Handbook for Muni-Bond Issuers. Mysak Joe

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