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The Bond Prospectus: What Is It and What Does It Tell You? 

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Richard F. Keevey
April 24, 2023

What is the overall financial condition of a state or local unit of government? Many metrics are available to shed light on one aspect or another. However, many of these measures reflect some type of limitation that does not allow for a comprehensive assessment.

If one wishes to understand the overall finances of a state or local government do not go first to the annual budget or the annual audited financial statements. Instead, obtain the latest bond prospectus, also referred to as the Official Statement (OS). Learning to navigate a bond prospectus can yield a trove of reliable and informative financial and economic data.

Its contents must meet certain disclosure standards set by the U.S. Securities and Exchange Commission (SEC) and other regulatory bodies, so its financial contents, including pension obligations and pending legal claims, must be explicitly detailed, and explained. No ’rosy’ projections or misleading statements are permitted which could  lead to unpleasant disciplinary actions.

Now, if it is a small jurisdiction that issues few bonds, its availability may be limited. However, most states, especially the large ones, sell bonds frequently ( i.e., multiple times during the fiscal year), and their OS contents are replete with current and historical financial information. More details shortly but first, let us describe what an OS is, and who the major players are in the bond issuing process.

The OS is prepared in conjunction with the sale of bonds to provide information to prospective purchasers of those bonds. Bonds can be sold on a competitive or a negotiated basis. The details of each approach (and its pros and cons) would require extensive discussion. In short, in a competitive sale the issuing government sets forth the size, maturities and purpose of the sale. At a designated date and time bids are submitted by potential bidders and the bids are opened in public view. The bonds are awarded (i.e., purchased by) a firm (e.g., banks, investment firms, etc.) that submits the lowest bid.

In a negotiated sale the issuer retains a specific underwriting syndicate to work on its behalf and under certain parameters to contact and negotiate with a wide range of potential investors with the goal of obtaining the best bid. The underwriter returns to the government with its recommended buyer.

There are other players in the process but two are critical—bond counsel and rating agencies. Bond counsel is a specialized and independent lawyer or law firm retained by the issuing authority, but in effect represents the interest of the potential bond buyer. In short, the bond counsel provides a legal opinion that the issuer is authorized to issue the security and has met all the legal and procedural requirements necessary for issuance. Suffice to say, bonds cannot be sold without a favorable opinion of bond counsel.

The rating agencies are another major player. There are three principal rating agencies: Moody’s, Standard and Poor’s and Fitch. Each issuer pays for a rating from one or all the agencies (a topic for a later day). The rating is intended to provide an independent assessment of the relative creditworthiness of the debt obligation in the market. The rating is based on information in the OS as well as independent research. All things being equal, the higher the credit rating (e.g., AAA for S&P) assigned, the lower the interest rate reflected in the bid. It would be exceedingly difficult for a government to sell a bond without a credit rating.

There are six major components to an OS:

  1. Authorization of the bond. For example, if it is a full-faith-and-credit or general obligation (GO) bond, when did the voters approve its issuance?
  2. How the bond proceeds will be used.
  3. The sources of payment for the bonds and security provisions.
  4. The bond counsel’s legal opinion.
  5. Tax implication matters, such as federal tax exemption status.
  6. The bond rating.

There are usually multiple sub-components related to the financial and economic information about the issuing entity. In short, at least the following data is included:

  • A description of the budget and accounting systems, and their most recent audit report.
  • Financial results of previous five years and projections for the current year, including summary for appropriations, expenditures, revenue (state and federal); and surplus.
  • All outstanding long term general obligation(GO) debt, revenue bonds, appropriation debt, short-term debt ; and projections of debt service.
  • Status of pension and health benefit funding, including funding policies and status of funding levels.
  • State employee count, including status of union / worker contracts and negotiations.
  • Economic situations impacting the jurisdiction.
  • Pending litigation.
  • A narrative description of major revenues, including a listing of the major tax-expenditures in the tax code.

While not exactly light reading, the OS is the most reliable, comprehensive, up-to-date, informative and easily available source of general and specific information about the finances and overall status of a state or local government.

Author: Rich Keevey was appointed by two New Jersey governors of each political party as state budget director. He held two presidential appointments as the CFO at the Department of Housing and Urban Development and as deputy undersecretary of the Department of Defense. He was also the executive officer of a nuclear missile unit in Germany. He is currently a senior policy fellow at Rutgers University and a lecturer at Princeton University.

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