We all know that municipal bonds are used to raise capital for local public projects, such as road repairs and community parks. But how exactly do the bonds get financed? Who decides how much financing is needed, how the issuance should be structured, and how it should be sold to investors?
There’s a lot of work that goes on behind the scenes to make a municipal bond issuance happen. Let’s meet the key players.
The public agency, such as a school district, that wants to raise money for a new project, is called an issuer once they start receiving investment through the bond market. The issuer is the focal point and the head of the financing team, and oversees the transformation of an idea for a project into an issuance. In many cases, the plan to issue bonds to pay for a project will need to be approved by voters, so the issuer will be responsible for putting the plan on the ballot and, if the proposition succeeds, passing legislation to authorize the appointment of the financing team and the creation of the bond.
The municipal advisor acts as a fiduciary for the entity issuing the bonds, which is a fancy way of saying that he or she is charged with taking care of all the assets and finances involved. The advisor is legally obligated to represent the interests of the issuer. They offer advice on how to structure, sell, and promote the bonds, and serve as a liaison to other members of the financing team, from underwriters to the credit rating agency. The municipal advisor will often play an important role in assembling the “deal team” — assisting the local agency in selecting the issuance’s underwriter and legal counsel. Although municipal financial advisory services have existed for many years, they were given new importance by regulations activated in 2014, which oblige issuers to appoint a Municipal Advisor – or submit a formal disclaimer opting out of doing so.
Behind every great bond is a team of legal wizards working to check every detail and sign off that the agency is complying with all applicable laws and regulations. The bond counsel will typically draft core documentation relating to bonds, including indentures, loan agreements, and other critical documents. As expected, the bond counsel is also tasked with reviewing and advising on any legal issues that might arise, and interpreting how tax laws affect the issuance. For instance, is this issuance exempt from federal and state taxes, or not? Look for a summary of their opinion at the top of any Official Statement.
The underwriter is the organization that administers the public issuance and distribution of the bonds. The underwriter connects the issuer with potential bond buyers, and determines the price at which to offer the bonds. It’s a key decision, because while underwriters typically collect fees in exchange for their services, they also assume the responsibility of making sure those bonds are distributed and ultimately sold. If the price is wrong, the underwriter is left holding the bonds.
The underwriter also serves as a strategic partner, analyzing market conditions and trading, to help decide how and when the bonds should be sold.
The underwriter often doesn’t work alone. In many cases there will be a co-manager, who helps provide the capital to buy the issuance. In large issuances, the underwriter(s) will often put together a syndicate or selling group – an entourage of bond salespeople who are skilled in the art of determining the right price for an issuance and a group of investors who’ll be willing to buy those bonds.
That’s right—more lawyers, and this time, they’ve got the underwriter’s back. The underwriter’s counsel is in charge of drafting bond purchase agreements, advising underwriters on legal and financial issues, and performing due diligence to ensure that any bond-related documentation is as accurate as it claims to be.
Ratings agencies evaluate the creditworthiness of the bond issuer – in other words, how likely is the school district to be able to repay its debts. The three major players in the market are Moody’s, Standard & Poor’s (S&P), and Fitch. S&P and Fitch use an almost identical ratings scale, while Moody’s has its own flavor. Periodically, agencies review the ratings they’ve given to issuers to reflect current events – for example, if a city is facing unexpected financial problems, a ratings agency may ‘downgrade’ the city’s rating, signalling to investors and the market that the city is more at risk of not paying its debts than previously thought. Not all bond issuances are rated, but issuances with ratings (especially a good one) are conventionally seen as safer investments than those without a rating.
A sort of band-aid for issuers, a credit enhancer is an organization that agrees to guarantee that the issuer will repay their debt (and will step in to pay the bill if the issuer runs into difficulty). The enhancer may provide that guarantee in the form of insurance, a letter or credit, or a custom-made guarantee with certain conditions. Credit enhancers are themselves rated by the ratings agencies, so when an issuer pays for credit enhancement, the rating of their issuance will be given the rating of the credit enhancer.
The bond trustee is sort of like the enforcer of the bunch. The trustee’s role is to ensure that the terms of the bond are being upheld. As such, the trustee makes sure bondholders are paid as they should, and is there to represent their interests in the event of a potential default.
Other Key Players
Depending on the circumstances, you might find some of these additional participants on hand when a municipal bond is financed:
- Other types of legal counsel, including special tax counsel, bank counsel, and borrower’s counsel.
- A feasibility consultant, whose services might be engaged for revenue bond sales
- A verification agent, who verifies cash flow sufficiency to prepare for the refunding of bonds
- An escrow agent, who holds funds and securities and disburses them as appropriate
So that’s the small village of people and organizations who help issue more than $1 billion a day in the municipal bond markets.
If you work on public finance teams, you can research Municipal Advisors, Underwriters and Counsel and the issuances they’ve worked on using Neighborly Pro. Email Rodrigo to get added to our beta.