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HANDBOOK FOR MUNI-BOND ISSUERS

ALL MUNICIPAL FINANCE officers have the same goal when they determine that the time has come to tap the municipal bond market – borrow money at the lowest cost, legally. Most officials seldom use the municipal market and find it unfamiliar turf when they do venture onto it.

This book will help municipal bond issuers realize their goal, by providing an understanding of how the process of public finance works, who the cast of characters attendant to a sale are, how the regulators see the market, how others have used innovations in their bond sales, how to measure bond performance using simple bench-marks, and how to work with underwriters should they choose negotiated sale.

The easiest way to understand municipal bond sales is to look at some successes and failures.

♦ The City of Richmond, Virginia designed a variable-rate, short-term note program that allows it to borrow for temporary capital and operating needs. “This program will enable the city to sell bonds more infrequently and in larger amounts, which is expected to lower debt issuance and debt service costs,” Moody’s Investors Service noted approvingly.

Lesson: Concentrate on lower debt service costs (see Chapter 2).

♦ Utah, one of only six states rated triple-A by all three of the major rating agencies, instituted a program that allows the state’s 40 school districts to use the state’s rating as a guarantee on their own debt, thus giving them the chance to save millions of dollars on their borrowings.

Lesson: Only half the states have these kinds of guarantee programs. If your state does, it can dramatically lower yields on your borrowings (see Chapter 12).

♦ San Francisco, mindful of one rating agency’s dictum that it “is more expensive to lure a new franchise than to retain an existing one,” used bond insurance to get voters to approve $100 million in bonds for a new stadium for the city’s 49ers National Football League (NFL) franchise. The agreement with the insurance company provided that the insurer, not the city, would make up any shortfalls in the special tax revenues that pay debt service. Usually bond insurance covers debt service only if the issuer actually defaults. “The upset victory confounded polls that showed the measure trailing by as much as 23 percentage points,” according to the Bloomberg wire service.

Lesson: Bond issues on ballots need champions (see Chapter 9).

♦ Constrained by certain aspects of the Tax Reform Act of 1986, New York City was forced to sell taxable bonds, rather than tax-exempt bonds. The city found that in some instances it could sell such bonds more cheaply abroad than at home, and it set up a special agency to sell yen-denominated bonds in Japan. The city later estimated that interest rate savings on one bond issue approached nearly $4 million.

Lesson: Your job is to borrow money at the lowest cost, legally (see Chapter 2).

To be sure, these are examples of advanced municipal finance strategies. But they show just what you can accomplish if you devote some time and attention to the municipal market.

Unfortunately, however, you are bound to learn more lasting lessons from the market’s horror stories. Cautionary tales abound. Here are some specific problems to avoid:

♦ Brevard County, Florida commissioners approved the construction of a new administration building using non-voter-approved securities called certificates of participation, whose repayment was subject to annual appropriation. Critics of the building forced a referendum on whether to repay or repudiate the issue.

Lesson: Don’t assume your project with a nonessential purpose has popular support.

♦ Lewisburg, Tennessee sold some securities to build a golf course. It took longer to build the golf course than first estimated, and revenues fell short. The city chose not to appropriate money to cover debt service payments, an option clearly outlined on page 9 of the official statement. The trustee sued the city, and it took more than a year of legal wrangling to refinance the debt.

♦ Lake Elsinore, California built a new baseball stadium for its minor league team. Cost overruns forced the city to borrow more to complete it. At the same time, the city embarked on an ambitious economic development program, eventually borrowing more than $8,000 for every man, woman, and child in town. Almost all of the debt was backed by appropriations, which the city, to its credit, tried to make.

The city now faces a costly series of debt refinancings.

Lesson: Don’t assume such a thing as no-fault public finance actually exists. Economic development projects begun with the best of intentions, and financed by securities backed solely by revenues from the project itself, may nevertheless wind up devouring your time, money, and credit.

♦ The City of Vallejo, California sold securities to build the Marine World/Africa

USA theme park, which was run by a nonprofit educational foundation. The city kept pouring money into the project in an effort to increase attendance, and eventually it decided to take over the theme park itself. The city is now trying to sell it.

Lesson: To be successful, theme parks need major new attractions every two years. Major new attractions require big money.

♦ Two Mississippi counties, Hinds and Warren, sold a series of housing bonds for which more than 5 percent of the proceeds were used to pay issuance costs. Internal Revenue Service (IRS) rules limit cost of issuance to 2 percent. The IRS determined that the bonds were taxable. The counties had to enter a closing agreement in which participants in the deal paid $1.2 million to the IRS.

Lesson: Don’t break IRS rules governing bond issuance.

♦ Maricopa County, Arizona was charged by the Securities and Exchange Commission (SEC) with securities fraud for selling two general obligation bond issues totaling almost $50 million without disclosing that the county’s finances were deteriorating. The county agreed to a cease and desist order.

Lesson: Don’t break SEC rules on disclosure of material events.

♦ One of the nation’s largest municipal authorities, the Washington Suburban Sanitary District, with an excellent record of administration and operation, nevertheless got into trouble with both the SEC and the IRS when it allowed its financial adviser to handle setting up escrow accounts for a refunding bond issue. The district may have to pay the IRS more than $4 million in “deflected arbitrage” as a result of the two agencies’ investigations into a practice known as “yield-burning.”

Lesson: To avoid self dealing and conflict of interest, have each professional working on your transaction handle only one job.

♦ Bondholders are suing the City of Denver for not clearly disclosing in the official statements to its borrowings for a new airport that a state-of-the-art automated baggage system might not work as designed. The faulty baggage system delayed the opening of the airport and depressed the bond prices.

Lesson: Disclose all material information in your official statement.

THESE EXAMPLES SIMPLY demonstrate that it pays to do it all right in the first place. The new regulatory reality in the municipal market is that the IRS is examining more bond issues to ensure that they comply with tax law, and will declare issues it determines in violation to be taxable, unless the issuer pays a penalty. The SEC is equally serious in its pursuit of issuers, as well as their professionals, who violate securities fraud laws. The message from these regulatory agencies is simple and clear: You, not the professionals you hire to help you, are responsible for your bond issues.

This need not be terrifying. Done the right way, your bond issue is nothing less than a glory of the credit markets and a wonder of the world. Municipalities from London to St. Petersburg are eagerly studying how thousands of U.S. municipalities each year are able to borrow money cheaply and efficiently owing entirely to their own credit. But done the wrong way, the costs that result from lost or impaired market access, decline in credit rating, and legal maneuvering are almost incalculable.

The process of coming to market, as we shall see, resembles less the streamlined workings of an assembly line than it does a walk down a long corridor, with stops at appropriate offices along the way. Surprisingly enough, the inhabitants of these offices do not all know one another, even by name. These professionals are usually tightly focused on a single subject, such as bond law in a single state, tax law, or how to run the numbers on an advance refunding to discover if it makes sense.

Over the years, municipal bond issuance has become, not more national in scope, not more consistent and uniform, but actually more specific and particular. In New Jersey, for instance, school districts that sell certificates of participation are ineligible to receive state aid for debt service payments; only bond issues qualify for such aid. In Wisconsin, not only out-of-state bonds are subject to taxation, but so are most in-state bonds.

There are hundreds, if not thousands, of such peculiarities on the books.

The most important thing for you to remember about the professionals who will help you come to market in the new era of increased regulatory oversight may be summed up in three unhappy words: Trust no one. It is no longer enough – if indeed it ever was – for issuers to hire professional help and then to rely on it. You must become deeply involved with every step of a financing, and you must understand precisely what is going on. Now let’s take a look at the basics.