DENVER – Issuers need to tread carefully as the new issue price regulations take effect next month, experts said, even though the new rule is in some ways an improvement over the old.
Lawyers, issuer officials, and municipal advisors made those points during a Monday panel discussion at the Government Finance Officers Association conference. Central to the discussion was the idea that issuers need to understand and be prepared for the June 7 effectiveness of the new Treasury and Internal Revenue Service rule that was finalized late last year, and consider avoiding coming to market right then if possible.
Treasury had been trying to change the issue price rule since at least 2013, when it proposed changes that were eventually withdrawn after public comment. Issue price is important because it determines the arbitrage yield restriction for rebate compliance purposes as well as the maximum allowable escrow yield for advance refunding bonds. 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.
Washington State deputy treasurer Ellen Evans, a member of GFOA’s debt committee, told attendees that the new issue price rule could impact their cost of funds if underwriters are forced to hold the price for five days. She told finance officials to have a plan in place and stated in their bond documents what will happen if at least 10% of a maturity doesn’t sell on pricing day.
“It’s just something that has to be anticipated,” she said. “You have to know from the get-go what you are going to do.”
Evans said issuers planning to price June 7 should avoid the uncertainty of diving in on transition day and consider moving the sale up or delaying it.
“Steer clear of June 7,” she said.
Darren McHugh, a shareholder in the Denver office of the law firm Stradling Yocca Carlson & Rauth who had a key role in drafting model documents on issue price for the National Association of Bond Lawyers, said that Treasury had a difficult job in crafting the new rule but improved it in some notable ways. One major improvement, he pointed out, was that the new rule removes ambiguity about which purchases of bonds count toward the 10% threshold. Under the existing regime, the sales have to be to the “public” and defined that term fairly nebulously and in a way that excluded broker-dealers. Under the new rule, broker-dealers not underwriting the deal qualify toward the 10% mark.
“It’s a better rule,” McHugh said of that aspect.
Steven Apfelbacher, president at municipal advisory firm Ehlers, stressed that the new rule will not change the proceeds paid to issuers, so it won’t create uncertainty regarding construction fund deposits, issue size, costs, or other related matters. The rule has the potential to hurt smaller competitive deals that might not qualify for the three bid safe harbor, he said. Apfelbacher said that a deal might fail to garner three bids for a variety of reasons, such as being too small to attract intetrest, a low credit rating, a short call provision, and more. A large number of transactions that don’t get three bids are bank-qualified deals, he said. Apfelbacher said there is no market consensus on precisely how the new issue price regulations will impact the market.
“Clearly this is new and this is going to require seeing how it plays out,” he said.