Dehesa School District in San Diego County, Calif., last year paid $200,138 to issue roughly $2.2 million of general obligation bonds.
Dehesa's costs included $16,854 for the underwriter discount, $40,113 for bond counsel, $128,185 for the financial advisor, $9,500 for the rating agency, $1,800 of trustee/paying agents fees and $3,685 for contingency, according to a report by Marc Joffe of Public Sector Credit Solutions.
The district's cost of issuance as a percentage of principal was 9.22%, while a similar bond sale from Cole County, Mo., was only 1.75%.
"The two bond issues were both offered in 2014 by small districts and have similar interest rates (for comparable maturities), so the bond and issuer characteristics don't appear to justify the very large difference in issuance costs," the report said. "Yet the Dehesa bonds were five times more expensive to issue than the Cole County bonds."
Joffe's report found that issuance costs average 1.02%, while ranging to around 10% for some California school districts, based on information gathered from official statements representing over 800 bond deals since 2012. The four largest contributors to total issuance costs, according to Joffe, are underwriter discounts, legal expenses, financial advisor fees and rating agency charges - in that order.
"We argue that some combination of increased price transparency and intervention from higher levels of government could substantially reduce issuance costs faced by local governments, especially smaller ones," he said.
The report found that the median cost of issuance for the sample of 812 issues was 1.71%, while the average weighted by principal amount was 1.02%. Costs ranged from a low of 0.13% for an issue of Salt Lake City, Utah, tax and revenue anticipation notes to 10.62% for a special tax bond issue from Jurupa Unified School District in California's Inland Empire.
"Six of the seven issuers reporting the highest issuance costs - all in excess of 8.5% of face value - were California school districts," Joffe wrote. "All were small issuers selling less than $5 million in bonds, and all were new money bonds rather than refunding bonds."
The Dehasa school district didn't respond to requests for comment.
According to the official statement for the deal, the financial advisor was Dale Scott & Co. Joffe's report said the Missouri issuer didn't pay an FA, in contrast to the more than $128,000 Dehasa paid. The Missouri issuer paid only $4,000 for bond counsel fees, in contrast to the Dehasa district's more than $40,000, the report found. Dehasa's bond counsel was Jones Hall. Stifel was underwriter.
Standard & Poor's, which rated the bonds AA-minus, was paid $9,500, according to Joffe, while Cole County paid nothing for ratings.
"There are a number of reasons" why California schools are paying so much, Joffe said in an e-mail. "Many districts get low ratings, and, in the absence of a state credit enhancement program (like the one available in Missouri) need to buy bond insurance to hold down their coupon rates. Others seem to be paying high financial advisor fees relative to elsewhere."
Tom Duffy, a legislative advocate at California's Coalition for Adequate School Housing, said one of the major factors in the discrepancy is that California is a have- or have-not state.
"People in the state capital, don't understand there is a huge divergence of wealth in property in California," said Duffy. "There are 1,000 school districts sprinkled in among 58 counties. The larger ones have more wealth due to the size of properties, and they can afford to pay a smaller percentage because of the greater volume of bonds they are selling."
In California "this has been an issue since the 1970's and still persists today," he said.
In 1972, the Legislature established revenue limits for California public schools. These revenue limits placed a ceiling on the amount of tax money each district could receive per pupil. The 1972-73 general purpose spending level became the base amount in determining each district's annual revenue limit. This was the beginning of the shift from local to state control of school finance.
Then in 1976, came the Serrano v. Priest ruling. The California Supreme Court decision found the existing system of financing schools violated the equal protection clause of the state Constitution. The court ruled that property tax rates and per pupil expenditures should be equalized and that, by 1980, the difference in revenue limits per pupil, known as the Serrano band, should be less than $100. This difference in revenue limits has subsequently been adjusted for inflation and is currently about $350. In equalizing funding, districts are divided into three types: elementary, high school, and unified. They are then further broken down into small versus large districts to ensure that appropriate funding comparisons are made. Special-purpose or categorical funds are excluded from this calculation.
Joffe said there's been a controversy in recent years as some California issuers used a premium on bond sales to finance issuance costs. Bonds are not necessarily sold at their face value.
"Depending on market conditions and the interest offered, bonds may sell at a premium or discount so that their yields conform to investor demand," Joffe said. "Some California school districts have generated very large premium by offering interest rates above market levels. By using the premium to offset issuance costs, school districts can use the full principal amount authorized by voters to fund school construction. But by paying higher interest rates, the issuer obligates future residents to pay more debt service than necessary."
Ron Bernardi, principal, president and chief executive officer of Chicago-based Bernardi Securities, said the report may not be representative of the muni market as a whole, as it's based on a relatively small sample.
While he acknowledged that costs have risen, Bernardi said both regulators and market participants have made the market more efficient and transparent, with much of the progress taking place in the past five or six years.
"The typical transaction today, disclosure and professionalism is much better today," Bernardi said. "As the market continues to evolve, disclosure counsels are new to the market now, but as they become older, the costs should start to decline."
Since 1996, underwriting spreads have decreased by $3.09 per $1,000 face value of bond issues, including a drop of $1.26 in the past five years alone. Joffe's report finds that underwriter's discount still accounts for 46.03% of the total cost. The next biggest bite is 15.14%, for bond counsel fees and expenses.
"I wanted to bring the lack of transparency issue to people's attention; if people in the market understood what other people are paying, it could make it more competitive and help bring the costs down," Joffe told The Bond Buyer. "There is variation to the costs, within small deals and large deals. I think it is useful for issuers to be aware of this may require reforms at the state level or even shopping around for different financial advisor, lawyer or underwriter."
The report finds that the municipal bond issuers face upwards of $4 billion of issuance costs annually. This represents taxpayer and ratepayer money diverted from infrastructure development and service provision to a variety of financial industry interests. The burden falls most heavily on smaller - often less financially capable - bond issuers.
Joffe said greater transparency can reduce these costs, as can greater involvement in municipal investment by State governments, the Federal Reserve, and federal government. Whether policy makers choose market-based or government-oriented approaches to constraining issuance costs - or some combination of both - those benefiting from municipal investment stand to see substantial rewards.
Bernardi Securities underwrites for small and medium sized issuers across the country, but focuses on the Midwest. It is involved in about 50-75 deals on the negotiated side and is co-manager on 100-150 competitive sales per year.
"It is a competitive market place, so you do want to get hired but at the end of the day you need to keep the lights on too and that is clearly why you are seeing capital leave the market, firms cutting back and/or leaving entirely the space entirely," Bernardi said of smaller underwriters. "It is an expensive process today but if the issuer ends up saving on the coupons during the deal, then whatever they paid for the underwriting fee is well worth it. We are doing deals for less than we used to, but those small school districts and towns need the capital and we have the investor base and they rely on us to do the deal right so that they can pay it back."
