put the deal together
and sell it to
Once a capital need has been identified and a decision made to pursue bond financing, the next step is to assemble a team of financial professionals. The team will include one or more investment banks responsible for selling the bonds (underwriter), and a law firm that will issue an opinion on the legality and tax status of the bonds (bond counsel). The team will also include a bank that holds the proceeds of the bond sale, authorizes expenditure of bond funds and represents bondholders in the event of a default (trustee).
The lead underwriter not only sells the bonds but may also serve as a financial advisor
by helping the issuer
alternatives. However some issuers opt to employ an independent financial advisor prior to the selection of an underwriter, or to provide a second opinion once the underwriter has been selected. The underwriter will retain counsel and the issuer may also choose to retain counsel apart from bond counsel.
RECOMMENDATION: Find out how the financial team was selected and investigate the players’ past performance
The selection of the financial players in a bond deal may not fall under the laws and regulations governing public procurement, since they are not typically paid directly by public agencies. Some issuers use a bidding process to select the underwriter while others retain the first underwriter that approaches them with a proposed deal.
Public officials should
be encouraged to solicit
bids from multiple
investment banks and law
firms – if only one bid
appears, it may be a
sign that the deal is
Residents can also
research past deals
managed by the
underwriter and reviewed
by bond counsel, to
determine whether any
are at risk of default
or have produced other
RECOMMENDATION: Clarify the relationship between bond counsel, issuer and underwriter
Public officials may assume that bond counsel represents the public and will protect its interests, but this is not always the case. Bond counsel may represent the underwriter or the client relationship may never have been clearly defined. Even when the issuer is the client, its interests may not coincide with the public’s interests, especially if the issuer is a pass-through bonding authority rather than a sovereign government.
Further, the scope of bond counsel’s work is limited to issuing an opinion regarding the enforceability of bonds and their taxability. Bond counsel is not responsible for advising the client whether a deal is prudent. Finally, bond counsel may have a longstanding relationship with the underwriter that outweighs the legal obligation to protect the issuer’s interests.
The relationship between
bond counsel and the
issuer should be
explained in a public
meeting and clarified in
counsel’s track record
and relationship to the
underwriter should also
be examined by looking
at past deals and
reviewing the financial
RECOMMENDATION: Push for second opinions on proposed financial and legal arrangements
Underwriters and bond counsel generally have a financial incentive to see bonds issued, since their fees come out of the borrowed funds. Large agencies that frequently issue bonds may have sufficient financial and legal expertise in-house to do their own analysis, but
where this is not the
case, public officials
should also seek a second opinion from a financial advisor and/or law firm that has no financial interest in the project.
How much money will be required to complete the project and get it off the ground?
Before a project is financed, the borrower must know how much capital is required to complete the work. The issuer must take into account the cost of construction and equipment (fixed capital); start-up expenses such as hiring and training project staff (working capital); bond payments that come due before the project begins generating revenue (debt service); money the issuer is required to set aside to deal with contingencies (reserve funds); and fees and other expenses associated with issuing the bonds such as the underwriter’s discount and the bond counsel fee (cost of issuance). All of this information will be included in the Official Statement under the heading “Proposed use of funds.”
RECOMMENDATION: Examine proposed use of funds to determine whether amounts are insufficient or excessive
When an issuer allocates too little for construction and start-up, it can end up running out of money before the project is complete and able to generate revenue. The issuer (or sponsoring agency) may then be forced to dip into its funds and/or issue more bonds to cover the shortfall. Either way, the result may be costly and harmful to the issuer’s credit rating. Contributing factors may include unanticipated expenses and cost overruns; delays in construction or start-up that increase costs while exhausting the debt service fund; and weaker than expected revenues in the first years of project operation
On the other hand, the issuer may allocate too much for certain items, unnecessarily increasing the debt load. If public officials are not watching closely or acting responsibly, the underwriters, bond counsel and other consultants who put the deal together may award themselves large fees. Excessive borrowing for startup costs or initial bond payments can also be a way to siphon money out of a bond deal. For example, a one-time development fee paid to a city or county government out of bond funds can temporarily conceal an operating deficit while giving officials an incentive to sign off on bad deals. Only after the borrowed funds are spent, a year or two down the line, will it become clear whether the project was viable in the long run.