This article is a quick primer for those who are relatively new to the process of issuing municipal bonds. My intention is to give readers a non-technical introduction to the municipal bond sale process, including an introduction to the bond professionals involved.
Bond Financing Goals
Broad goals for a bond financing include the following:
- Safely execute an affordable borrowing to fund capital projects;
- Achieve the lowest payments and best loan terms possible; and
- Practice proper post-bond sale (continuing) disclosure and administrative practices.
Bond Definition
A bond represents the government’s promise to repay borrowed money on time and in full, with interest. It is the district’s promise, its bond to investors.
Notable bond provisions include the agreed-upon terms of the bond; the security backing the pledged payments; years until final maturity; bond amount; interest rate; and administrative details, such as where and how it will be paid off. Once the original bond is created and then sold, investors may re-sell it to other investors throughout its term – this is called the “secondary market.”
Bond Creation and the Financing Team
Addressing the challenge of making and selling a bond requires the coordinated effort of a group of finance professionals often referred to as the “financing team.”
Issuer – The issuer is the district borrower as represented by the CFO and other leaders. The issuer appoints other teammates to the team, organizes meetings, prepares required information, and manages activities related to the bond sale.
Bond Counsel (“BC”) – BC is a law firm that specializes in bonds. BC makes sure the issuer’s bonds constitute legal and binding obligations. Workload is expansive, including: prepare ballot questions and bond legislation, consult with the financing team, prepare legal documents, deliver tax opinions, and help issuers with their post-sale duties.
Municipal Advisor (“MA”) – The issuer’s MA is a financial advisor who specializes in planning and managing district bond issues. By federal law, the MA has a fiduciary duty to work in the issuer’s best interest. MA’s help with the following: plan ballot issues, select outside team members, prepare a plan of finance, review documents, prepare rating requests and monitor the underwriting process.
Underwriter – The bond underwriter is a securities firm that sets interest rates for your bonds and finds investors for them. The underwriter’s investment bankers help organize and execute the bond sale. The underwriter is obligated to the district issuer but also to the investors, a dual role that must be carefully balanced.
Underwriter’s Counsel - Underwriters sometimes bring an additional lawyer to the financing team to protect the underwriter’s legal interests and help it comply with securities laws.
Paying Agent – District CFO’s make their periodic bond payments to a bank paying agent. The paying agent transfers the payments to the registered bond-holders.
Trustee - More complex bond issues, including lease purchase certificates, require a bank trustee. Trustees act as paying agents for the issuer and as overseers on behalf of bond holders.
What the Bond Investors Want From the Financing Team
Legal Opinion – Investors must have confidence that all state and federal laws were followed in creating the bonds. For that, they rely on bond counsel.
Security – Investors need to know the bonds are a legally secure investment. The financing team works to create the strongest possible security provisions for the district's bonds, and BC defines the security for investors. Investors determine a bond’s value in large part from the quality of its security.
Bond Ratings – Most district CFOs are familiar with bond ratings. Rating agency analysts review district credit fundamentals and assign a rating somewhere on their scale of strongest to weakest. The rating is a comment on the district’s ability and likelihood to pay its bonds back in full, and on time. Most investors rely on bond ratings as part of their investment review.
Payment Structure and Bond Type – Structuring annual payments and bond types is a somewhat complex process, and MAs and underwriters use sophisticated software to manage it. A district can structure its payments in any number of ways – level each year, low to high, high to low, and so on. Likewise, there are many types of bonds the financing team use can use to achieve its desired structure, including serial bonds, term bonds, capital appreciation bonds, and discount and premium bonds, just to name a few. Investors play a part in this also. There are certain bond types they prefer over others and some types are better than others for the district.
Communication and Disclosure –Someone needs to tell buyers that an issuer is selling bonds. This duty falls mostly on the underwriter who is the district’s bridge connecting the district to potential investors. Also, to participate in a bond sale, buyers must have access to complete and accurate information to help them to make an informed buying decision. For most bond sales this process starts with the creation of a preliminary official statement, or POS. All members of the financing team assist in the creation of this document.
Bond Underwriting
Think of a bond sale along the same lines as a public auction. Your bonds are the valuables being sold and the investors are the bidders. The underwriter is the auctioneer. The more investors your underwriter brings to the auction the better your bond sale should go. And that translates into a lower interest rate.
Bond Refinancing
Your new bond issue will most likely become a candidate for a refinancing not too many years after the original sale. This depends on future interest rates to a degree, but also, bonds are sometimes structured in such a way that elevates the likelihood of a relatively quick refinancing. There is complexity behind all of this structuring and you may wish to ask your bond professionals to disclose all of this during the original bond sale.
Continuing Disclosure
Now that your bond sale is completed, there’s one more thing to do. As a bond issuer, you will be required to prepare and submit annual disclosure updates per your bond agreement. Many issuers retain counsel to navigate this for them.
John Payne is Partner at Bradley Payne Advisors, an OASBO Platinum Sponsor. He can be reached at 740.500.1088 or jp@bpayneadvisors.com.