DENVER – Issuers are heading into uncharted waters with a new issue price rule taking effect next month, and many members of the Government Finance Officers Association’s Committee on Governmental Debt Management are anxious, even if the rule likely won’t impact them much.
The discussion during the committee’s meeting Saturday focused on the potential for issuers who sell bonds competitively to get into trouble under the new issue price rules, which were finalized by the Internal Revenue Service and the Treasury late last year and which are effective June 7. Issue price regulations are critical for issuers of muni bonds, because issue price determines the yield on bonds and whether an issuer is complying with arbitrage rebate or yield restriction requirements, among other things. Under rules that had been in place for years, the issue price of each publicly offered maturity of bonds was generally the first price at which 10% of the bonds was reasonably expected to be sold to the public.
Under the new rule, the issue price will be the price at which the first 10% of a maturity of bonds is actually sold to the public. If 10% of a maturity is not sold, a special rule can be used under which the issue price is the initial offering price (IOP) as long as the underwriters hold the IOP for five business days after the sale date. The five-day "hold-the-offering-price" requirement was designed to prevent pricing abuses such as flipping, in which a dealer sells the bonds almost instantaneously to another dealer or institutional investor with the prices continually rising before the bonds are eventually sold to retail investors.
The rules contain an exemption for competitive sales under which an issuer may treat the reasonably expected IOP of the bonds to be the issue price if the issuer obtains a certification from the winning underwriter bidder as to the reasonably expected IOP upon which it based its bid. But to use that exemption requires that the issuer receive at least three bids from separate underwriters and award the bonds to the bidder who offers the highest price or lowest interest cost. It is issuers likely to fall into this category that Debt Committee members expressed the most concern for.
“This may be solving a problem that doesn’t exist,” said one committee member, who warned that issuers conducting competitive deals need to meet with their municipal advisors and other important parties to discuss what will happen if the three bid threshold is not met. Will the sale be canceled, will the winning bidder hold the price, or will the winning bidder provide updated pricing information until 10% of each maturity is sold and issue price can be established?
“We sort of have to think about a Plan B,” that committee member said.
Another committee member said the three bid requirement stood out as a problem when the rule was finalized in December.
“This three bid requirement jumped out immediately,” he said. “It’s a really unnecessary requirement to ensure the integrity of the competitive market.”
Another member said he wanted to dispel the myth that only small, infrequent issuers would be impacted by this change to the rules, saying he was aware that Milwaukee, Wis. had recently completed a competitive deal in which it did not get three bids.
“The road to hell is paved with good intentions,” said yet another member of the panel, who wondered whether more issuers might feel pushed by the rule into doing negotiated deals with higher yields.
Kristine Tallent, assistant city administrator and chief financial officer for Franklin, Tenn., said her city is coming to market with a competitive general obligation bond sale right about when the new issue price rule takes effect. She said that while she could be concerned about the rule under different circumstances, Franklin historically has had far more than three bids for every offering, and eight its last time out.
One member of the committee said he hopes the Trump administration might address the issue price rule, and some market participants have previously said they would like the Treasury to revisit the rule under an April 21 executive order in which the President instructed that departments conduct a review of significant rules adopted since early last year that may be overly complex or burdensome. Another member said she expects the situation to evolve with real-world experience.
“There are lots of questions,” she said. “It’s not clear what changes might have been anticipated by Treasury and the IRS. I’m interested in watching and waiting.”
GFOA produced an alert for members earlier this month, and model documents for issue price compliance have been produced by both the Securities Industry and Financial Markets Association and the National Association of Bond Lawyers.