(Aug. 1, 2014) Thanks to the intricacies of the bond market, the city will have an extra $1.1 million to work with for upcoming capital projects, if needed.
During the city’s budget reconciliation this week for the recently-ended 2013-2014 fiscal year, it was noted that the $8.3 million bond sale for construction at the convention center had actually netted the city $9,408,770 of investment.
“This was really unusual,” said city Finance Director Martha Bennett. “We would’ve reduced the amount of the bond if we had anticipated this much of a premium.”
The overage is likely the result of a rising-interest rate environment, something which speculative investors have become increasingly feverish about as the economy slowly improves and the Federal Reserve loosens its grip on rates.
In a flat market, all bonds would theoretically sell for their face value – $8.3 million in the case of the city’s bond for the Performing Arts Center expansion. This is known as the par value.
However, such a bond may not retain its value relative to other bonds in a rising-rate environment, in which the return on investment of newer bonds will outpace it.
In order to be re-sold by the original investor, the bond will have to be priced at a discount from par value. This is so that the buyer’s final yield is is consistent with the new, higher interest rates despite the comparatively low rate of the older bond.
In order to protect their investments against this, firms will often purchase bonds form their issuer – in this case, the Town of Ocean City – at greater than par value. This drives the interest rate above current market value, although the net cost for the town remains the same since it is essentially getting “free” money in the form of a premium above par.
While this may seem like a six of one, half-dozen of the other scenario, the relative value of having a higher-return bond – depending on how fast rates rise – may outpace the relative penalty of having paid above pair at the outset.
This is useful, of course, only for those who plan to speculate in the market and re-sell their bonds before they fully mature. Morgan Stanley purchased a total of $12.7 million in Ocean City bonds, including the convention center issue, at the end of the last calendar year.
For the city, the extra funds could simply be used to pay off the additional interest.
“This money borrowed for the convention center has to be used for the convention center,” Bennett said. “The only other use would be to pay interest with it on the bond itself. We would target part of the money, if it’s not used for the convention center, for repayment as early as next year.”