State of Texas Debt Issuance Guidelines and Swap Policies

About the debt issuance guidelines

The 77th Legislature passed HB 2190 (Junell). It requires BRB to develop and adopt debt issuance guidelines and policies for state issuers and to make sure state debt is prudently managed.

BRB wrote these policies to standardize and rationalize how the State of Texas issues and manages debt.

The main goal is to set conditions for using debt. The policies also create procedures that keep the State's debt service and issuance costs low, keep the highest possible credit rating, and maintain full and complete financial disclosure and reporting.

The policies apply to all debt the State issues. That includes leases and other debt supported by state general revenues.

Every state issuer should still develop and keep its own debt policies based on its own goals and programs.

These are guidelines for general use. They leave issuers room to respond to changed economic conditions.

BRB says to review the policies as a guideline once every biennium.

Creditworthiness objectives

• Policy 1, Credit Ratings: Texas seeks the highest possible credit ratings for all categories of short- and long-term general obligation debt. It will not give up basic services and programs or its adopted policy goals to get them. The Executive and Legislative branches commit to prudent actions within their control.
• Policy 2, Financial Disclosure: Texas commits to full and complete financial disclosure. It shares clear, accurate financial information with rating agencies, investors, state agencies, other governments and the public. It meets secondary disclosure requirements on time. Official statements, Comprehensive Annual Financial Reports and continuing disclosure statements aim to meet the minimum standards of the SEC, MSRB and GASB and to follow GAAP. The State Comptroller of Public Accounts, with individual issuers, is responsible for ongoing disclosure to state and national information repositories and for meeting national disclosure standards.
• Policy 3, Capital Planning: Texas will prepare a systematic capital plan and do long-term financial planning. State agencies and oversight bodies, including BRB and the Legislative Budget Board, share data for it. BRB prepares the Comprehensive Capital Expenditures Plan and gives it to state leadership under SB1, Article 9, Section 6.38, 77th Regular Session. The plan is carried out through biennial capital budget items in the Legislative Appropriations Request process.
• Policy 4, Debt Limits: Texas keeps outstanding debt within the limits of the state constitution, specifically Article 3, Section 49-j, and at levels consistent with its creditworthiness objectives.

Purposes and uses of debt

• Policy 5, Capital Financing: Issue debt for a capital project when it is an appropriate way to share costs fairly between current and future beneficiaries, or in an emergency. Do not issue debt to pay operating costs, except short-term borrowing to meet cash flow needs.
• Policy 6, Asset Life: Consider long-term financing for buying, maintaining, replacing or expanding physical assets, including land, only if they have a useful life of at least five years. Use debt only for capital projects, except in an emergency. Do not issue debt for longer than the useful life of the project, except in an emergency or to share costs fairly between current and future beneficiaries.

Debt standards and structure

• Policy 7, Length of Debt: Structure debt for the shortest period that fairly allocates costs to current and future beneficiaries or users and fits federal tax law.
• Policy 8, Debt Structure: Aim for the lowest possible net cost to the State or state issuer, given market conditions, the project and the security. Design repayment so the issuer's or State's credit capacity returns quickly for future use.
• Policy 9, Level Principal Debt Service: Consider level principal repayment for bonds repaid from state general revenues. For a twenty-year term, it repays 50 percent of the debt in ten years and creates room for debt service on more bond issues. Keep level debt service for bonds repaid from a dedicated revenue stream, if necessary or appropriate.
• Policy 10, Backloading: Consider backloading debt service costs only in four cases. (1) Natural disasters or extraordinary or unanticipated outside factors make the short-term cost prohibitive. (2) The benefits are clearly greater in the future than now. (3) It helps the issuer's overall amortization schedule. (4) It lets debt service match project revenues in the early years of operation.
• Policy 11, Variable Rate Debt: A state issuer may issue securities with a rate that varies by a set formula or periodic remarketing, consistent with state law and the covenants of existing bonds. Convert variable rate debt to fixed rate as needed to keep the State's creditworthiness objectives, to meet a financing program's needs, or to lock in low fixed rates. Consider how long the variable rate debt has been outstanding when setting the final maturity of the fixed rate debt.
• Policy 12, Subordinate Debt: Issue subordinate debt only if it is financially beneficial as the issuer defines that, or consistent with creditworthiness objectives.
• Policy 13, Derivatives: Consider derivative products when they meet the specific needs of a financing program or give a demonstrated economic benefit that outweighs the costs and risks. Retain financial advisors and legal counsel so the State gets fair market value.
• Policy 14, Refundings: Review all outstanding debt from time to time for refunding opportunities. Consider a refunding, within federal tax law limits, when it gives a net economic benefit or removes restrictive covenants that operations and management need. Advance refundings for economic savings should reach a net present value savings of at least 3 percent of the refunded debt. Current refundings with positive net present value savings may also be considered. A current refunding that seeks exemption from formal review must produce net present value savings of at least 2 percent. Do not consider refundings with no savings or negative savings unless there is a compelling public policy objective, such as removing restrictive bond covenants or adding financial flexibility.
• Policy 15, BANs: Use bond anticipation notes only if transaction costs plus interest are less than the cost of internal financing, or available cash is not enough for working capital needs.
• Policy 16, COPs: BRB discourages certificates of participation (COPs) and participation interests (PIs) in lease with option to purchase (LWOP) transactions. They often carry higher interest rates, are more complex to structure and document, and cost more in legal fees than lease revenue bond issues. Exiting the lease later would need expensive credit enhancement to protect the State's credit ratings. Unless a unique situation justifies them, BRB does not consider them the most cost-effective financing and recommends lease revenue bond financings.
• Policy 17, Credit Enhancements: Use credit enhancement, such as letters of credit or bond insurance, only when it cuts net debt service on the bonds by more than the cost of the enhancement.

Debt administration and process

• Policy 18, Investment of Bond Proceeds: Invest bond proceeds on a schedule that reflects when funds will be drawn for the project. Match investment maturity dates to cash needs. Investments must fit state law and the issuer's investment policies.
• Policy 19, Competitive Sale: Award bids on a true interest cost (TIC) basis if the other bidding requirements are met. If the issuer finds all bids unsatisfactory, it may sell through a negotiated sale under its standard procedures.
• Policy 20, Negotiated Sale: Consider a negotiated sale when the issue's complexity needs specialized expertise, when it would save substantial time or money, or when market conditions are unusually volatile or uncertain.
• Policy 21, Underwriters: For negotiated sales, underwriters must show enough capitalization and experience for the issue. They must also show minority and women participation within their firms.
• Policy 23, Bond Counsel: Retain outside bond counsel for all bond transactions where needed to market the bonds. The bonds should carry a written opinion from bond counsel that the issuer is authorized to issue the debt, has met all state constitutional and statutory requirements, and, if applicable, that the issue is tax-exempt.
• Policy 24, Financial Advisor: Consider an outside financial advisor if the issuer lacks the expertise for the transaction. The issuer decides case by case.
• Policy 25, Compensation for Services: Pay reasonable compensation to bond counsel, underwriters' counsel, financial advisors and others, based on the level of service, qualifications, expertise, industry standards and complexity of the issue.
• Policy 26, RFP/RFQ Process: State issuers make final selections of legal and other services under Chapter 1201 of the Texas Government Code. They decide after an independent review of responses to requests for proposals or qualifications. At least the issuer's financial professional in charge of debt oversight, or the agency's financial advisor, should review the RFPs and RFQs.
• Policy 27, Arbitrage Compliance: Keep a record keeping and reporting system that meets the arbitrage rebate requirements of the federal tax code.
• Policy 28, Intergenerational Housing: Housing developments that mix age-restricted units and family units must meet the definition of intergenerational housing and follow the Board's policy.
• Policy 29, Property Tax Exemption: Some multifamily housing revenue developments are owned by an organization designated a Community Housing Development (CHDO) that qualifies for a 100 percent property tax exemption under Section 11.182 of the Texas Tax Code. For these developments, BRB approves the bond application only if it includes a payment in lieu of taxes (PILOT). The PILOT equals 50 percent of the property taxes the school district would have imposed for the year the exemption applies. It is payable to the Comptroller of Public Accounts and must be submitted to the Comptroller by February 1 of the year after the Board approves the project.

About the interest rate management policies

BRB created these policies to standardize and rationalize how issuers of state securities use and manage interest rate management agreements, mainly interest rate swaps.

Here, "swaps" includes swaps, caps, floors, collars, options and other derivative financial products used with issuing and managing debt.

The policies are guidelines for general use. Each issuer should still develop and keep its own swap policies based on its own goals and programs.

The main goals are to set conditions for using swaps, to balance risk and reward, to provide credit protection, and to maintain full and complete financial disclosure and reporting.

Swap policies 1 to 4

• Policy 1, Legal Authority: State the basis of the legal authority to use swaps. Chapter 1371 of the Texas Government Code usually provides the framework. Before each swap, get an opinion from qualified legal counsel that the transaction has legal authority. Also get an opinion from the swap provider's counsel that the provider's obligations are valid, binding and enforceable.
• Policy 2, Procedure: Before entering a swap, define how you will evaluate and approve it. Include a financial analysis of the risks and rewards, with sensitivity analysis for stressful markets. Review the swap's possible effect on the credit rating, credit costs and the mix of fixed and floating-rate debt. Estimate any added administrative burden. Name the officials who can authorize the size, terms and pricing.
• Policy 3, Risk Evaluation and Mitigation: Evaluate and try to reduce all relevant risks. The next eight points name them.
• Policy 3, counterparty risk: a counterparty fails to perform under its swap contract.
• Policy 3, termination risk: the swap ends before its scheduled maturity for reasons outside the issuer's control.
• Policy 3, collateral posting risk: the issuer must post collateral after a credit downgrade or a market change.
• Policy 3, interest rate risk: the issuer's variable-rate costs rise.
• Policy 3, basis risk: the swap's floating rate does not offset the floating rate on the debt.
• Policy 3, amortization risk: the swap's term or amortization schedule does not match the term or schedule of the debt.
• Policy 3, bank facility rollover risk: a needed liquidity or credit facility on the debt is shorter than the swap.
• Policy 3, pricing risk: the swap is not priced fairly against the market for similar swaps.
• Policy 4, Documentation: Use the standard forms of the International Swap and Derivatives Association, Inc. (ISDA) for standardization, better pricing and transparency. The documents should give credit protection, with downgrade and collateral provisions that reflect the issuer's credit strength compared with the swap provider's. They should also let the issuer end a swap at "market" at any time, at its option, without necessarily giving the provider the same right.

Swap policies 5 to 8

• Policy 5, Purposes: Use swaps for one or more of these purposes. Manage exposure to floating and fixed interest rates. Hedge floating-rate risk with caps, collars, basis swaps and similar instruments. Lock in fixed rates in current markets for later use. Cut the cost of fixed or floating-rate debt by creating synthetic fixed or floating-rate debt. Reach the capital markets faster than conventional debt allows. Manage the risk of changes in the legal and regulatory treatment of tax-exempt bonds. Manage credit exposure to financial institutions through offsetting swaps and other credit management products. Use other applications that raise income, lower costs or strengthen the balance sheet.
• Policy 6, Savings: When a swap replaces conventional bonds to produce savings, such as in a forward or advance refunding, the savings should exceed the 3 percent refunding savings target for conventional fixed-rate bonds. The extra savings pay for the added risk. If the swap's risks are eliminated or greatly reduced, the threshold can match the one for conventional bonds.
• Policy 7, Non-Speculation: Do not enter swaps for purely speculative purposes such as trading profits.
• Policy 8, Protection from Counterparty Credit Risk: Use highly-rated counterparties. As a general rule, deal only with counterparties rated at least double-A by one nationally recognized rating agency. Require collateral if a counterparty's rating weakens or exposure grows large. The standard document for this is a Credit Support Annex. Keep a right to terminate on preferential terms if a counterparty's credit weakens too far. Consider requiring notice of any negative rating action. Avoid too much exposure to a single counterparty or guarantor. Track termination values at least semi-annually, using a mark-to-market calculation.

Swap policies 9 to 12

• Policy 9, Competitive Procurement: Issuers may choose swap counterparties on a negotiated or competitive basis. A competitive process fits when the product is relatively standard, can be broken into standard parts, two or more providers have proposed a similar product, or competition will not hurt the issuer through market pricing effects. Award a competitive bid on the lowest fixed rate paid, the highest fixed rate received, or a similar objective standard.
• Policy 10, Negotiated Procurement: Consider a negotiated procurement when a provider proposes an original or proprietary product or idea. Also consider it to avoid market pricing effects that would hurt the issuer, such as when a swap's size or complexity could move market prices. It can also be used at the issuer's discretion with other business purposes. As a safeguard, get outside professional advice on structuring, documenting and pricing the deal, and get a written certification that the issuer obtained a fair, on-market price.
• Policy 11, Hybrid Procurement: To reward unique ideas or special effort, an issuer may add to a competitive process a provision that reserves a set percentage of the swap for one provider. The provider must match or beat the best bid.
• Policy 12, Reporting and Financial Disclosure: The state commits to full and complete financial disclosure and to meeting secondary disclosure requirements on time. Issuers that enter a swap may report regularly to their governing bodies and the public on its financial effects.
• Policy 12, report contents: Such a report may cover the key terms of the swaps, including notional amounts, interest rates, maturity and how each was procured.
• Policy 12, report contents: It may cover the mark-to-market (termination) value of the swaps and the exposure to each counterparty.
• Policy 12, report contents: It may cover each counterparty's credit rating and any change, and any collateral posted.
• Policy 12, report contents: It may compare actual debt service with the amount projected when each swap was entered. For swaps used in a refunding, it may compare actual cumulative savings with projected savings.
• Policy 12, report contents: It may include an updated contingency plan to replace a terminated swap or fund a termination payment.
• Policy 12, report contents: It may report the status of any liquidity support for floating-rate bonds tied to a swap, including the remaining term and current fee.