CHICAGO – Missouri local governments’ penchant for negotiated sales over competitive bidding resulted in an estimated $43 million in higher costs over a four-year period, according to the state auditor.

Auditor Tom Schweich’s review found that 88% of the general obligation bonds sold by school districts and other local governments over the last four years came to market through negotiation.

The auditors contend that $43 million could have potentially been saved if competitive bidding were used during the period reviewed from 2008-2011.

In 2012, only 30 Missouri bond deals from all issuers were sold competitively, compared to 400 negotiated transactions, according to Thomson Reuters data. Nationally, about a third of all bond transactions came competitively in 2012, representing about 20% of par, according to Thomson Reuters.

The Missouri auditor’s office found that competitive bidding may not have been suitable for all 538 GO bond issues totaling $3.1 billion it reviewed, but that it would have been suitable for a significant number.

“Our analysis concludes increased competition leads to lower interest costs,” the report said. Auditors found that each bid received on a competitive bond sale resulted in a 3.9 basis point reduction in the interest rate paid on the bond issue with the average number of bids at 7.6 bids per issue.

“The increased borrowing costs are the result of the inherent conflict of interest which exists between underwriters who provide financial advice and the local government, and because state law does not require GO bonds be sold through a competitive process,” the report said.

The report contends that many local government officials lack sufficient understanding of the issuance process and the expertise to evaluate and negotiate bond prices with underwriters.

The state does not provide assistance or guidance to local entities on borrowing. Governments often rely on underwriters for guidance creating an inherent conflict of interest since it’s in underwriters’ best interest for bonds to carry higher rates to attract more investors, Schweich’s report said.

Of the 355 local governments issuing GO bonds via a negotiated sale during the audit period, only 16 hired independent advisors to aid in the negotiation process and review terms and prices.

The report restates the office’s long-held position that “local governments and the General Assembly should require the use of independent financial advisors, ensure local governments receive guidance on debt issuance, and require the use of competitive sales in appropriate circumstances” such as for higher rated credits. The report also noted that six of eight surrounding states require all or most local entities to use competitive sales.

The report was forwarded to Gov. Jay Nixon and members of the General Assembly.

The auditor’s staff interviewed various government representatives and found some did not recognize the potential conflict of interests or did not consider them significant, citing their trust in and relationships with underwriters. Some local governments also argued against the use of an advisor, citing costs, without realizing often that underwriters’ “free” advice is rolled into the financing fees and so less transparent, the report said.

The report said a recent regulatory fine agreed to by a Missouri broker-dealer for improperly handing out sports tickets underscores the potential conflicts of interest as underwriters seek bond business.

St. Louis-based broker-dealer L.J. Hart & Co. was censured and paid a $200,000 fine to settle Financial Industry Regulatory Authority charges that it violated municipal rules on gifts and supervision by distributing more than $183,000 in tickets to issuer clients.

The tickets scrutinized by FINRA came from season ticket purchases made by the firm for Kansas City Chiefs, Kansas City Royals, St. Louis Blues, St. Louis Cardinals, and St. Louis Rams games. The firm also purchased additional tickets for playoff games or additional regular season games the firm “believed municipal issuer representatives would enjoy,” according to the settlement order entered in September. The auditor’s report said the firm was involved in 254 negotiated bond issues covered by the new analysis.

The analysis outlined assistance it received in reaching its conclusions. The office conducted interviews with local governments and districts to assess their practices and challenges, and with leading bond underwriters in the state to understand their services, and reviewed Government Finance Officers Association publications on best practices.

The office also received technical help from Bill Simonsen and Mark Robbins of the University of Connecticut, Department of Public Policy.

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