Note: This Best Practice (BP) is one of a group of documents relating to the sale of bonds. These documents should be read and considered in conjunction with each other because of the interaction of the processes to which they apply. The documents are:
When not required by state or local laws, issuers should sell their debt using a method of sale that is most likely to achieve the lowest cost of borrowing, while considering both short-range and long-range implications for taxpayers and ratepayers. Differing views exist with respect to the relative merits of competitive sales, negotiated sales, and private sales (direct placements and bank loans). Moreover, research into the subject has not led to universally accepted findings as to which method of sale is preferable when considering differences in bond structure, security, size, and credit ratings for the wide array of bonds issued by state and local governments. In addition, issuers should be aware of, and take into consideration, all disclosures (current and future) that may be required based on the method of sale that is selected.
The appropriate duties, roles and responsibilities of municipal advisors and underwriters are often not well understood but have been solidified with recent regulatory changes. Municipal advisors are the only parties with a federal fiduciary duty to the issuer. In contrast, the relationship between the issuer and underwriter is one where the relationship has a common purpose (sale of debt) but competing objectives (issuer: lowest interest rate, underwriter: higher interest rate to reduce the risk of not being able to sell the debt at a profit). It is important for issuers to become familiar with the Securities and Exchange Commission’s (SEC) Municipal Advisor Rule and understand its implications on underwriter responsibilities. Resources to help issuers become familiar with the Rule are included in the References section of this document.
When state and local laws do not prescribe the method of sale of debt, the Government Finance Officers Association (GFOA) recommends that issuers select a method of sale based on a thorough analysis of the relevant rating, security, structure, and other factors pertaining to the proposed bond issue. If the issuer has in-house expertise (dedicated debt management staff whose responsibilities include daily management of a debt portfolio), this analysis and selection could be made by the issuer’s staff. However, in the more common situation where an issuer does not have sufficient in-house expertise, this analysis and selection should be undertaken with the advice of a municipal advisor. Note: Municipal Securities Rulemaking Board (MSRB) Rule G-23 states that a firm may not serve as a municipal advisor and an underwriter on the same transaction.
Competitive Sale. For public sales, GFOA believes that the presence of the following factors may favor the use of a competitive sale:
- The rating of the bonds, either credit-enhanced or unenhanced, is in the single-A category or higher.
- The bonds are general obligation bonds (full faith and credit obligations of the issuer) or are secured by a strong, known, and long-standing revenue stream.
- The structure of the bonds does not include innovative or new financing features that require extensive explanation to the bond market.
- The issuer is well known and regularly in the market, although infrequent issuers issuing debt that meet the above three factors may also successfully issue debt through a competitive sale.
Studies suggest that receiving three or more bids is desirable to ensure a competitive interest rate. The issuer should take steps, or work with its municipal advisor, to ensure that information related to, and notice of, the competitive sale is widely distributed. In addition, receipt of three competitive bids allow the issuer to meet an exception to certain issue price regulations.
Negotiated Sale. For public sales, GFOA believes that the presence of the following factors may favor the use of a negotiated sale:
- The rating of the bonds, either credit-enhanced or unenhanced, is lower than the single-A category.
- Bond insurance or other credit enhancement is unavailable or not cost-effective.
- The structure of the bonds has features, such as a pooled bond program, deferred interest bonds, or other unique or innovative structure, that may be better suited to negotiation.
- The sale of debt is occurring during or shortly after events that led to any market disruption, in which the negotiated sale process provides more market information and timing flexibility.
- Variable rate demand bonds, or commercial paper, where an on-going remarketing agent or dealer is required.
- The issuer desires to target underwriting participation to include disadvantaged business enterprises (DBEs) or local firms.
- The issuer desires to maintain a long-standing relationship with an underwriter that will contribute relevant experience from previous issuance with the issuer to the success of the transaction.
- Refunding transactions, which are often dependent on market conditions and/or other structure considerations.
- Other factors that the issuer, in consultation with its municipal advisor, believes favor the use of a negotiated sale process.
If an issuer, in consultation with its municipal advisor, determines that a negotiated sale is more likely to result in the lowest cost of borrowing, the issuer should undertake the following steps and policies to increase the likelihood of a successful and fully documented negotiated sale process:
- There should be a written contractual relationship with a municipal advisor (a firm unrelated to the underwriter(s)), to advise the issuer on all aspects of the sale, including selection of the underwriter(s), structuring, disclosure preparation and bond pricing. Issuers with sufficient in-house expertise and access to market information may not need to retain a municipal advisor. At a minimum this means the issuer has experience in the pricing and sale of bonds, including historical pricing data for their own bonds and/or a set of comparable bonds of other issuers, and has dedicated full-time staff to manage the bond issuance process, with the training, expertise and access to the necessary debt management tools.
- Select the underwriter(s) through a formal request for proposals (RFP) process. The issuer should document and make publicly available the criteria and process for underwriter selection so that the decision can be explained, if necessary.
- Remain actively involved in each step of the negotiation and sale processes in accordance with the GFOA’s Best Practice, Pricing Bonds in a Negotiated Sale.
- Require that financial professionals make disclosures pursuant to MSRB Rule G-17 and disclose any conflicts of interest that may exist, as well as the name(s) of any person or firm compensated to promote the selection of the underwriter; any existing or planned arrangements between outside professionals to share tasks, responsibilities and fees; the name(s) of any person or firm with whom the sharing is proposed; and the method used to calculate the fees to be earned.
- Review the “Bond Purchase Agreement” and “Agreement Among Underwriters” to ensure that the terms and conditions are acceptable to the issuer, and to identify issues that need to be negotiated with the underwriters.
- Openly disclose public-policy issues for selecting a negotiated sale, such as the desire for Minority, Women and Disadvantaged Business Enterprises (MWDBEs) and regional firm participation in the syndicate and the allocation of bonds to such firms.
- Have service providers prepare a post-sale summary and analysis that documents the pricing of the bonds relative to other similar transactions priced at or near the time of the issuer’s bond sale, record the true interest cost of the sale and the date and hour of the verbal award, and trading on the bonds between the sale and closing to evaluate the underwriter’s performance.
Direct Placement and/or Bank Loans. Another possible method of sale is a direct placement. A direct placement, or direct purchase, is when the debt is sold directly to investors and not re-offered to the public. Bank loans are sometimes included in the discussion of private placements. GFOA believes that the presence of the following factors may favor the use of a private placement:
- Bond insurance or other credit enhancement is needed for a public sale but is unavailable or not cost-effective.
- Elimination of exposure to the public bond rating process.
- Elimination of the cost of issuance associated with rating agencies, underwriters, and preparation of an offering document. However, there may be a placement agent fee, and an offering memorandum will be prepared for potential investors.
- Securing bank lines of credit for on-demand interim borrowing, and short-term liquidity needs.
- Subsidized state and federal loan programs, in which private placement is solely for the security issued to evidence repayment of such loans.
- Other factors that the issuer, in consultation with its municipal advisor, believes favor the use of a private placement process.
If an issuer, in consultation with its municipal advisor, determines that a private placement is more likely to result in the lowest cost of borrowing, the issuer and its municipal advisor should undertake the following steps and policies to increase the likelihood of a successful and fully documented private placement process:
- Select a placement agent (if deemed necessary), the investor, or bank through a formal request for proposals (RFP) process.
- The issuer should document and make publicly available the criteria and process for placement agent, investor, or bank selection so that the decision can be explained, if necessary.
- In conjunction with bond counsel, review the sale or placement documents, such as Commitment Letter from the Investor and the Bond Purchase Agreement, to ensure that the terms and conditions are acceptable to the issuer and identify issues that need to be negotiated with the investor.
- Make sure the investor clearly states what documents are required in conjunction with the transaction, i.e., an Official Statement, Offering Memorandum, or Private Placement Memorandum.
- Make sure to understand the post-issuance continuing disclosure requirements, filings required by SEC Rule 15c2-12, as well as tax and regulatory requirements.
It is important for issuers to become familiar with and understand the Municipal Advisor Rule’s implications on placement agent responsibilities as discussed in the materials related to the Municipal Advisor Rule.
- Board approval date: Friday, March 5, 2021