Monday, December 28, 2015

Shining a Light onto Municipal Bond Issuance Costs

In a recent study of 800 municipal bond issues for UC Berkeley, I found that issuance costs varied widely – from less than 0.2% of face value to over 10%. Issuance costs are to local governments like points are to a consumer taking out a home mortgage. In both cases, the goal should normally be to minimize them. While consumers have many forums to compare against and thus reduce financing costs, local government officials have been less fortunate – but that situation is starting to change.
Aside from publishing the study, I also released a data set showing each bond’s total issuance costs – as shown on Official Statements – and itemized details for a sub-sample of the bonds. My group obtained these details by sending Public Records Act or Freedom of Information Act requests to local government bond issuers. We found that the largest components of issuance costs were underwriting expenses, legal fees, financial adviser expenses, rating agency fees and bond insurance premiums.
While my study provides data for a nationwide sample of bonds, the California State Treasurer’s Office has now posted issuance cost details for all municipal bonds issued in the largest state. This impressive data set can be found here. The data were collected by the California Debt and Investment Advisory Commission (CDIAC), a unit of the State Treasurer’s Office. Under state law, California local governments must report their debt data to CDIAC. The commission had been publishing some of this data, but Treasurer John Chiang, an advocate for transparency, recently decided to publish everything, including details on issuance costs.

Issuance Costs often > 10%
A review of the California data shows numerous issuance cost ratios in excess of 10% of the issued amount - and even some exceeding 20%. Just like a consumer would never pay 20 points on a home mortgage, it is hard to understand why a bond issuer would do the same.
Many of the higher issuance cost levels were associated with small bond issues from rural school districts and special districts. Since some of the issuance costs don’t vary with issuance size, they can hit small issuers relatively hard. Further, small issuers often receive lower bond ratings, creating the necessity to purchase municipal bond insurance.
Monoline insurance was not a factor in a couple of the 20%+ cost of issuance situations I found in the CDIAC data. 

In 2013, San Jacinto special districts (called Community Facilities Districts) issued two special tax bonds totaling $985,000 and $925,000 respectively. In each case, cost of issuance exceed 20%.
Focusing on the $925,000 bond, we find that the district received a mere $532,066 of the bond proceeds (see the Official Statement).   The Estimated Sources and Uses of Funds on page 6 of the document, show $90,428 being deposited into a reserve fund and a total of $295,890 going to the underwriter and other service providers. The remaining $6,616 reflected an original issue discount, arising from the bonds being sold below face value.
The debt service schedule on page 10 of the Official Statement shows that the district will spend $1,240,252 of interest on the $925,000 of bonds through 2043.  Total debt service of $2,165,252 over the life of the bond issue is four times the net proceeds received by the district. All in all, not a great deal for San Jacinto's taxpayers.
In an influential 2011 paper, Andrew Ang and Richard Green found that state and local governments lose billions of dollars due to the opacity and illiquidity of the municipal bond market. They proposed the creation of a municipal bond issuer consortium (they called it CommonMuni) to share information and best practices in order to lower these costs. A cost of issuance data set that allows us to identify disparities across issuers seems like a good opportunity to begin realizing the CommonMuni vision.