Handbook for Muni-Bond Issuers

Joe Mysak

• Publisher: Bloomberg Press
• Year: 2010
• Print ISBN: 9781576600238
• eBook ISBN: 9780470884560
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

From Bloomberg, the authority on municipal bond valuation, this is the first book to give issuers (municipalities and their officers, attorneys, and other advisers) step-by-step tips on (1) lowering the cost of financing and (2) how to do it right and avoid trouble--with the press, with the market, with constituents, and with the Securities and Exchange Commission. With an insider's perspective, Joe Mysak debunks the myths and reveals thepractical realities of today's municipal bond market. Fresh and clearly written, this excellent primer on issuing municipal bonds is a key to the market that no participant should be without.

CHAPTER 1

GETTING STARTED

MOST MUNICIPAL FINANCE officers have more in common with the director of finance whom I once called at home—only to be told that he was at work in the cranberry bog and would call me back later—than they do with Wisconsin’s full-time director of capital finance, or New York City’s comptroller.

Unlike these professionals, who have access not only to all of the analytical tools described later in this book, but also to professional staffs, most municipal finance officers find bond sales to be a very small (but irksome) part of the job. They represent a knotty problem that must be handled once every few years. With this in mind, let’s review the market basics.

First of all, there is no one thing called the “municipal market.” Those who generalize about such a thing (as in, “Hey, what about all these scandals roiling the municipal bond market?”) are unlikely to know what they are talking about.

The municipal market is an over-the-counter market, meaning that there is no organized central exchange where a bell goes off to signal the start and finish of the day’s trading. Buyers and sellers communicate and negotiate by telephone. If an investor and a broker agree on a transaction at midnight, that is the “municipal market” at that point in time.

Comparatively few of the millions of separate bonds outstanding, totaling more than $1.3 trillion at last count, actually trade at all. And more often than not, the prices of inactive securities are based on little more than a very educated guess.

What is a municipal bond? In simplest terms, it is an interest-bearing certificate issued by a government when it wants to borrow money. Most of today’s market is electronic, and comparatively few investors ever get to see the single representative paper “bond” held at a repository. A bond is a loan, unlike a share of stock, which represents ownership in a corporation. Stock-holders agree to ride out both good times and bad, including bankruptcy. Bondholders agree to loan money in return for interest and return of principal. This is why bonds are considered one of the most conservative investments.

Municipal bonds are singular and highly specific. The various characteristics that set each of them apart are far more numerous than the qualities they share. One analyst for a portfolio manager recently observed that there were more than 50 varieties of municipal bonds for him to study, and that was just a rough estimate.

The “municipal market” is highly fractured. Municipal market? There are highly evolved state-specific markets (California, Colorado, Florida, Illinois, New York, Texas); regional markets (the upper Midwest, the Deep South); and sector markets (health and hospital bonds, housing bonds, public power bonds, American Indian tribe financings, even high-yield bonds).

Most of the market is state specific. In other words, a Florida municipal bond firm might spend all its time dealing strictly with the issuers and buyers in its own state. It is not too far off the mark to say that, because of their independent, decentralized nature, nearly every state has a highly developed municipal bond market all its own. Comparatively few firms operate on a truly national basis. Those that do (the major Wall Street firms), typically deal with only the largest bond issues and issuers.

Most municipal bonds are relatively small. In 1996, more than $183 billion in municipal bonds were sold, but in more than 11,500 issues: The average size was approximately $15 million. And even this number is skewed higher by a relative handful of blockbuster deals. About 85 percent of the bonds sold each year are for an average of just over $5 million.

But the 80-20 rule also applies to municipal bond issuance: 80 percent of the actual number of bonds sold make up only about 20 percent of the dollar volume. These larger, more lucrative deals are the bond issues that Wall Street finds it worthwhile to chase. But in reality, small issuers just like yourself make up the bulk of the business. It is up to you to insist on the same level of service the larger issuers get in the big market.

Why do you sell bonds? For the same reasons that individuals take out loans. You, your municipality, does not have ready money at hand; or you find it more efficient to match up liabilities with the useful life of whatever it is you are paying for; or you think that a project’s users should also pay for it; or any one of a number of reasons.

Municipalities—and the term covers everything from a fire district, to an authority, on up to a state—today sell bonds for purposes ranging from repairing roads and bridges, to paying for sewer systems and mass transportation systems and even telecommunications systems, to funding pension liabilities, to building theme parks and sports stadiums and acquiring historic properties, to preserving farmland and beaches.

In a typical week, the municipal market handles 194 separate bond sales; the number rises to 250 or more in busy times and falls to 150 or less in a holiday-shortened week. In a typical week last year, as the York County, Pennsylvania Solid Waste and Refuse Authority was preparing to sell $114 million to refund bonds it had sold at higher interest rates back in 1985, Fergus Falls, Minnesota sold $6.6 million in general obligation bonds to fund various public improvements, and the Darlington, South Carolina School District sold $3.1 million to pay for school improvements.

Municipalities also sell bonds to help spur economic activity. What could be more of a public purpose than providing jobs, a North Carolina politician asked not too long ago, in response to criticism about a bond sale for a factory.

What indeed? But the most important question buyers of your municipal bonds have is this: How will they be repaid? Normally, economic development bonds are repaid either by special assessments or from the revenues a particular project generates. But what happens if not enough people move into a new housing development, and the special assessments they pay just do not cover debt service? What happens if not enough people visit a new aquarium? Are the bonds insured? Did the municipality make any promises to step in if those revenues proved insufficient?

The answer has a direct impact on how much you will have to pay to borrow money from investors, which leads us to a discussion of the kinds of municipal bonds that are sold.

In this discussion, bond sale refers to the original pricing and sale of your bonds: the primary market. Secondary market refers to the trading of bonds that have already been sold. Some bonds trading in the secondary market date from the 1950s and 1960s.

Municipal Bond Types: GO Bonds and Revenue Bonds

THERE ARE TWO main categories of municipal bonds: general obligation (GO) bonds and revenue bonds. There are of course some hybrids, but in order to understand all else that follows, you must understand the distinction between these two.

General obligation bonds are backed by the full-faith and credit pledge of an issuer with taxing power. Most historians agree that New York sold the first GO bonds in the United States, in 1812. The Municipal Securities Rulemaking Board’s (MSRB) Glossary of Municipal Bond Terms (this handy 117-page paperback guide has not been updated since 1985, but it remains a valuable resource, should be on the desk of every issuer, and is available from the MSRB for the bargain price of $1.50; 202-223-9347) defines GO bonds:

Such bonds constitute debts of the issuer and normally require approval by election prior to issuance. In the event of default, the holders of general obligation bonds have the right to compel a tax levy or legislative appropriation, by mandamus or injunction, in order to satisfy the issuer’s obligation on the defaulted bonds.

Characteristics of GO Bonds versus Revenue Bonds

GO Bonds

♦ Backed by full-faith and credit taxing power of municipality.

♦ Typically must be approved by voters.

♦ Provides cheapest rate of financing.

♦ Citizens’ “willingness to pay” difficult to quantify.

♦ Vulnerable to property tax revolts.

♦ Very conservative structure.

Revenue Bonds

♦ Backed by identified revenues, usually user fees.

♦ Need not be approved by voters.

♦ Rates usually 25 to 55 basis points higher than GO rates.

♦ Relies solely on “ability to pay.”

♦ Invulnerable to property tax revolts.

♦ Very flexible in structure.

The GO bond is the most basic type of municipal bond. From an investor’s point of view, it is also the safest, which is why GO interest rates are typically cheaper than those on revenue bonds by anywhere from 25 to 50 basis points or more (bond yields are figured in basis points, which are one-hundredth of a point; GOs, then, are typically one-quarter to one-half point cheaper for you to sell than revenue bonds). It is no mystery why. In essence, you are telling your lenders that you will do whatever is necessary, that you will raise taxes to whatever level is required, in order to pay the debt service or annual principal and interest payments due on your bonds.

Who sells GO bonds? Any municipality with the power to levy taxes: New York City sells GO bonds, hundreds of millions of them every year. So does the State of California. But so does the First Colony Municipal Utility District #2 in Texas, which in October 1997 sold $2,170,000 in general obligation bonds.

The other kind of municipal bond, called a revenue bond, is secured by a specific revenue stream such as tolls or other user fees. The concept of using a particular project’s fees to support it dates from approximately 1885. In 1931, the Port of New York Authority, as it was then styled, added a new spin with its consolidated revenue bond, which allowed for the revenues from a number of different projects undertaken by the same agency to back the bonds sold to build those projects. This enabled stronger projects, whose revenues exceeded expectations, to support weaker ones, whose income might not cover their own costs for decades.

A more modern example of a revenue bond was the $20 million issue sold by Iredell County, North Carolina for the Iredell Memorial Hospital in the fall of 1997. The bonds are, in the words of the official statement, “payable solely from, and secured solely by a pledge of, the Net Revenues” of the hospital.

Or take the University of North Carolina at Chapel Hill. In 1997 it sold several million dollars in “Student Fee Bonds,” which are backed by a special $10.25 per-student, per-semester fee. The university’s Board of Governors promises that it will:

Fix, charge and collect from each student ... the Student Indebtedness Fee and that from time to time and as often as it is necessary it will adjust the Student Indebtedness Fee so that the Revenues will at all times be sufficient to equal 120 percent of the average annual Principal and Interest Requirements on all the Student Fee Bonds then outstanding....

GO and revenue bonds are not the only kinds of bonds sold. Municipalities also sell bonds backed by the so-called moral obligation of the issuer to make up shortfalls in debt service. And they also sell securities called certificates of participation, which are backed by nothing more than a promise by the issuer that it will appropriate money annually to pay debt service. Analyst Robert Zipf defines these in his How Municipal Bonds Work: “A certificate of participation is a security that represents an interest in payments which the issuer has promised to make, but which are subject to annual appropriation by the issuer’s governing body. The issuer must actually appropriate the funds each year.”

Until the 1970s, the issuance of GO debt far outstripped sales of any other kind. Since then, however, the tide has turned the other way, and now 70 percent or so of the dollar volume of bonds sold every year is in revenue bonds.

Why the sea change? For one thing, a municipality’s tax base is limited, which is why the adjective precious is so often used to describe GO bonding capacity. For another, revenue bonds generally are not subject to the whims of voters, which may at times seem downright capricious. For a third, the idea that actual users, rather than all taxpayers, pay for a project is intrinsically attractive in a democrac...

Table of contents

• HANDBOOK FOR MUNI-BOND ISSUERS
• Praise
• ATTENTION CORPORATIONS
• Title Page
• Copyright Page
• Dedication
• Acknowledgements
• Foreword
• Introduction
• CHAPTER 1 - GETTING STARTED
• CHAPTER 2 - CHOOSING YOUR METHOD OF SALE
• CHAPTER 3 - GETTING ADVICE
• CHAPTER 4 - HOW TO SELL BONDS THE RIGHT WAY
• CHAPTER 5 - THE ROLE OF THE UNDERWRITER
• CHAPTER 6 - HOW TO GET INTO TROUBLE
• CHAPTER 7 - THE BOND COUNSEL
• CHAPTER 8 - WHO BUYS YOUR BONDS?
• CHAPTER 9 - PUBLIC RELATlONS
• CHAPTER 10 - WHAT HAPPENS IN A BOND SALE
• CHAPTER 11 - CREDIT RATINGS
• CHAPTER 12 - AFTER THE SALE
• RESOURCES
• GLOSSARY
• INDEX
• About Bloomberg
• About the Author