State Bond Banks: Municipal Borrowing Made Easy
by Louise Anderson, IEDC
Say you need a loan. Wouldn’t it be great if someone else would do the work of getting it for you, and for a cheaper price?
That’s essentially the function that bond banks in nearly a dozen states across the country provide for their local governments.
Bond banks consolidate local bond issues to create a single, pooled issue. This capability takes advantage of high investment grade ratings and spreads the risk, netting better interest rates and lower issuing costs. For smaller localities with smaller bond issues and fewer staff resources to handle the paperwork and administration, bond banks save time and money.
“Working through the Virginia Resources Authority (VRA) simplifies the process for us, because they handle a lot of the steps that we otherwise would have done ourselves,” says Terry Adams, Utility Controller for Hanover County, of Virginia’s bond bank. “The rates were close to what we had gotten on our own, but they were able to save on issuance costs,” she said of several recent VRA financing projects for Hanover County.
How bond banks lower borrowing costs
Bond banks assume the ultimate risk; communities pay interest and borrowed capital to the bond bank rather than to the actual holders of the bonds. They can take debt for as low as $500,000 which otherwise would be cost-prohibitive for most localities. The bond bank can offer lower issuance costs, frequently with higher credit ratings (a high credit rating means a lower interest
rate).
- Costs of issuance. A number of administrative charges involved with issuing a bond can add up. These include a financial advisory fee; a rating agency fee; printing and postage of the official statement; the bond insurance premium and local bond counsel. (The rating agency fee is charged by Standard & Poor’s, Fitch, and Moody’s Investors Service to review a locality’s finances, management, demographics and development trends and issue a credit rating.) Based on a $1 million bond issued for 20 years, the Maine Municipal Bond Bank (MMBB) estimates that these costs can add up to $15,000 - $20,000.
Ongoing annual costs – including fees for SEC disclosure and for the paying agent (the entity designated by the issuer to make payments to bond holders) – of $800 - $1,000 yearly add $16,000 to $20,000 over the life of a 20-year bond. Thus, the MMBB estimates the cost to sell a $1 million bond by a locality at $31,000 - $38,000, versus the cost to sell it through the bond bank of $2,000 - $5,000, a savings of $28,550 to $33,300.
- A higher credit rating = lower interest rates. Credit ratings (AAA, AA or lower) are how bond buyers gauge the level of risk tied to a particular bond. They have a direct impact on the interest rate – the town’s cost of borrowing capital. A lower credit rating can result from negative fund balances, thin cash reserves and uncertain future revenue streams.
“The legal costs associated with not having to reinvent the wheel each time are a huge savings to borrowers,” says Ceci Harrison, Director of Administration for the VRA. The VRA also knows whether a bond issue will require a referendum and can help put together a community’s public hearings.
How bond banks operate
Most bond banks are created as instruments of the state, organized as independent authorities with their own commissioners or board of directors. Unless specified otherwise in the bond bank’s enabling legislation, the bond bank is rated separately and distinctly from the state by the rating agencies. MMBB has a AAA credit rating, the highest possible, while the state of Maine’s rating is AA.
MMBB is self-funded through fees generated by the multiple types of financing they provide. Like many other state bond banks, MMBB not only has the base pooling program for all governmental entities below the state, but also manages other financing programs, including revolving loan funds for clean water and drinking water, school renovation and a lease purchase program.
Bond banks typically do at least two bond issues per year. Most issuances are tax exempt, but that depends on how the proceeds will be used. For example, MMBB has done some small taxable deals, including one for a hospital administrative district. Before state clean water and drinking water revolving loan funds were created in the late 1980s and early 1990s, water projects were a much larger part of MMBB’s bond portfolio. With fewer water and sewer borrowers in the pooling program, approximately 55 percent of the bonds now issued by MMBB are for schools; 35 percent for general municipal activities such as road maintenance or construction, city hall construction, buying fire trucks and similar projects; and the remainder for water and sewer projects.
The Virginia Resources Authority
The Virginia Resources Authority was created in 1984 and is the second oldest bond bank in the country, after Maine. Like most other state bond banks, the VRA has the authority to lend for infrastructure projects such as water, wastewater, solid waste and stormwater drainage, plus airports, brownfields and public safety. VRA’s credit rating was recently upgraded from AA to 70 percent AAA and 30 percent AA, a unique structure that results in lower interest rates.
Legislation effective July 1, 2005, will allow Virginia local governments to finance local transportation projects and improvements to federal properties through the VRA. The transportation authority will enable the finance of roads, public parking facilities and commuter rail. The federal property authority is designed either to keep installations open or to make them more suitable to private enterprise.
“Virginia has so many military bases, more per capita than any other states,” says the VRA’s Harrison. “We need to have a way to help people to make those bases economically viable in other ways. Being able to fund infrastructure changes for a federal property that’s located in Virginia is very helpful to localities, especially because they don’t own it themselves.”
Why do it independently?
So why wouldn’t Virginia localities use the bond bank for all their borrowing needs? If they already have their own AAA rating, the highest, the bond bank can’t get a better rate. Larger municipalities are more likely to match or outperform bond banks’ rates, and tend to prefer having more hands-on control over their finances.
Or, they could be financing a project that the VRA doesn’t have the authority to finance. Sometimes localities will have several projects they want to finance at the same time, of which the VRA can finance one or more but not all, so the local government will combine the projects into one bond and issue debt on their own. If a locality has a bank-qualified project, it might not use the bond bank; issuers who hold low levels of debt receive “bank qualified” status. The label increases demand for the bond and potentially lowers interest costs. And then there are localities that can’t afford loans and have to go for grant money.
Despite many advantages, it is impossible to say that the cost of borrowing will always be lower through a bond bank. Like a home mortgage, much depends on timing, credit ratings and the amount borrowed.
But if they are so useful, why don’t more states have them? It’s hard to say, according to Robert Lenna, Executive Director of MMBB. The 1986 tax act placed restrictions on issuers of tax-exempt debt, so bond banks that were created before 1986 had an opportunity to build up resources that later entities did not. Also, he says, there has been concern at the local level in some states that a state bond bank would have more control over local finances than desirable.
Questions? For more information, visit, www.virginiaresources.org or www.mainebondbank.com.
This month's feature comes courtesy of Louise Anderson and the International Economic Development Council (www.iedconline.org). For questions concerning this article please email Mrs. Anderson directly.
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