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11.3 Issuance of new bonds
Publication date: 30 Nov 2022
us NFP guide
Municipal bonds are issued in either a public offering or a private placement.
Excerpts from AAG-NFP 10.24 and AAG-HCO 7.12
Municipal bonds are issued through negotiated sales, competitive bids, or private placements. In a negotiated sale, the issuer or obligor negotiates a price with one or more underwriters. In a competitive bid sale, the securities are sold to one or more underwriters who submitted the best acceptable bid(s). The underwriters then resell the securities to the general investing public. Municipal bonds issued in negotiated sales or competitive bids are deemed to be traded in public markets….In a private placement, the securities generally are sold directly to qualified investors (for example, an institutional investor), rather than through an offering to the general investing public. Municipal bonds issued in private placements are not deemed to trade in public markets because the investors typically are subject to restrictions on resale.
11.3.1 Public offering of municipal bonds
Municipal bonds sold in public offerings are exempt from registration under the Securities Act of 1933 but are subject to SEC enforcement and indirect oversight (see NP 11.7).
New bonds are issued pursuant to an indenture (sometimes referred to as a trust agreement). A bond indenture is a contract between the governmental issuer and a bond trustee (typically a financial institution) that represents the rights of the bondholders. The indenture establishes the rights, duties, responsibilities, and remedies of the issuer and the trustee, the features of the bonds, the security for the bonds, and whether the bonds can be repaid prior to maturity.
In most conduit offerings involving NFPs, the issuer loans the bond proceeds to the conduit obligor (the party responsible for repaying the bonds). This occurs simultaneous with issuing the bonds. The loan agreement establishes the terms of repayment of the loan, the security for the loan, and various covenants with which the borrower must comply. Through the indenture, the issuer will collaterally assign the right to receive these loan payments to the trustee, to serve as security for the bonds. While loans are the most common mechanism used for repayment of the bonds, sometimes a lease/leaseback structure, an installment sale agreement, or some other form of contract is used.
The prospectus used to market the offering to the public is referred to as an Official Statement (OS) if proceeds from the offering are tax exempt, or an Offering Memorandum (OM) if the proceeds are taxable. The OS/OM provides information about the offering and the participants, including the fact that the issuer has no responsibility for repayment, the identity of the conduit obligor who is responsible for repayment, the purpose for which the bonds are being issued, the sources of funds available for the project (including money from sources other than bond proceeds), and the security for the bonds. Usually, a separate appendix provides detailed information about the conduit bond obligor, its operations, and its finances (including the most recent financial statements).
Subsequent to issuance, these bonds will be regarded as “publicly traded,” even though trading typically occurs relatively infrequently. In FASB pronouncements, NFPs with publicly-traded debt are identified as “a not-for-profit entity that has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.”
Accounting considerations related to recording a new debt issue are discussed in FG 1.2. If bonds are issued at a premium or discount, see FG 1.2.1. Debt issuance costs incurred in connection with the new bonds (incremental fees and commissions paid to third parties in connection with a new bond issue, including investment banks, law firms, and auditors) would be capitalized and amortized as discussed in FG 1.2.2. If bond insurance is taken out on the new issue, any prepaid premium would be included in the capitalized debt issuance costs.
11.3.2 Private placement of municipal bonds
New offerings of municipal bonds can also be privately placed. In the conduit financing context, “private placement” typically refers to either a single party (typically a bank) that purchases and holds an entire bond issue or a limited offering to a small group of investors. In a private placement, the transaction is directly negotiated among the investors, the issuer, and the obligor. Investors often must meet certain standards of sophistication and agree to restrictions on resale of the bonds. Generally, private placements of municipal bonds do not characterize an entity as a public entity.
In these issuances, the offering document might be referred to as an offering circular, an offering memorandum, a private placement memorandum or a limited offering memorandum. If the securities are placed with a bank (in economic substance, a loan), in addition to the authorizing and governing documentation typically found in a public offering (e.g., the bond indenture), a separate agreement between the bank and the issuer typically will set forth structures or terms similar to commercial lending transactions.
11.3.3 Forward delivery bonds
Forward delivery bonds are municipal bonds for which the offering occurs in two stages. At inception of the forward delivery arrangement, the bonds are priced (i.e., the interest rate is determined). The issuance of the bonds (cash funding and closing of the offering) occurs at some future date. During times of low interest rates, issuers find forward-delivery bonds attractive as they enable them to “lock in” a lower rate and protect against future interest rate increases. Typically, issuers pay a premium (in the form of additional basis points) to lock in the interest rate until the closing of the offering.
In general, an issuer will not recognize an asset or a liability for the forward delivery bonds until the closing of the offering.
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