Northern Trust - 10 yr SFR
Boston Bank & Trust - 20 yr FR
California Bank & Trust - 7 yr FR
$550,000
First Republic Bank - 30 yr FR
Boston Bank & Trust - 30 yr FR
Comerica Bank - 5 yr SFR
Northern Trust - 5 yr SFR
California Bank & Trust - 5 yr FR
Umpqua Bank - 5 yr - 5+5 FR
Boston Bank & Trust - 10 yr FR
Union Bank - 7 yr SFR
Union Bank - 5 yr SFR
First Republic Bank - 10 yr FR
Umpqua Bank - 5 yr - 5+5+5 FR
$500,000
Legend
"FR" - Fixed Rate
"SFR" - Synthetic Fixed Rate
- 20 year term
First Republic Bank - 7 yr FR
Boston Bank & Trust - 7 yr FR
First Republic Bank - 5 yr SFR
Boston Bank & Trust - 5 yr FR
$450,000
0
5
10
15
Term
20
20
25
30
Good Governance and a Tax-Exempt Financing

Hiring a financial advisor to assist your
school, (1) in developing the appropriate
policies for undertaking a financing and
(2) in building a financial model. A
financial model allows your school to:
→
Analyze and understand debt
capacity
→
Develop prudent risk guidelines
→
Understand the long-term impact
of debt on the school’s finances
→
Stress-test downside scenarios
→
Evaluate different project and
campaign sizes and timing
21
“I knew that notebook would
come in useful one day…”
Finance Committee: How do you Resolve the Issue?
•
Add cartoon with two guys shouting
Debt!
22
Sample Financial Planning Model
Debt Service Coverage from Operations
Endowment to Debt
5.0x
Liquidity to Debt
4.0x
0.80x
3.5x
0.70x
IS SCENARIO FEASIBLE?
YES
Criteria:
Min Debt Service Coverage Ratio (incl. Campaign):
1.25x
Min Unrestricted Liquidity to Debt:
0.20x
Funds Required for Capital Project:
$6,000,000
Unrestricted Cash to be Raised Prior to Bond Closing:
$790,000
Deficit in Campaign / Liquidity for Debt Retirement:
N/A
4.0x
3.0x
2.0x
3.0x
0.60x
2.5x
0.50x
2.0x
0.40x
1.5x
0.30x
1.0x
0.20x
0.5x
0.10x
0.0x
0.00x
1.0x
0.0x
FINANCING SCENARIOS
A
B
$6.85 Million Debt
Campaign Falls Short
C
2 Size of Bond Issuance
$6,850,000
$8,900,000
$6,850,000
$8,900,000
3 Size of Capital Project
$6,000,000
$8,000,000
$6,000,000
$8,000,000
Scenario Switch:
1
Strategic Factors
C
$6.85 Million Debt
$8.90 Million Debt
$8.90 Million Debt
Campaign Falls Short
D
RESULTS
4 Timing of Construction / Bond Issue
June 2013
June 2013
June 2013
June 2013
5 Size of Capital Campaign (Allocated towards capital projects)
$7,000,000
$10,000,000
$4,500,000
$4,500,000
Medium
Medium
Medium
Medium
Yes-At Completion of Interest Only
Yes-At Completion of Interest Only
Yes-At Completion of Interest Only
Yes-At Completion of Interest Only
6 Expected Timing for Receipt of Pledges
9 Pay Down Debt with Capital Campaign Proceeds?
10 Level of Debt Outstanding After Pay Down
$2,025,000
$3,000,000
$4,500,000
$7,300,000
11 Tuition & Fees Annual Increase
12 Targeted Tuition Discount (%)
13 Annual Increase in Tuition Discount Rate (%)
4.50%
16.50%
0.10%
4.50%
16.50%
0.10%
4.50%
16.50%
0.10%
4.50%
16.50%
0.10%
14 Blended Employee Salaries & Benefits Annual Increase
4.00%
4.00%
4.00%
4.00%
15 Enrollment Growth
Stable
Stable
Stable
Stable
16 Endowment Spend Rate
4.50%
4.50%
4.50%
4.50%
17 Endowment Rate of Return
6.00%
6.00%
6.00%
6.00%
Actual
2011
Actual
2012
Min DS Coverage (from Operations):
1.29x
Min DS Coverage (incl. Campaign):
2.46x
Min Unrestricted Liquidity / Debt:
0.25x
Funds On Hand for Capital Project:
$7,488,213
Unres. Cash Raised at Bond Closing:
$969,625
OTHER CONSIDERATIONS:
50% Cash and Pledge Threshold
at Bond Closing:
$2,250,000
Budget
2013
Projected
2014
Projected
2015
Projected
2016
Projected
2017
Projected
2018
Projected
2019
Projected
2020
2.82x
Debt Service Coverage (including campaign gifts)
N/A
N/A
57.53x
11.36x
4.86x
3.63x
5.03x
4.55x
2.46x
Debt Service Coverage (excluding campaign gifts)
N/A
N/A
11.77x
2.81x
1.44x
1.29x
1.97x
2.28x
2.46x
2.82x
Bond Facility Outstanding (at end of FY)
-
-
6,850,000
6,850,000
6,850,000
4,500,000
4,405,000
4,305,000
4,200,000
4,095,000
232,338
186,225
89,858
86,905
223,914
296,165
342,210
420,170
Net Cash Flow Available After Debt Service
Endowment to Debt
Unrestricted Liquidity
Unrestricted Liquidity to Debt
161,638
212,185
N/A
N/A
1.54x
1.63x
2.02x
2.80x
3.05x
3.29x
3.43x
3.58x
580,000
N/A
580,000
N/A
1,302,713
0.19x
1,941,494
0.28x
2,444,969
0.36x
1,137,672
0.25x
1,767,449
0.40x
2,330,195
0.54x
2,529,119
0.60x
2,801,704
0.68x
23
How Does A Financial Model
Aid in the Financing Process?
 How did the financial modeling process influence the School’s
Finance Committee?
 Is “not borrowing” really the conservative strategy?
 Can the School afford debt?
 What financial parameters did the School use to test
affordability?
→ Liquidity to Debt
→ Cash Flow – Debt Service Coverage
24
Stress Testing the Financial Model
25
Best Practices in Independent School Governance
 Post Issuance Compliance Policy
 Debt and Derivatives Policy
 Conflict of Interest Policy
26
Why is a Post Issuance Compliance Policy Important?
IRS/Tax exempt bond compliance requirements fall into several different categories. Many Schools
are having problems with Use – triggering the dreaded IRS VCAP
Direct Placement & Public Issue
USE OF FUNDS
FOLLOW THE
MONEY
Purpose
(Bricks and Mortar)
Bonds
Use of Property
Change in Use
Disposition
Remediation &
VCAP
Debt Payment
Public
Issue
INVESTING
CONTINUING
DISCLOSURE
Arbitrage
Rebate
15c2-12
Undertakings/Emma
Qualified
Investment
Annual Financial
Information
Yield
Restriction
Operating Data
Hedges
Funds/Accounts
Material Event
Notices
GICs
EMMA
Records/Invoices/
Statements
27
Brookwood School – Navigating the Tax Law Restrictions
Use of the School’s Turf Field
• Only 5% of the tax-exempt issue can be used for nonqualified use – should you use bond proceeds for
this?
Dining Hall Contract
• Tax law restricts profit sharing contracts with food
vendor services
28
VCAP!
Tax-Exempt
could
be deemed
taxable
• Voluntaryissue
Closing
Agreement
Program
• Zero tolerance
Five months to a year to resolve
• No sense of humor – or “materiality”
context
Legal fees
Fines for lost interest to the IRS
29
Do We Need a Debt Policy?
• Courted by several banks – “We are anxious to do business
with your School!”
• Incumbent bank - ?
• Inside the RFP Process – 26 options, 7 banks
• How do we decide? What were our goals?
• The role of an outside financial advisor
30
The Purpose of a Debt and Derivative Policy
31
Key Components of a Debt & Derivatives Policy
• Internal process required before undertaking a borrowing
• Fixed vs. variable rate debt
• Reasons for use of derivative instruments (swaps, caps, etc.)
and permitted instruments
• Internal process required before derivative executed
• Maximum life of financing relative to life of assets
• Minimum benchmark savings requirements for any
refinancing
32
What Not to Include in a Debt & Derivatives Policy
• Borrower may only borrow utilizing certain type of debt
• Borrower must maintain a minimum credit rating in order to
borrow
• Requiring a certain person to sign off on a debt/derivative
transaction
• Requirement for specific financing covenants
• Allowable security provisions (i.e. tuition revenue pledge, first
deed of trust, etc.)
The School’s Financial Advisor will help the School determine the
full range of options available in the market and the risk vs.
cost tradeoffs
33
The Purpose of a Conflicts of Interest Policy
34
What is a Conflicts of Interest Policy?
• A CIP is aimed at avoiding any actual or potential conflicts
between the interests of the School and any personal interest
a Trustee or Officer may have
• Generally, conflicts arise when:
1. a Trustee or Officer has an existing or potential financial or
other interest which impairs, or might appear to impair, his or
her independence or objectivity in serving the School; or
2. the Trustee or Officer might derive, or appear to derive, a
financial or other material benefit from confidential
information learned in the course of his or her employment or
Board service.
35
When Should a School Utilize a CIP?
Disclosure should be required, and abstention or recusal may be
necessary, whenever a Trustee or Officer or a related party (spouse,
children, etc.) engages in the following activity:
1. has a material interest in any transaction or any proposed
transaction to which the School was or is to be a party, or serves
as a director, officer, trustee, partner, employer, or employee of
any person or entity having a material interest in an actual or
proposed transaction with the School, or
2. serves as a director, officer, trustee, partner, employer, or
employee of any person or entity that competes directly with
the School, holds more than 5% of the stock or equity of any
such organization, or has received substantial compensation,
gifts, or services from any such organization or person.
36
Bottom Line: Conflicts of Interest
• Ultimately, a School’s Conflict of Interest Policy relies on each
Trustee’s and Officer’s sound judgment as it is difficult to anticipate
all potential conflicts in advance
• Potential conflicts of interest should be discussed with the Chair of
the Board and Head of School as soon as knowledge of a potential
conflict arises and a decision should be made by the Board prior to
any discussion/decisions to avoid any conflicts of interest
• All Trustees and Officers should annually disclose actual and
potential conflicts of interest by completing a Confidential Conflict
of Interest Disclosure Statement
37