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Providence Financial












MONTHLY NEWSLETTER:  AUGUST 2007 ISSUE

ANATOMY OF A BOND ISSUE
BY BRENT VAN ALFEN
PROVIDENCE FINANCIAL CO., INC.


A medical doctor once told me that it is easier to understand the function of an organ or a muscle in the body if you understand how it fits into the whole system. The same reasoning applies to many things in life including a charter school’s use of a tax-exempt bond issue to finance a facility acquisition. If the school management understands the bond transaction basics better, it will be easier to determine if that method of financing is right for them. I will try to explain the rudimentary basics of a bond underwriting to try to help those of you who are in that position. I won’t pretend that this discussion will be exhaustive or even very complete, but it will at least provide a basis for someone to start learning about it. Put aside everything you have learned about mortgage or commercial borrowing as little of it applies to tax-exempt bond underwriting, and we can begin.

First, school management must decide what type of bond offering is best for the project needs. There are several types of structures, and some will suit a school better than others. This requires that someone at the school knows the market well enough to complete this analysis or that the school engages a qualified financial advisor who can help them with this critical analysis.

Second, once a bond structure is decided upon, a qualified underwriter must be retained. Sending out an open request for proposal is generally not productive as underwriters don’t like getting into a bidding contest, especially when they are already very busy. One must know the underwriters well enough to understand their strengths and weaknesses and to know which one will be a good fit for a school’s particular situation. The underwriter, along with the school and the school’s financial advisor then prepare an offering document that discloses information relevant to a potential investor’s decision of whether to purchase the bonds. Completing this document requires a significant amount of work. The underwriter provides the offering document to potential investors in order to sell the bonds. It’s important that the underwriter gets the offering document in front of as many prospective investors as possible so that a sort of auction process can be created that has the effect of lowering the school’s interest rates on the bonds. If the underwriter does not do this but instead takes the bonds to only one or two investors, the school will likely be forced to pay too high of an interest rate on the bonds. The bonds are then sold and the transaction is closed.

There are a number of other key participants in the bond offering. Their roles are as follows.

An issuer must be identified that is willing to issue the bonds on behalf of the school, because charter schools do not have authority to issue their own bonds. The issuer is usually a municipality such as a city, county, IDA, etc. that has authority to issue bonds. In a charter school transaction, the issuer issues the bonds, and in turn loans the proceeds to the school. In doing so, the issuer takes no responsibility for the repayment of the bonds. They incur no liability in the transaction.

A trustee is engaged to receive the school’s monthly payments and disburse them to the bondholders at the established intervals.

The professionals involved also include attorneys for the school, the issuer, and the underwriter. The transaction also requires a bond counsel. Let’s take a look at what they do.

The school’s attorney has the responsibility to protect the interests of the school in the transaction, particularly the real estate aspects. He must also make certain that the school has the authority and standing to enter into the transaction and must give an opinion to that effect. It is important to keep the school’s attorney working in his own area of expertise and not let him try to play a role for which he is not qualified. I know of an example in a charter active state where an attorney who is aggressively seeking charter school business also tries to act as the school’s financial advisor. He is patently unqualified to do so, but his clients don’t usually question his qualifications because he is their attorney. He has damaged many schools by this conduct.

When financing a facility, I cannot emphasize enough that it is critical to know what you are doing before you start and to retain an experienced financial advisor…

The issuer’s counsel protects the interests of the issuer and ensures that there is nothing in the documentation that may cause the issuer to incur any liability for repayment of the bonds.

The underwriter’s counsel protects his client’s interests by ensuring there is complete disclosure of all relevant facts pertaining to the school and the sale of the bonds. They also ensure that the offering document is complete and complies with securities law.

The bond counsel is the party who provides a legal opinion that the bonds are exempt from federal income tax. He assures that all documentation is complete and comprehensive to support his opinion.

After reading this, one will readily see that the up-front effort and cost of completing a tax-exempt bond offering is considerable. However, it will be well worth the up-front effort and cost due to the significantly lower interest rates.

Because I have seen so many schools pay too much for this complex process, I cannot emphasize enough that it is critical to know what you are doing before you start and/or retain a qualified, experienced financial advisor who can guide you through this process.

For information contact Brent Van Alfen, Providence Financial Co., Inc.
Phone: 801-299-8555
Email: brent@providencefinancialco.com