How to Decipher the Cover Sheet of an OS

Introduction

In the previous post, we discussed how to obtain an official statement on a municipal bond issue. Now, we will explore various areas of relative importance on the cover sheet of an OS. The particular Official Statement used in this analysis is the Glendale Arizona Industrial Development Authority Hospital Revenue and Refunding Issue dated in 2007 (The file can be downloaded here). On this document, there are numbers next to the highlighted information that can be used as a guide. Throughout this post, we will explain various parts on the cover page of this Official Statement.

Please note: Not all OS’s are created the same. These sections are not necessarily in the same order as other Official Statements. The goal is to showcase the wide array of information on the cover of an OS.

Details

1. The upper right corner of this Official Statement is the rating(s) on the bond. Some issues may be non-rated (NR). The three largest rating agencies are:

a. Moody’s

b. S&P

c. Fitch

2. There is an opinion from bond counsel on the exemption status for several areas of taxes:

a. Federal

b. State

c. Alternative Minimum Tax (AMT)

d. Corporations

3. This section contains:

a. the Size of the Deal

b. the Issuer

c. the Type of Issue (Revenue, General Obligation, Certificate of Participation, etc.)

d. the Particular Series

4. A few key points in this area are:

a. the quantity and increments in which the bonds can be purchased

b. the dates of the year in which interest is paid to the bondholder

5. A subject to redemption prior to maturity is noted in this section. More information about the provision can be found inside the OS.

6. This division consists of descriptions of the obligator, the trustee, and agreement specifications.

7. The Maturity Schedule for the various series of bonds is displayed which includes:

a. Due Date

b. Principal Amount

c. Interest Rate

d. Yield

e. CUSIP

8. This piece includes the specifics of who are not the obligators.

9. Investing in the municipal bonds involves various risks. These risks are disclosed within the Official Statement. The table of contents in the OS allows the reader to efficiently search for a variety of topics such as the risks involved in the municipal bond deal.

10. Appendices are mentioned in this section, which are located towards the conclusion of the OS and can include items such as:

a. General Information

b. Financial Statements

c. Certain Provisions

d. Opinion of Bond Counsel

11. This section notes various counsel involved in the municipal deal such as:

a. Bond Counsel

b. Disclosure Counsel

c. Financial Advisor(s)

12. The manager of the deal and co-managers (if applicable) are located in this segment. If an investor is interested in buying this deal, he/she should give their order to one of the managers.

13. The date the OS was created for distribution is included for recordkeeping purposes.

Conclusion

It is important to navigate through research material in an effective and efficient manner when evaluating potential investment opportunities. The cover page of an Official Statement includes valuable information on the bond issue, but is meant to be a supplement to the entire statement as opposed to a substitution when performing due diligence.

How to Obtain an Official Statement

Introduction

There is a wealth of information available to research municipal bonds. One resource with a plethora of information about a municipal bond issue is the Official Statement (OS). This can be used to become more familiar with the credit of a municipality (issuer). The OS includes such items as the purpose of the deal, the maturity schedule, the status of tax-exemption, sources of payment, debt service requirements, financial statements, and any other pertinent data. The underwriter / senior manager puts together the Official Statement for distribution to dealers, advisors, and investors. The OS is the disclosure notice for a municipal bond issue.

How-To

One might ask, "Where do I find Official Statements?" This brief process will explain the steps needed to retrieve an OS.

1. Go to the website http://www.investinginbonds.com (A picture of the webpage is shown below).

2. Under the Markets in Depth section, there is a subsection titled Municipal Markets. Click on the hyperlink: See Municipal Market At-A-Glance (The section of interest is highlighted in the picture below).

3. Next is a page where you can either select the bonds traded today category, the bonds traded yesterday category, or the bond history category. If you choose bonds traded today or bonds traded yesterday, go to 3A. If you want to enter a CUSIP into bond history, go to 3B.

a. By clicking on bonds traded today or bonds traded yesterday, the page following will show the history of municipal bond trades. In the example below, the State of Arizona was chosen to view bond trade history. You can select a particular bond in the history. On the right side of the page, there is a column labeled More Info. One of the links in this column is Statements (See 4A for further instructions).

b. If you know the CUSIP for the bond you are interested in, you can type it into the bond history box. The following page should show the actual bond and it's description. Click on the hyperlink below the column titled # of Trades.

This will take you to a screen shown below (See 4B for next step).


4. a. By clicking on the Statements link, the site will take you to a page where you can download the Official Statement for this particular issue. The user has an option t0 download the cover page, the entire OS, E-mail the document, or download part of the document. The picture below shows an example of what this page looks like.


b. If you click on the link for Search Munistatements.com, you will come to a page that allows you to download the Official Statement. The user has an option t0 download the cover page, the entire OS, E-mail the document, or download part of the document. The picture below shows an example of what this page looks like.


Conclusion

After the Official Statement is available for viewing, the next step is to research the particular issue. The following post will begin discussion of how to go about performing due diligence on a municipal bond issue beginning with deciphering the cover page of an OS.

What Happened To Bonds?

During the last month, the bond market has weakened dramatically. This is particularly evident in maturities from 10-30 years. The 10 Yr Treasury yield went from 4.63% on May 8 to an intra-day high yield of 5.25% on Friday (6/8) before ending the day at 5.14%. The Treasury market has suddenly become big news, and dominates the talking heads on TV. Investors would do well to ignore the trader talk on TV about bonds, and concentrate on the long-term fundamentals for bonds.


The Fundamentals

The two most important determinants of bond yields are:
1. Inflation expectations
2. Strength/weakness of the economy

The Fed has been concerned about reining in inflation, and raised the Fed Funds rate from a low of 1.0% on 5/4/2004 to the current level of 5.25%. This target was established almost 1 Yr ago on 8/8/2006. Since then, they have been in a holding pattern as inflation has fallen from 2.4% to 2.0% on the core PCE price index. The Fed would like this measure to be within the 1-2% target band. We view the progress on inflation as a positive for bonds. There is no evidence that the recent decline in the bond market is linked to an increase in inflationary expectations. The economy has slowed from about a 2.5% growth rate in August of 2006 to a recent weak 0.6% for the 1st quarter of this year (while the Fed has been on hold). This slowing in the economy is also a positive for the bond markets. So, the economic fundamentals are still positive for bond investors.


The Technicals

Since the long-term fundamentals are still positive for bonds, the most likely explanation for the sharp rise in bond yields last month is to be found in short-term changes or the technicals that pre-occupy the minds of traders. Here are some of the technical developments of the last month:

1. The amount of 10 Yr Treasury securities purchased at the last quarterly refunding on 5/8 by Foreign Central Banks was the highest since November 2005. This appeared to be a positive technical development for the market. These bonds sold at 4.63% at the May auction.
2. Shortly after the auction, the Fed stated it was still concerned about inflation and began to raise doubts that it would ease rates soon. These doubts increased during the month as several hawkish comments were made by different Fed Governors. The chart below from a 6/8 Citigroup report shows the change in expectations for a Fed easing over differing time periods.


As recently as 4/18, the market was pricing in an easing of 75 bp’s this year. This probability has now declined to a 0.0% chance. We believe this change in perception is the primary catalyst for the sell-off this month.
3. There has been Foreign Central Bank tightening by the European Central Bank and the Bank of New Zealand, which has added to the change in psychology of bond traders. Their logic is, "how can the Fed ease when the rest of the world is raising rates?" Were we overly optimistic about the Fed cutting rates 75 bp’s this year?
4. Mortgage durations have been rising in lenders' portfolios as ARMS are replaced with longer fixed rate mortgages by borrowers. This has led to hedging activity by lenders such as FNMA, selling 10 Yr Treasury securities to help shorten the duration of their huge loan portfolios.
5. Traders who look at charts feel that the 20 year bond market rally has ended and are shorting bonds. This has contributed to the weakness in the market.
6. The yield curve has steepened significantly which has been caused by large curve flattening trades being liquidated and replaced by curve steepening trades. This is very plausible because during the time long term yields have risen, short term yields have fallen modestly. Since 3/2/2007, the yield curve has gone from being inverted by (60) bp’s to having a positive slope of 17 bp’s on 6/1/2007. To implement this trade, the trader sells the long bond and buys shorter maturity bonds. This has contributed to the recent rise in rates.


Conclusion

There have been several technical factors that have contributed to the recent rout taking place in the bond market. This has driven yields to attractive levels for investors. This is a good time to ignore the traders on TV. Traders frequently change their opinions and have different time horizons than the investor. These same traders were telling us less than 2 months ago that there was a high probability that we would see a 75 bp's cut in rates this year by the Fed. Now they think there is no chance for a cut in rates. Future actions by the Fed are data dependent. If inflation continues to slow and the economy stays weak, rates will fall. The recent rise in rates should have a dampening effect on the economy which could lead to lower rates in the future. We feel the current sale in the bond market represents an opportunity for investors to add to their fixed income positions.