MOASBO LETTERHEAD Dear MoASBO Member, The recently released State Auditor s report on General Obligation Bond Sales Practices has generated substantial discussion. This study attempts to resolve an issue that has been debated by financial professionals for many years. Is there a bond sales practice, negotiated or competitive, that consistently results in lower costs for taxpayers? Although the State Auditor s Report has been characterized as an oversimplification of an extremely complex issue, it has raised the level of awareness on current bond sale practices and initiated the following discussion. The role of the school business official is to provide children the best education possible with available resources. The Missouri Association of School Business Officials (MoASBO) supports the ultimate goal of educating children by providing a forum to share expertise and best practices, which helps school business officials meet the fiduciary responsibilities that they and their Boards of Education have to their many publics. The attachment to this letter is the work product of a committee of your peers regarding the role of the school business official in bond issues, what Missouri Law requires, and what we recommend. The report addresses competitive and negotiated bond sales, and the selection of underwriters and financial advisors in preparing for bond sales. The MoASBO Board of Directors has approved and recommended this report. It should be used as support and guidance for planning the issuance of bonds once you have passed a successful bond issue, if you are considering refunding bonds, or seeking other funding alternatives. We hope you find it a useful tool. MoASBO Committee On Bond Sales David Glaser, Chairperson Rockwood School District Paul Fedchak, Clayton Bryan Silvey, St. Clair Mark Stockwell, Parkway Diane Vaughan, Webster Groves Dan Wallace, Clinton Joyce West, Kirkwood Lenoard Westbrook, Rolla Mick Willis, Riverview Gardens
Missouri Association of School Business Officials Report and Recommendations Related To General Obligation Bonds We acknowledge that it is very difficult for us or any organization to conduct a study which adequately considers the many complex issues involved in the decision to sell bonds on a negotiated (private) or a competitive (public) basis, much less assign a dollar value to the public benefit of one form of sale compared to another, because there are many variables influencing the resulting interest rate. Some of these variables are bulleted below. As superintendents and school business officials, our perspective on this issue is completely unbiased and devoid of political implications. As committed professionals, our focus is upon serving the students who attend our districts, their parents, and the taxpayers that provide us financial support to whom we owe the highest fiduciary responsibility. In addition, since 73% of the general obligation bond sales studied by the State Auditor s Office (SAO) were for school districts, it is important that we provide guidance to our members. Some of the factors which need to be considered when deciding how best to sell general obligation bonds and serve our community are as follows: Timing of the Sale: Interest rates can fluctuate significantly on a daily, monthly, and quarterly basis. Such fluctuations affect the ultimate interest cost to the school district. While we acknowledge that a competitive sale will likely obtain the best interest rate on a given date, it may not select the best date. A negotiated sale provides more flexibility in the date selection. Due to advertising and publication requirements, a competitively sold bond issue must select the date about three weeks in advance. Average Life: As documented in the SAO report, the average life of a bond issue will significantly affect the interest cost of the issue --- with longer average lives tending towards higher interest costs. While we agree that a shorter repayment schedule will reduce the total interest cost to the district, frequently this must be balanced with an interest from district taxpayers in maintaining a stable debt service tax levy. Debt Retirement Schedule Tax Levy Stability Risk/Rating of Bond Issue: Investors expect a higher rate of return for an investment that they perceive to entail greater risk. A measure of this perceived risk, although certainly not perfect, is the rating assigned to the bond issue by the various rating agencies including Moody s, Standard & Poor s, and Fitch.
Type of Issue: The type of issue (for example, whether it was a capital appreciation bond that earns interest on interest ) could impact the investor s perception of the related risk. Call Provisions: Frequently the issuer of bonds will include a provision allowing them to call or repay the bond issue in advance of the planned maturity dates. Such call provisions are typically included to enable school districts to reduce their interest costs if interest rates decline, while locking in the current rates if rates increase. On the other hand, the purchaser of the bonds may expect a slightly higher rate of return for giving up the opportunity to earn their expected rate of interest until maturity. Size of Issue: Because of certain inherent fixed costs associated with selling bonds, the size of the bond issue may affect the interest rates. In addition, although there are numerous investors interested in smaller bond issues, by definition, there will be a greater number of investors interested in bond issues of higher amounts. This makes it somewhat easier to sell a larger issue on a competitive basis. According to the SAO report, the average size of a competitively sold bond issue was $7.5 million while the average size of a negotiated bond issue was $3.8 million. The above issues, as well as others elaborated on the attached table, make it impossible to state that one type of general obligation bond sale is always the best recommendation in every circumstance. School administrators and their Boards of Education should carefully review and consider all of the above issues as well as those described on the attached Government Finance Officers Association (GFOA) adopted table prior to deciding which method of sale will be in the best interest of their constituents. Recommendations The committee makes the following recommendations to its MoASBO members: When electing to sell bonds on a negotiated basis and hire a financial advisor, such financial advisors should be independent from the underwriting firm. This is consistent with the SAO recommendation 2.1 on page 20 as well as industry regulations under the Municipal Securities Rulemaking Board (MSRB) rule G-23. If the district decides upon a negotiated sale, the bond underwriter should be competitively selected. It is recommended that Requests For Proposals be distributed to qualified underwriting firms with such firms selected on a weighted basis using criteria such as qualifications of the firm, qualifications of staff assigned, responsiveness of the proposal to the request, and fees. This recommendation is also consistent with SAO recommendation 2.1 on page 20. This process ensures that multiple proposals are considered. School districts should develop a similar competitive process to select financial advisors. School district administration should be actively involved in each step of the negotiation and sale processes and ensure that either an employee of the district or an outside professional other than the underwriter who is familiar with and abreast of the condition of the municipal market, is available to assist in structuring the issue, pricing, and monitoring sales activities.
The cost of bond insurance should be compared to the expected benefit of obtaining a lower interest cost and a decision made on this basis. If the bonds are sold on a negotiated basis, the interest rates set should fully consider the benefit of the related bond insurance. In the fall of 1995, MOHEFA developed a cooperative program to enable school districts to be reimbursed for their costs of issuance related to the sale of bonds as well as to receive an enhanced bond rating of AA based upon Missouri s high credit rating. The role of MOHEFA in this process should allow for an increased number of school district bond issues to be sold on a competitive basis. We believe adequate competition exists among underwriters, financial advisors, and bidders upon competitive bond sales to facilitate a competitive process. There are 41 underwriters who have purchased bond issues in Missouri since 1997. There are numerous independent financial advisors in the state of Missouri and competitively sold bond issues typically receive five to ten bid responses. Finally, entering this profession does not require a significant capital investment and, therefore, there are very limited barriers to entering the market. Missouri s school business officials are dedicated to serving the children in their community and their school districts. The focus of their service is their community and the children who they recognize represent our future. Frequently such professionals voluntarily initiate bond refundings resulting in significant interest savings to the taxpayers within their community. These individuals are professionals, many with advanced degrees, specialized certifications, and years of school finance and public administration experience. The quality and sophistication of the questions these professionals ask their bond underwriters, financial advisors, and bond counsel indicates a thorough understanding of the important issues. School district administrators are a closely knit group who belong to numerous professional organizations and seek to implement the cumulative best practices of their peers at their school district.
COMPETITIVE v. NEGOTIATED SALES: Summary of Conditions Favoring Each Method of Sale (GFOA Adopted Table) Debt Structure Pledged Revenues Security Structure (for Revenue Bonds) Debt Instrument Conditions Favoring a Competitive Sale General Obligation or Strong System Revenue Conventional Resolution and Cash Flow; Rate Covenant and Coverage Traditional Serial and Term, Full Coupon Bonds Conditions Favoring a Negotiated Sale Project Supported Revenues Unusual or Weak Covenants; Subordinated Debt Use of Innovative Structuring, Derivative Products, Structure to Attract Particular Investors (e.g. Discount Bonds), etc. Credit Quality Rating A or better Below Single A Outlook Stable Weak but Improving, or Under Stress Issuer Characteristics Type of Organization Frequency of Issuance Market Awareness Broad-Based General Purpose Borrower Regular Borrower in Public Market Active Secondary Market with Broad Investor Base Special Purpose, Independent Authority New or Infrequent Issuer Little or No Institutional Awareness of Issuer; Historical Antipathy Investor Comfort Well-Known, Stable Issuer Issuer Experiencing Significant Financial, Legal or Other Problems Market Conditions Interest Rates Stable; Predictable Market Volatile or Declining Market Supply and Demand Policy Considerations Participation in Sale of Bonds Stimulation of Investor Interest Strong Investor Demand, Good Liquidity, Light Forward Calendar Broad Market Participation Desired for Sale of bonds Broad Market Participation Desired for Purchase of Bonds Oversold Market, Heavy Supply Desire to Direct Business to DBE or Local/Regional Firms Desire to Direct Business to Local/Regional Investors