Good luck with that! Because there are many variables associated with a municipal bond issue, achieving “the best” rate is challenging. All too often, the demands on school treasurers such as payroll, budgets, forecasts, routine accounting, monthly reporting, and annual audits make bond issues just “one more thing” to do. However, there are steps a school CFO can take to ensure a successful bond issue that results in a competitive interest rate.
Next to funding the annual operating budget for an Ohio school district, the biggest single expenditure taxpayers are asked to bear is repaying a bond issue for building projects. Currently, due to higher interest rates, the largest single expense is not principal repayment, but the interest component. So, how can a treasurer have a positive impact on the resulting interest rates?
Many steps with the potential to impact the final pricing of a bond issue require the involvement of the treasurer. In particular, issue structuring and the credit rating process will have the greatest impact on investor demand. Knowing this, it is crucial to achieve a balance between investor preference and effective pricing.
How can treasurers ensure a successful bond issue and approximate the best available interest rate given the already high demand on their time? Proper preparation starts at the inception of the process with the assembly of your finance team.
- Bond counsel is required to meet the legal requirements.
- The municipal advisor (MA) represents the district at the negotiating table to effectively accomplish structuring, rating, and pricing, all in the best interest of the taxpayer.
- The underwriter is necessary to gain access to investors. They are obligated to represent the interests of the investor.
Regarding selection of the underwriter, the Government Finance Officers Association (GFOA) recommends that a thoughtful process be conducted to select a firm. Critical differences exist among firms that most frequently represent Ohio schools. These differences include the size and composition of their sales staff (stockbrokers), the volume of the firm’s municipal bond business, and their capitalization. The individual responsible for setting interest rates, the bond trader, sits on the trading desk. That person is usually at the out-of-state headquarters, and not with the banker that interacts locally with the treasurer. Additionally, firm strategies evolve year-to-year, with the focus on municipal bonds ebbing and. The MA is the only member of the financing team equipped with market knowledge to formulate an independent assessment of potential underwriters and can best help the treasurer understand pricing performance.
Once the finance team has been assembled and the bond issue prepared for marketing, pricing day finally arrives. One of three investor order outcomes will occur:
- Commensurate orders are received to purchase all the bonds with appropriate maturities,
- Fewer orders received than required, i.e., undersold,
- More orders received than necessary, i.e., oversold.
A perfect match of orders received vs. bonds available is uncommon. Usually, at the end of the 90-minute pricing period, the issue is undersold or oversold. If undersold, depending on magnitude, the trader will suggest increasing rates to attract additional orders to fully sell the bonds. If oversold, the trader should recommend rate reductions, as the bonds were apparently priced too low, (i.e., rates were set too high). When presented with repricing proposals, the best approach for a treasurer is to make an informed decision about repricing with expert, independent advice. An experienced MA has the objectivity to provide such advice and will command respect from the trader to complete a reasonable repricing negotiation. Without an MA on their side, a treasurer is at the mercy of the banker and trader to accept the repricing proposal. Only through an effective repricing negotiation is the “best” interest rate achieved.