Navigating the municipal bond market.

• Author: Hallacy, John

With debt issuance continuing to reach peak levels, local governments--particularly small to midsize issuers--are being bombarded with information and inquiries about opportunities in the tax-exempt market. Local governments preparing to issue debt to finance buildings, infrastructure, or other public projects need to understand the economy, market conditions, credit rating and insurance underwriting criteria, federal and state laws and tax regulations governing debt issuance, and a host of other important considerations. This article outlines many of these considerations and offers some insights into the current market environment in an effort to help local government issuers obtain the most favorable financing terms possible.

MARKET DYNAMICS

How does a small or midsize size issuer receive an appropriate level of attention from marketplace participants in today's market environment? With the forward weekly supply approaching $10 billion and the issuance pace for the year to date leading forecasters to predict a $400 billion annual total issuance for municipals, it is a wonder how any issuer will be received in this market. We do not profess to have all of the answers; however, a somewhat disciplined approach with attention to detail continues to be a sound approach.

One source of reassurance for local government issuers is that the average municipal transaction is still around $25 million--relatively small compared to other segments of the credit markets. Despite the relative insignificance of the municipal market, it generally meets the financing needs of the tens of thousands of local governments in the United States. Most international business people are envious of how well our municipal market works for small to midsize issuers. The U.S. municipal market continues to be the beneficiary of the tax exemption for public projects. There have been several efforts over the years to curtail the tax exemption, but these have been largely unsuccessful. Despite ongoing discussions about modifications in tax policy that would affect the municipal market, there appears to be no serious support for changing the tax exemption--a move that would result in much higher borrowing costs for state and local governments.

Credit ratings play a central role in the issuance process, since these assessments largely determine the interest rate an issuer will pay on its bonds. It is the enterprise of the rating agencies to weigh all of the relevant factors behind an issuer's ability to meet its debt service requirements and then issue an opinion on the likelihood that the issuer will pay the principal and interest on the obligations in a timely manner. Ultimately, a rating assignment is a simple and straightforward summation of a very complex process.

The process is not simplified any by the fact that there are three major rating agencies. Each rating agency examines a nearly identical set of data on a particular issuer. This data comes from the issuer itself and from generally available sources. The recent explosion of financial information on the Internet has facilitated the ratings process. Whereas just a few years ago only a select group of local governments posted financial...