Table of Contents
HANDBOOK FOR MUNI-BOND ISSUERS
Praise
ATTENTION CORPORATIONS
Title Page
Copyright Page
Dedication
Acknowledgements
Foreword
Introduction
CHAPTER 1 - GETTING STARTED
Municipal Bond Types: GO Bonds and Revenue Bonds
Revenue Bonds and Authorities
The Cast of Characters
CHAPTER 2 - CHOOSING YOUR METHOD OF SALE
Politics Enters the Picture
Why Are So Many Deals Negotiated?
Subscription Sale
Don’t Run afoul of Regulators
How to Choose Your Debt Sales Team
CHAPTER 3 - GETTING ADVICE
How to Choose a Financial Adviser: Look Before You Leap
CHAPTER 4 - HOW TO SELL BONDS THE RIGHT WAY
Full Disclosure
Legal Advertising
Paying the Lowest Interest Cost
The Difference between Yield and Spread
Choosing Your Underwriter
CHAPTER 5 - THE ROLE OF THE UNDERWRITER
Pricing Municipal Bonds
What We Mean When We Talk About Structure
New Opportunities: Swaps
Fixed Rate or Variable Rate?
Short and Shorter
Good and Bad Underwriting
Don’t Be Snowed
CHAPTER 6 - HOW TO GET INTO TROUBLE
The New Regulatory Reality
IRS Scrutiny
CHAPTER 7 - THE BOND COUNSEL
Who They Are, and Why They Exist
Questionable Practices
CHAPTER 8 - WHO BUYS YOUR BONDS?
The Players
“The Evil Syndicate”
Other Strategies
CHAPTER 9 - PUBLIC RELATlONS
How to Win Bond Elections
The Press (Here’s What You’re Up Against)
CHAPTER 10 - WHAT HAPPENS IN A BOND SALE
What to Do Before a Competitive Sale
The Big Day
CHAPTER 11 - CREDIT RATINGS
Controversy at the Rating Agencies
The Rating Process
CHAPTER 12 - AFTER THE SALE
Reinvestment Strategy
RESOURCES
GLOSSARY
INDEX
About Bloomberg
About the Author
HANDBOOK FOR MUNI-BOND ISSUERS
IN TODAY’S HIGHLY STRATIFIED and heavily regulated municipal bond market, nothing can be left to chance. It is imperative that issuers have a working knowledge of the bond market and a solid understanding of all of its rules.
The Handbook for Muni-Bond Issuers provides professionals with succinct guidance on what issuers need to know before beginning the issuance process—choosing a method of sale, getting the right financial advice, disclosure and legal guidelines, and lowering the cost of financing. It includes a detailed discussion of what happens prior to a sale through what to expect after the close.
Author Joe Mysak takes issuers through the process, step-by-step, with smart answers and pragmatic strategies for success in today’s muni-bond market.
This book provides an insider’s perspective on:
♦ Choosing a method of sale
♦ Finding the right financial advisers
♦ What to expect from regulators
♦ Earning a high credit rating
Fresh and clearly written, this excellent primer on issuing municipal bonds, from an industry insider, is a key to the market that no participant should be without.
Praise for
Handbook for Muni-Bond Issuers
by Joe Mysak
“Joe Mysak has written
the new bible for municipal bond issuers. The search is over; this book
provides clear guidance and smart answers for everyone in the field.”
JAMES B. G. HEARTY
Managing Director of Marketing and Client Services
Relational Investors LLC
“Joe Mysak explains even the most complex subjects with a refreshing simplicity. He maintains his ever-present skepticism about much of what usually turns out to be flimflam in the guise of new products and financial engineering.
This is a book for anyone, even investors without specialized financial backgrounds,
who needs to understand what all the noise is about in a bond sale.”
FRANK R. HOADLEY
Capital Finance Director
State of Wisconsin
‘Joe Mysak has prepared a “pocket-sized financial adviser” for both large and small municipal bond issuers. The book provides
a good mix of timeless as well as currently topical subjects. All recently elected
public finance officials should read this book.”
CHRISTIAN McCARTHY
Former Managing Director, Municipal Markets
Merrill Lynch & Co.
”The Handbook for Muni-Bond Issuers is what public finance professionals want to have on their shelves, both a good read and a useful reference. Joe Mysak treats the fundamentals—and the foibles—of the municipal bond market in clear, concise language and takes time to tour some frequently bypassed, but very practical subjects, like winning bond elections and investing bond proceeds.”
JOHN PETERSEN
Senior Consultant
Government Finance Group
“Joe Mysak has once again proven that he’s
the conscience of the public finance business.”
F. JOHN WHITE
Chief Executive Officer
Public Financial Management
“Joe Mysak’s book will guide any municipal finance professional through the labyrinth of bond issuance. His
user-friendly style bypasses the usual esoteric and technical jargon.
Finally, a book of practical solutions for any muni-bond issuer.”
ED ALTER
Utah State Treasurer
ATTENTION CORPORATIONS
THIS BOOK IS AVAILABLE for bulk purchase at special discount. Special editions or chapter reprints can also be customized to specifications. For information, please e-mail Bloomberg Press, press@bloomberg.com, Attention: Director of Special Markets, or phone 212-617-7966.
For Jim Grant, and no wonder.
— J.M.
Acknowledgments
THE WRITER THOMAS WOLFE once wrote a story called Only the Dead Know Brooklyn. The title was an allusion to the sheer size of the borough, which before its inclusion into the City of New York at the turn of the century was once one of the biggest cities in America.
In similar fashion, we have the municipal bond market, which is vast, and which is particular and specific to a remarkable degree. No one can know the entire municipal market. This book is an attempt to distill 16 years of experience in covering this most fascinating of all credit markets into a brief and readable format. I have had a lot of help along the way.
First, I wish to thank James Grant and Jay Diamond at Grant’s, who in 1994 welcomed me into their publishing family. Grant’s Municipal Bond Observer, a fortnightly magazine aimed at the trade, was born. In 1997, they further endorsed the idea of launching a special magazine aimed at municipal bond issuers: Grant’s Municipal Bond Issuer. It was not until I put together a fortnightly magazine that I really became a student of the market. Jim and Jay are thorough professionals dedicated to putting out first-rate products, and are also good guys.
There are not many municipal bond journalists, but I have had a chance to work with the best ones, including John Allan, Bill Ryan, Craig Ferris, and John McCorry. These were my teachers.
And then there are my colleagues, the former merry band who comprised the staff of what we then termed the Greatest, Most Elite Newsgathering Organization in the History of the World, now sadly dispersed. These include Jack Doran, Steve Dickson, Dennis Walters, Lynn Stevens Hume, Vicky Stamas, Karen Pierog, April Hattori, Keith DuBay, Sean Monsarrat, Patrick Fitzgibbons, Jim Murphy, Ted Hampton, Aarons Pressman and Task, Kathie O’Donnell, David Gillen, Sharon King, Suzanne Montanaro, Susan Kelly, Christina Pretto, Rob Taylor, Maggie Soares, and Joan Pryde. These people made it a lot of fun to come to work in the morning.
This book would not have been possible without the active assistance of professionals in the field: Jim Hearty, Gary Killian, and Spencer Wright of Lehman Brothers; Christian McCarthy of Merrill Lynch; Jim Lebenthal; Doug Watson and Fran Laserson of Moody’s; Vlad Stadnyk of Standard & Poor’s; Byron Klapper and Frank Rizzo of Fitch Investors Service; Austin Tobin of Delphis Hanover; Mike Ballinger of MBIA; J.B. Kurish of the Municipal Issuers Research and Analysis Center; Sylvan Feldstein; and Jack Kraft of the American College of Bond Counsel.
Not a few issuers have helped me over the course of the years, including Utah’s Ed Alter, Frank Hoadley of Wisconsin, Jan Rzewnicki of Delaware, Bob Lenna of Maine, and Joe Lhota and Mike Geffrard of the City of New York. Three former bankers, Mike Lissack, Steve Strauss, and Bill Wood, helped me on the reinvestment of proceeds and yield-burning sections.
Special thanks, too, to Steve Gittelson of Bloomberg Press—who during a party at Janet Sullivan’s asked, “Do you want to write a book for us?”—and to my editor at Bloomberg, Jacqueline Murphy.
The glossary is largely drawn from the book I wrote with George J. Marlin in 1992, The Guidebook to Municipal Bonds, which was published by The Bond Buyer. The book is not only out of print, but also out of date, which goes to show how fast things have changed in the municipal market.
Finally, I would like to thank some friends for their support over the years, including the aforementioned Marlin, Patrick Foye, Mike Crofton, Mark Reed, Parker Bagley, and Steve Gustavson. And finally I would like to thank my wife, Susan Merett, who is also my best friend.
FOREWORD
BY MICHAEL R. BLOOMBERG
SOME YEARS BACK,
The Bonfire of the Vanities
author Tom Wolfe suggested to Joe
Mysak that he write a book about the
municipal bond market. Call it
The Dark
Continent, Wolfe suggested. You hold in
your hands the result.
The municipal market is a vast place, and
not a little scary for those not privy to its mysteries. Despite its intimate connections with all of us—look no further than the sewers and the side-walks beneath your feet for examples of things financed through the sale of municipal bonds-the municipal market has never really become a part of our financial culture.
The consequence is that most people probably know more about how to sell an initial public offering in the stock market than they do about selling municipal bonds. How do you choose a financial adviser, an underwriter, a bond counsel? How are bonds priced? How do underwriting syndicates work? Why do we need a credit rating? How do we pay all these people? This book takes you through the whole process, step by step.
The municipal market is, by any measure, big. It has been estimated that more than 80,000 entities have the authority to issue municipal debt. And every year, more than 7,000 of them do so, selling some 10,000 separate bond issues. As Joe Mysak points out, the municipal market is particular and specific to a remarkable degree. But there is a basic framework to all municipal bond transactions, and it is explained here.
That basic framework now includes heightened regulatory scrutiny. The Securities and Exchange Commission Office of Municipal Securities’s advice to issuers is simple and direct: You are responsible for your bond issues. You can rely upon the professionals you hire, but only up to a point. You have to understand exactly what is going on and why. Before you can do this, you have to know what questions to ask.
I believe Joe Mysak delivers solid advice on how to tap a market that has become a wonder of the (increasingly decentralized) world. I think you will find this book a reliable source of guidance and good practice.
A Few Notes on the Format
♦ This book packs a lot of information. It is designed to be functional as well as factual, trim enough to be carried in a coat pocket and taken on the road, and read easily on train, ship, or plane.
♦ The book’s organization accommodates your hectic schedule. The material flows logically and offers real-world applications at every turn.
♦ Graphics are designed with the busy reader in mind, highlighting important concepts from the experts in color throughout.
INTRODUCTION
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.
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.