Basic Debt Financing Scenario

"It's the same reason that revolver lenders don't want junior capital to mature within the maturity date of the credit facility and usually have a covenant in the credit facility to mitigate that risk."

I agree with this. It sounds like the revolver will be used to pay out the convertible debt, which means your funding other people to get their money out of the company. That's usually a bad sign, even if you're getting security on your revolver. You don't want to end up having to enforce.

At the very least, your revolver is giving the company necessary capital which will benefit the convertibles - they get the equity upside if they convert to equity, plus the proceeds of the revolver if they instead demand repayment. Sounds like all good for them, all risk for the revolver lender. Smells fishy.

I'd want to see the redeemable debt convert to equity or give an irrevocable undertaking that they will convert to equity before I'd even think of providing a revolver. That gives me assurance that pre-existing lenders who know the business better than I do have enough confidence to take the equity.

Even then, I'd be skeptical. Next question would be what's the leverage as a multiple of FCF or EBITDA - how much debt is in the capital structure?

Hedgehog68:

Hey guys, I was wondering if anyone could help clarify the process in a Municipal Bond financing project. This question stems from understanding what has happend in Detroit, so if anyone could give examples from that I would appreciate it.

Let me know if I am right here, because I am a little confused on how this works: So the City of Detroit underwrites Municipal Bonds for Company XYZ to issue at X price and at Y rate. Company XYZ then issues these bonds (through capital markets?) to bondholders, whether institutional or individual. They use the proceeds to Finance some sort of project, lets say a Capital Expenditure of a new Facility. Assuming the new facility will generate more revenue, the cash flow from that facility then flows back to Company XYZ and is then paid out in the form of interest repayments and eventually covering the principal. ----> Is this the correct process of how municipal debt financing works? Also could someone explain to me the liability that, in this example, the City of Detroit holds as the underwriter of these instruments for Company XYZ to issue? It seems that Company XYZ is holding all of the debt/liability here, but when Company XYZ cannot repay their debts, ultimately defaulting on such loan, what happens to the underwriters of this Financing plan, and the City of Detroit? I assume that the City marks these debts on their Balance sheet, and then when a company defaults, they eventually get marked down? Or something like that?...

Would appreciate any help regarding the process with this. Thanks guys

I never worked on a TON of Redevelopment shiz but it depends on the indenture in terms of the order of the cash flows. Whenever private companies issue debt on a tax-exempt basis it is through a redevelopment authority with a muni backstop. This is how stadiums get financed. Also some larger redevelopment projects where it is believed the project will be a value add to the municipality.... So a develpment authority will issue bonds for a project that is owned by Company XYZ with states prices and yields and there will be a backstop by the city or an obligation to pay should the cashflows from the project not be sufficient to cover P&I.... But again it depends on the indenture, so if the City issues on behalf of the project they are likely fucked... if it is the development authority and the city doesn't backstop the deal they could potentially get out of it without the liability and the default could just end with the authority...

@HedgeHog68

You have the issuance process twisted around a bit. Municipal bonds are obligations of the issuing municipality, and the debt appears on the municipality's balance sheet. A single Investment bank, or a predetermined syndicate of investment banks, purchase the bonds from the issuer in the primary market. The investment banks purchases all of the bonds at a discount (called underwriter's discount), and agrees to sell all of the bonds to investors at the prices stated in the official statement. A typical underwriter's is $5 per bond or 0.05%.

If Detroit issues $100,000,000 of par bonds, the Investment bank pays Detroit $99,500,000, and sells the bonds to investors for $100,000,000. The Investment bank assumes the risk of selling the bonds, and can earn up to $500,000 ($5 per bond x 100,000 bonds) by selling all of the bonds. Detroit is responsible for paying the principal and interest payments.The investment bank has no liability to pay principal and interest. Their only risk is trying to sell the bonds. If they can't sell the bonds they just hold on to them and receive the principal and interest payments from Detroit. If the bank sells all of the bonds they are out of the picture.

There are generally two types of Municipal Bonds: General Obligation (GO) Bonds, and Revenue Bonds. The difference between the two bonds is the security that backs the principal and interest payments. GO bonds are backed by the full faith and credit, or taxing power of the municipality. Only Cities, Counties, and States can issue GO bonds, and GO Bonds are the most senior obligation a municipality must pay. The main taxing power for Cities like Detroit is property taxes. In order to pay its GO obligations, Detroit agrees to use property taxes to pay its debt. If a City has problems paying its debt, it can raise property taxes.Property taxes are based on assessed value.

Revenue bonds are subordinate obligations, and have dedicated revenue streams. These revenue streams may be road tolls, stadium leases, public transit fares, etc.

Okay great that makes perfect sense. Still wondering in this aspect though, so maybe you can help me out: In my example, lets say Company XYZ is using Municipal bonds to finance some sort of expenditure/project. So the investment bank purchases the bonds from the Municipality and issues them to the Company, and then they re-issue them to investors? How does it work in this process?

Hedgehog68:

Okay great that makes perfect sense. Still wondering in this aspect though, so maybe you can help me out: In my example, lets say Company XYZ is using Municipal bonds to finance some sort of expenditure/project. So the investment bank purchases the bonds from the Municipality and issues them to the Company, and then they re-issue them to investors? How does it work in this process?

You do not seem to understand the very basics of municipal bond issuance. Reread Blocka's post above and try again. A company can not use municipal bonds to finance a project, municipal bonds are issued by local gov't to finance projects.

There is no "Company XYZ" issuing the bonds, the municipality is the company. If "Company XYZ" wanted to finance something, and was issuing bonds to do so, the securities would just be normal corporate bonds.

Ah I see, sorry guys I never actually learned too much of this but that makes sense. So lets put this into the Detroit example: could anyone maybe briefly explain how the current municipal debt crisis in Detroit has happened? How exactly did the City go underwater and have such massive default?

Hedgehog68:

Ah I see, sorry guys I never actually learned too much of this but that makes sense. So lets put this into the Detroit example: could anyone maybe briefly explain how the current municipal debt crisis in Detroit has happened? How exactly did the City go underwater and have such massive default?