There are typically multiple parties involved behind-the-scenes in the process of issuing municipal bonds. Discover who they are and their respective roles in this segment for experienced investors.
>>Johnathan Ward: Issuing bonds for municipal governments can be a daunting process, but there are those who understand the path and can guide public officials in this journey. Today we’re going to talk about this process. My name is Johnathan Ward. This is Alan Westenskow.
This video is a continuation of our series giving individuals who have some familiarity with fixed income securities a little more understanding with a behind-the-scenes look at issuing municipal bonds.
Alan, let’s talk about the process. Let’s start at the beginning of the process and figure out how city officials are able to issue municipal bonds.
>>Alan Westenskow: Well, the first thing a local government has to do is identify what kind of a capital project need they have and get to the point where they identify they really need to borrow money to get it. They just don’t have enough cash on hand to get the project done. And so, once that process starts, everything else is really part of helping them identify who is that investor that’s going to get them the very best terms for their financing, because there’s investors out there that would love to buy that as an investment.
>>Johnathan Ward: They’ve got to find those investors and give them the opportunity, right, to show their colors. Every debt process starts with a governing body authorization, a resolution in most cases, that outlines the approval of the governing body to issue bonds. And there’s usually also a step in there which involves some public input. That’s either an election, in the case of a General Obligation bond, or a public hearing for all the other types of bonds issued.
>>Alan Westenskow: That’s right. And depending on the state and the type of bond, like you said, it depends, the resolution and the authorization that’s required is different and if you do have to have an election, there’s a whole other step, a list of steps you have to do to get that authorized.
>>Johnathan Ward: It’s a lot more cumbersome of a process, isn’t it?
>>Alan Westenskow: That’s right. And I think it’s also important to identify that these local governments, in most cases, have a lot of different options for issuing bonds, and different types of bonds they can issue, and they have to identify which is going to make the most sense for them to issue. Now, once they make the decision about what type of bond they want to issue, they want to get a team of professionals together because, as you were indicating, this can be kind of a daunting process. But the good thing is there are a lot of professionals who can help them through all those different steps.
>>Johnathan Ward: Tell us who you’d choose first. Who’s the first player you’d get on board?
>>Alan Westenskow: Well, of course, we always think the most important player is a financial advisor. And the financial advisor’s role is to represent the best interests of that local government, help them understand their financing options, and really walk them through every step of the financing to make sure that they’re getting the very best terms possible.
>>Johnathan Ward: The financial advisor could not do it without the help of the bond attorneys, what we call the bond counsel. Their role is to document the transaction and make sure that all the steps are followed and that the municipality is complying with all the state statutes and federal tax regulations. They give an opinion, after all is said and done, that the transaction is legal, valid, and binding, and also that the interest income earned by investors when they purchase these bonds is exempt from federal income taxation.
>>Alan Westenskow: That’s right. And so, I think it’s important to note that it’s great to have a good advisor and it’s great to have someone who can give good opinions and structure the deal legally, but at the end of the day, you have to have an underwriter because – someone who is actually going to go out there and find those investors for you and put their capital on the line to help you get those terms. And you want to work with someone who you trust and you feel like is really going to give you the best service in getting those best terms and finding those investors.
>>Johnathan Ward: In order to find the best terms and conditions and find those best investors, you want to have an underwriter who has great capacity and a broad market approach so that you can capture, if you will, the most investors possible.
>>Alan Westenskow: That’s right, because the more people who know about your bonds, the better chance that you’re going to find someone who’s looking for those same terms as an investment.
>>Johnathan Ward: Now once bonds are sold, and you’ve signed, sealed, and delivered all of the other closing documents, the transaction isn’t over. Now the municipality has to pay the obligation back.
>>Alan Westenskow: And meet their terms, right?
>>Johnathan Ward: And meet their terms, and the other covenants in the bond documents. Tell us about who helps us in that department.
>>Alan Westenskow: Yeah, so the person – you know, investors aren’t like banks where they have a whole internal process that actually manages what your payments are, so they actually hire a third party called a paying agent or a trustee, and that party, their job throughout the next 10, 20 years of those bonds is to send out a notice that the payments are due and then to make sure that throughout the process that all of the covenants that were part of the bonds are being maintained.
>>Johnathan Ward: Now, depending on the size, larger usually requires excess players. You may have Disclosure Counsel, who is responsible for preparing all of the facts, figures, and information that the investors need to know and that the SEC, or the Securities and Exchange Commission, require to be disclosed to investors. Also, sometimes underwriters want their own attorneys involved called Underwriters Counsel. Who else usually gets involved?
>>Alan Westenskow: Well, you also have your local attorney that’s going to be involved and I think the point of all this is that everybody wants to make sure that the right information is being disclosed to identify what the risk is for both the investors and for the bond issuer.
>>Johnathan Ward: Yeah, rating agencies also help determine what that risk is and is supposed to be a third party, independent review of potential credit risk, so you’re exactly right. This is a good summary of the process, Alan. We appreciate the opportunity to discuss this with you.
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