Bank Fees Refunded

Best practices optimize debt management.

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For many finance officers, issuing bonds and managing outstanding
debt is just one of many tasks, and local governments sometimes go years
between bond issues, in which case the market is likely to have evolved
since the last time they entered it. Keeping up with market changes and
industry best practices is, therefore, an ongoing challenge. The
Government Finance Officers Association’s 22 best practices on
nearly all aspects of debt management provide a resource to help finance
officers explain, document, and defend their debt-related decisions and
recommendations to elected officials, staff, and the taxpayers and
ratepayers they serve. This article highlights the GFOA’s key
recommendations.

PLANNING AND PREPARING TO ACCESS THE CAPITAL MARKETS

The Debt Management Policy. A debt management policy is a group of
written guidelines and restrictions that describe debt capacity and
limitations, and provide direction regarding debt portfolio management
and implementation. A well-written debt management policy identifies
goals and objectives, guides the debt issuance process, improves the
quality of decisions, and ultimately demonstrates commitment to good
management and long-term planning. A debt management policy functions
best when it includes all debt-related factors and interacts efficiently
with broader governmental policies and priorities.

Before creating or revising a debt management policy, an issuer
should consider the primary objectives and desired outcomes, and
fine-tune the document to the specific nuances of the organization. All
debt management policies are aimed at supporting the lowest possible
cost of borrowing, but a small entity might achieve that goal through a
different set of conditions than a larger one.

Review, input, and support are needed, not just from financial
managers and elected officials, but also from individuals across the
organization–especially capital project managers and staff members who
are responsible for budget preparation. Furthermore, policies should be
reviewed at least annually and revised as necessary. Given the pace of
regulatory and market change in recent years, maintaining a policy that
accommodates the current environment is more important than ever.

Using a Website for Disclosure. Providing timely access to quality
financial information demonstrates accountability and transparency and
can enhance communication to investors, credit analysts, citizens, and
other public
stakeholders

. Publishing information on an issuer website
does not meet continuing disclosure responsibilities as set forth in
Securities Exchange Commission Rule 15c2-12.

Things that may be made available via a website include relevant
policy documents (including the debt management policy and other
financial policies), audited financial statements, official bond
offering disclosure, continuing disclosure documents, and other interim
financial or management reports. Any documents posted online should be
identical to those made available via hard copy. Many governments
already post information about their actions online, but not with their
financial or debt information.

Online information must be protected from misuse or
misinterpretation. Access points to financial information should include
a legal disclaimer stating that documents are accurate only as of the
date on the page or form, and are not intended to reflect the entirety
of the issuer’s financial condition. Bond counsel can help identify
appropriate precautionary language. Issuers also need to develop and
test security provisions and software compatibility, including
instructions for downloading software needed to view a document.

Websites that are used for disclosure also require ongoing
monitoring and maintenance. Documents that are no longer current should
be moved to an archive section that is labeled as historical information
provided for information only. If the organization has advanced IT
capabilities, it can also be useful to monitor exactly which information
is accessed most frequently and adjust its presentation to make that
information more prominent and easily accessible.

Maintaining an
Investor Relations

 Program. Capital financing would
not be possible without a substantial pool of informed investors.
Developing an investor relations program can provide another
enhancement, leading to reducing borrowing costs. An issuer should
identify the individuals responsible for speaking on its behalf and
managing communication to investors; issuers often use a website to
communicate information about their investor relations programs. Your
bond counsel and financial advisor will provide advice on appropriate
conditions for program development.

THE BOND SALE

Who Should I Hire First? Every bond sale requires the participation
of several outside parties that the issuers retain to carry out the
financing. The primary parties include bond counsel, the financial
advisor, underwriters, the underwriters’ counsel, and the
trustee/paying agent. The specific order in which these outside parties
should be selected is driven by the recommendations contained in several

GFOA

 best practices. Issuers should retain a financial advisor and bond
counsel in the earliest stages of a financing because issuers and their
financial advisor will determine early on whether the bonds will be sold
through competitive bidding or through a negotiated sale with a
pre-selected underwriter or syndicate of underwriters. If a competitive
sale is determined to be in the best interests of the issuer, then there
is no need to conduct a request for proposals process for pre-selecting
an underwriter, since the underwriter is determined at the time the
bonds are sold, based on the lowest true interest cost that is bid for
the bonds.

Bond counsel should be hired early on to provide consistent legal
advice throughout the bond sale process. The role of the bond counsel
does not depend greatly on the method of sale chosen, so there’s no
reason to defer the selection. Some issuers prefer to hire bond counsel
without the assistance of a financial advisor, but may wish to involve
the financial advisor if the issuer is not experienced in evaluating the
skills and experience of legal counsel.

The underwriter’s counsel is typically not a party in a
competitive sale. If the issuer and its financial advisor select a
negotiated sale, underwriter’s counsel is typically determined soon
after the underwriter is selected. The trustee/paying agent can be hired
at any time after the financial advisor and bond counsel; however, the
scope of the trustee/paying agent’s role may not be determined
until later in the bond sale process.

Selecting the Financial Advisor. The financial advisor represents
the issuer on matters related to the bond sale. Unlike the underwriter,
the financial advisor has an absolute fiduciary obligation to represent
the best interests of the issuer in the financing. Municipal Securities
Rulemaking

Board Rule G-23 now prohibits a firm that is initially hired as
financial advisor from switching roles in the middle of the financing to
become the underwriter in a negotiated sale. Previously, broker-dealers
that also provide financial
advisory services

 could be hired as
financial advisor, recommend a negotiated sale, and subsequently resign
as financial advisor in order to
underwrite

 the bonds. This practice
demonstrates a clear conflict of interest and was finally prohibited by
the
MSRB

See Municipal Securities Rulemaking Board (MSRB).
 in November 2011.

The GFOA recommends that the issuer hire financial advisors through
a competitive
RFP

 process. The RFP is intended to identify the firm that
best matches the needs of the issuer.
Most importantly

, the issuer
should assess whether the individuals identified in the proposal have
the skills and expertise that best match the types of bonds expected by
the issuer (revenue, general obligation, tax
increment

). The proposing
firm should also demonstrate an understanding of the issuer’s debt
profile and financial condition.

Financial advisors should also be asked to describe their access to
timely bond market information. This is especially critical if the
issuer expects to issue bonds through negotiation with an underwriter. A
financial advisor who doesn’t have sufficient market information is
less able to effectively negotiate the pricing of the bonds on behalf of
the issuer.

Issuers should request fee proposals in the RFP, but should be

mindful
  
adj.
Attentive; heedful:  See Synonyms at careful.


mind
 that the lowest fee should not necessarily be the deciding
factor. Fees should be presented in a standard format so they can be
compared accurately, and any conditions attached to the fee proposal
should be clearly identified. Fees charged by the hour, with a
“not-to-exceed” cap, may be in the issuer’s best interest
since fees based on transaction size can lead to a perception that the
financial advisor is recommending a larger transaction than necessary.

A financial advisor should be familiar with debt management best
practices and express a commitment to following them. Finally, it should
go without saying that a financial advisor should never be selected
based solely on the recommendation of an underwriter seeking to
underwrite the issuer’s bonds.

Selecting the Method of Sale. Having selected the financial
advisor, the next task is to determine how the proposed bonds should be
sold. The two primary ways are through competitive bidding or a
negotiated sale with pre-selected underwriters. The question of
competitive versus negotiated sales generates more heated discussion and
debate than almost any other topics in public finance. While the
majority of studies and academic research have found that competitive
sales result in lower borrowing costs for issuers, the findings of these
studies have not been universally accepted in the industry, especially
among those firms and individuals whose business relies on negotiated
sales. The GFOA’s Method of Sale best practice recommends that the
method of sale decision should be based on an analysis of the specific
characteristics of the proposed bonds and should not be influenced by
outside parties with a
vested interest

 in the outcome of the decision.

The GFOA believes that the presence of the following
characteristics may favor the selection of a competitive sale:

* The rating bonds of the bonds is A or better.

* The bonds are general obligation bonds or full faith and credit
obligations, or are secured by a strong, known, and long-standing
revenue stream.

* The structure of the bonds does not include unusual features that
require extensive explanation to the market.

Conversely, the presence of the following characteristics may favor
the use of a negotiated sale:

* The rating of the bonds is less than A and
credit enhancement

 is
unavailable or not cost-effective.

* The structure of the bonds has features such as a pooled bond
program, variable rate debt, or deferred interest.

* The issuer’s desire to target underwriting participation
specifically to include disadvantaged business enterprises or local
firms.

In recent years, approximately 80 percent of the bonds sold in the
municipal market have been sold through negotiation. This suggests that
many issuers decide their method of sale based on factors other than
those outlined in the GFOA best practice. Determining what optimal
percentage of bonds “should” be sold competitively, based on
the criteria above, is a not a perfect science and is beyond the scope
of this article. However, the universe of bonds that lend themselves to
competitive sale would seem much larger than the approximately 20
percent of bonds that are actually sold through competitive bidding.

Many issuers approach new bond issues with the presumption that the
bonds will be sold through competitive bidding. However, if the issuer
and its financial advisor determine that the bonds may be better suited
for negotiation, then the method of sale can be switched. For example,
if the ratings of the bonds are lower than anticipated, or if the
structure of the bond issue becomes especially complex, then the bonds
may become better suited for negotiation. In any event, the method of
sale should be determined by rational analysis.

Selecting Underwriters for Negotiated Bond Sales. If a negotiated
sale is determined to be the best option, given the characteristics of
the proposed bonds, the next step in the bond sale process is to select
the underwriter or team of underwriters that will offer to purchase the
bonds from the issuer at the time of the bond sale. The primary role of
the underwriter is to market the bonds to investors.

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The GFOA’s best practice on this subject, Selecting
Underwriters for Negotiated Bond Sales, recommends most issuers not to
consider a negotiated sale unless it is represented by a financial
advisor. When the issuer isn’t represented by a financial advisor,
the underwriter may be free to dictate compensation and bond pricing
without minimal meaningful negotiation by the issuer. Few issuers have
access to reliable real-time bond market data or sufficient experience
in negotiating the pricing of their bonds.

The GFOA further recommends that underwriters in a negotiated sale
be selected through a competitive RFP process to promote fairness,
objectivity, and transparency. The RFP process allows issuers and their
financial advisors to select the most qualified firm or firms, based on
relevant selection criteria stated in the RFP. A key criterion in
selecting the underwriter is its experience with the type of bonds
proposed by the issuer. Relevant experience is also important for the
investment bankers who will work most closely with the issuer and the
underwriting desk of the firm that will be responsible for selling and
distributing the issuer’s bonds. Proposals should also demonstrate
an understanding of the issuer’s financial condition, including
ideas on how the issuer might approach the structure of the bonds,
credit rating strategies, and investor marketing strategies.

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Underwriters are compensated in the form of an underwriting
“spread,” or discount from the face amount of the bonds.
Underwriters are typically compensated only if the bonds are
successfully sold and closed. The RFP should request that proposers
provide their best estimate of the
underwriting spread

, broken down into
the four typical spread components:

* Management fee, or the compensation paid to the underwriter for
transaction management and banking-related services.

*
Takedown

, the sales commission. m Expenses, or
reimbursement

 for
fees and direct overhead expenses.

* Underwriting, a fee paid only in the event that the underwriter
agrees to underwrite a substantial amount of unsold bonds.

While the spread estimate provided in the proposals should not be
viewed as a firm bid, it does provide a basis for the issuer and
financial advisor to negotiate the final spread at the time the bonds
are sold. If the spread proposed at the time of sale is significantly
higher than what the underwriter originally proposed, the issuer and its
financial advisor should require an explanation. The GFOA’s best
practice on Pricing Bonds in a Negotiated Sale provides additional
guidance on negotiating the underwriting spread.

Pricing Bonds in a Negotiated Sale. Pricing bonds in a negotiated
sale refers to the process of determining the bond yields, coupons,
underwriting spread, optional redemption provisions, serial versus term
bonds, and other structuring and pricing details. From the finance
officer’s perspective, the process can be simple or difficult.
Issuers that choose not to be represented by a financial advisor are
likely to simply accept the interest rates, yields, and underwriting
spread offered by the underwriter with little informed negotiation. This
approach is simple, but it isn’t likely to result in a
defensible
  
adj.
Capable of being defended, protected, or justified:


de·fen
 best outcome. On the other hand, issuers represented by an experienced
financial advisor that is armed with current data on comparable
transactions and prepared to reject the proposed pricing, if necessary,
can be confident they will receive fair pricing of their bonds.
Negotiation can be challenging and time consuming, but it is also the
only way to ensure that the pricing of a negotiated sale reflects actual
market conditions. Issuers that aren’t willing to obtain the
resources necessary to negotiate the best price on their bonds should
probably not use a negotiated sale. The GFOA’s best practice,
Pricing Bonds in a Negotiated Sale, provides a roadmap for leveling the
playing field in a negotiated sale.

Perhaps the most critical task in preparing to negotiate the
pricing of bonds is assembling data on similar bond issues near the time
of the issuer’s pricing (often referred to as
“comparables” or “comps”). The finance officer
should require both the underwriter and financial advisor to provide
independently prepared information about comparable transactions and be
prepared to recommend a scale of bond yields and coupons based on other
transactions in the market. This data should be accompanied with
information about general bond market conditions, expected economic and
financial releases that might affect the bond market, and other
information that helps to provide an understanding of the “tone of
the market” at the time the issuer plans to price its bonds. This
information should be provided several days before the proposed pricing
date and updated until the point of final pricing, as market conditions
change.

The pricing bonds best practice also lists other important steps to
help the issuer realize the best possible results from its negotiated
sale. These include preparing a marketing plan for the bonds,
considering retail order periods, evaluating alternative structuring
features such as premium or discount bonds and optional redemption
provisions, negotiating priority and designation policies, monitoring
order flow during the order period, and analyzing the pricing after the
sale.

POST-ISSUANCE REQUIREMENTS

A finance officer’s debt management responsibilities do not
end once the bonds are closed and the proceeds are received.
Post-issuance requirements require ongoing attention throughout the life
of the bonds (and beyond). Post-issuance activities include:

* Investing and reinvesting the bond proceeds.

* Tracking the
arbitrage
 see foreign exchange.


arbitrage

Business operation involving the purchase of foreign currency, gold, financial securities, or commodities in one market and their almost simultaneous sale in another market, in order to profit from price
 rebate of tax-exempt bonds.

* Monitoring the use of facilities financed with tax-exempt debt to
make sure the bonds remain tax-exempt over their life.

* Filing annual continuing disclosures and material event
notifications.

Understanding Your Continuing Disclosure Responsibilities. Debt
issuers are obligated, under the continuing disclosure agreements
entered into at the time of closing, to provide the market with annual
updates of certain financial and operating data
pertaining
  
intr.v. per·tained, per·tain·ing, per·tains
1. To have reference; relate:

2.
 to their
outstanding bonds. Certain “material events” described in the

CDA

 must also be disclosed when they occur. The GFOA best practice on
continuing disclosure recommends that finance officers thoroughly
familiarize themselves with their ongoing obligations prior to executing
the CDA. In particular, the finance officer should be familiar with the
type of information that must be filed annually with Electronic
Municipal Market Access, the Municipal Securities Rulemaking
Board’s electronic repository of continuing disclosure filings, and
the required annual filing dates. Governments’ debt policies should
acknowledge continuing disclosure obligations.

Issuers can also voluntarily disclose budgets, interim financial
reports, investment information, and revenue forecasts through
EMMA

.
Issuers should discuss this decision with their bond counsel and
financial advisors. As with all disclosure filings, the voluntary
information must be accurate and complete.

SPECIAL SITUATIONS

A debt policy should also address several situations that
don’t arise often. Appropriate policy considerations can help limit

overexposure

 to unique risks that can be associated with special
situations such as refundings, taxable debt, tax increment financing,
and public-private partnerships.

Analyzing and Issuing Refunding Bonds. Refundings can be a useful
tool for reducing ongoing interest costs, removing burdensome bond
covenants, or accommodating short-term cash flow challenges. If not
managed appropriately, however, refundings can lead to unnecessary costs
and reduced savings potential due to premature action or poor
structuring. The GFOA strongly recommends that issuers solicit the
advice of their financial advisor and bond counsel when evaluating a
refunding opportunity.

A debt management policy should define the level of savings
required in order to execute a refunding. For example, a common
requirement is that a refunding produce a minimum of 3-5 percent present
value savings. For smaller issues, it might be appropriate to set a hard
target such as a minimum of $100,000 present value savings (net of
issuance costs). Under current federal tax code, issuers typically get
only one opportunity to perform a refunding in advance of the bond call
date. Issuers might therefore choose to have more stringent policies for
pursuing advance refundings- for example, setting a higher savings
threshold, or adding a provision requiring additional analysis of the
opportunity cost of an
advance refunding

 versus waiting for a later
date.

Issuing Taxable Debt. While tax-exempt debt offers a comparatively
lower borrowing cost, there are circumstances where governments might
want to consider taxable debt –to provide operating flexibility for a
financed project, in conjunction with projects that have private-use
elements (such as stadium/concert venues, economic development, and
mixed-use projects), or for financing pension obligations. From a policy
perspective, however, a government should prevent overexposure to the
increased costs associated with taxable debt.

Tax Increment Financing. Policies related to tax increment
financing should include descriptions of when it is appropriate to use
tax increment financing and how it can be used to support broader
economic development efforts.
TIF

TIF Tax Increment Financing
TIF Temporary Internet Files
TIF Transport Innovation Fund
TIF Telecommunications Infrastructure Fund
 is typically rated lower than general
obligation debt or essential service revenue bonds, so governments need
to define minimum credit rating thresholds and limit the amount of total
TIF relative to another benchmark (such as general obligation debt
capacity).

Because tax increment revenues can be unpredictable, it might also
be important to define minimum revenues that must be generated before
tax increment debt can be accommodated. In addition to describing a
conservative methodology for projecting future tax increment revenues,
this may include a requirement that feasibility studies or other
financial analysis be performed. If TIF financing is to be supported by
other legally available revenues, a policy might describe limits or
conditions under which those supporting revenues can be applied. In
general, a debt management policy should encourage management to perform
appropriate
due diligence

 and conservative planning targets to protect
against potential tax increment revenue shortfalls.

Public-Private Partnerships, Conduit Debt, and
Privatization
 see nationalization.


privatization

Transfer of government services or assets to the private sector. State-owned assets may be sold to private owners, or statutory restrictions on competition between privately and publicly owned
. While
projects developed with nongovernmental partners can encourage
significant economic development, public-private partnerships and
quasi-governmental debt frequently entail relatively higher risk to a
government issuer. A debt management policy needs to ensure that
appropriate due diligence is performed so the jurisdiction does not take
on excessive risk that could damage its broader credit quality and
negatively affect borrowing capacity for more essential projects. Risks
associated with these projects can also be mitigated by setting a
minimum rating threshold (such as A3/A-, or “above investment
grade”) and limiting sale of bonds to
accredited

 investors.

CONCLUSIONS

The GFOA’s best practices provide valuable guidance on nearly
all aspects of debt management. Adhering to these best practices can
help to ensure successful outcomes on an issuer’s financings and
can help staff, elected officials, and the public understand the policy
basis for a finance officer’s decisions. Including best practice
recommendations within an issuer’s adopted debt and financial
policies can help to further strengthen the credibility of those
policies. All 22 best practices
relating to
 relate prep

 relate prep → ,  
 debt management are
available on the GFOA’s website at www.gfoa.org.

RELATED ARTICLE: Swaps in the aftermath of the banking debacle: the
importance of reviewing the GFOA’s advisory and checklist on
derivatives.

By Peter Shapiro

The importance of developing appropriate
policies and procedures

 for your jurisdiction–and understanding the new regulations–has never
been greater.

From 2000 to 2007, many cities, counties, states, school districts,
and public authorities rushed into the swap market, seeking promised
savings and, sometimes, underestimating risks. * We now look back at
this period as one of excessive optimism–across all markets, from
derivatives to equities to mortgages of every stripe. Like other market
participants, governmental entities took on greater risk in the swap
market for often
meager
 also mea·gre  
adj.
1. Deficient in quantity, fullness, or extent; scanty.

2. Deficient in richness, fertility, or vigor; feeble:

3.
 benefit. In some cases, governments entered into
30-year swaps for a benefit of only 0.25 percent per year, which, even
in those complacent times, was not a great risk-reward trade-off. In
reaction to this and other markets within the financial system, Congress
acted to impose tough new regulation of the
derivatives market

,
including special protections for municipal swap users.

New Regulations, Protections

Under the Dodd-Frank Act, the
Commodity Futures Trading Commission

 and the Securities and Exchange Commission have begun developing rules
for a multi-trillion-dollar market that developed in a largely

unregulated

 environment. These new rules could directly affect your
organization’s activities both today and in the future. The key
provisions include:

* A narrowing of who can use swaps without going through a
clearinghouse. (Swaps are an exchange of two securities, interest rates,
or currencies for the mutual benefit of both parties.)

* Reporting requirements to enhance accountability and visibility.

* Registration requirements for all parties using swaps.

* Business conduct standards for banks to help prevent abuses.

The act creates a new set of protections for state and local
governments, which are classified as “special entities.” Banks
will no longer be able to act as both advisors and swap counterparties,
so governments will need to obtain the services of a qualified swap
advisor or other “qualified independent representative.” An
independent advisor will be charged with evaluating any recommendations
made by banks and will be required to take on a
fiduciary duty

 to the
governmental entity –something that banks have always been
loath
 also loth  
adj.
Unwilling or reluctant; disinclined:


[Middle English loth, displeasing, loath
 to do.

Taking Another Look at Swaps and the Importance of Developing a
Derivatives Policy

The changing regulatory landscape hasn’t hampered the
recovering market, as some governments have saved money using swaps. But
before determining if these transactions are right for your
jurisdiction, carefully review the GFOA’s Use of Debt-Related
Derivatives Products and the Development of a Derivatives Policy
advisory and the accompanying derivatives checklist, and have extensive
discussions with financial and swap advisors about the appropriateness
of any potential transaction.

As state and local governments again consider using swaps, they
need to look at how the financial crisis revealed fundamental issues
that had not been well-recognized before. Most important were two shaky
assumptions: first, that the market for floating rate bonds (notes with
variable interest rates) would always function well; and second, that a
swap could always be terminated at a reasonable cost. The crisis showed
just how shaky these assumptions were.

Floating rate debt had been a reliable mainstay of the municipal
market since the 1970s; then the unheard-of happened. First, an entire
part of the market, whose smooth functioning was
taken for granted

,
collapsed. The Auction Rate Securities market’s demise put more
than $300 billion of floating rate debt into
limbo

, at a cost to muni
borrowers that few anticipated. Then, the longest-standing segment of
the floating rate market, variable rate demand bonds (securities with
interest rate resets that are reset periodically, often referred to as
daily or weekly
floaters
 /float·ers/ () “spots before the eyes”; deposits in the vitreous of the eye, usually moving about and probably representing fine aggregates of vitreous protein occurring as a benign degenerative change.
) was severely weakened by the banking debacle.
Variable rate demand bonds require a backstop from a
creditworthy
  
adj.
Having an acceptable credit rating.


credit·wor
 bank
to gain market acceptance, and the biggest single casualty of the crisis
was the
creditworthiness

 of banks. With fewer healthy banks standing,
bank backstops became much more costly and harder to come by. Because
most swaps are used in conjunction with floating rate bonds, the
unsustainability of the floating rate market made swap structures
crater
 circular, bowl-shaped depression on the earth’s surface. (For a discussion of lunar craters, see moon.) Simple craters are bowl-shaped with a raised outer rim. Complex craters have a raised central peak surrounded by a trough and a fractured rim.
 or become much more costly. Financings that were expected to save 0.25
percent
per annum

, compared with conventional fixed rate bonds, were
instead costing 1.75 percent or more.

Next, when governments wanted to exit their swaps, they found that
the costs had turned much uglier than anyone had forecast. The cause was
straightforward: When interest rates drop, the cost of terminating swaps
(when the government is a
fixed-rate payer

) increases. Pre-crisis,
governments had evaluated this risk looking at interest rate scenarios
in which 10-year Treasury rates dropped to the lows of the prior
generation, less than 4 percent. But in the aftermath of the crisis,
rates fell below 2 percent, and remain there today. Swap termination
costs rose astronomically, and government finance officers throughout
the nation rued the day they ever heard the word “swap”.

Once burned, twice shy. But now governments may wish to give swaps
a second look First, there could be an opportunity to finance long term
at rates in the 1.5 to 2 percent range –less than half the cost of
conventional fixed-rate bonds. Second, the problems in the floating rate
market have led to a new set of products that allow governments diverse
new ways to gain market access: direct purchase programs, index notes,
extendible securities, and other products that don’t rely on the
continued shaky health of banks. Third, governments have the opportunity
to design better swap programs. A key error of earlier swap
programs–which is abundantly clear with the benefit of hindsight–was
the failure to include par calls (the earliest date a bond can be
called–when the issuer gives notice that the amount of the bond will be
paid–at face value) in swaps. Ten-year par calls are standard features
of most fixed-rate bonds, and they should have been included in swaps.
In fact, swaps can include even greater flexibility, with par calls
beginning as soon as three years. With a par call, a swap can be
terminated at no cost, regardless of where rates have moved, virtually
eliminating the risk of a
crippling
  
n.
1. A person or animal that is partially disabled or unable to use a limb or limbs:

2. A damaged or defective object or device.

tr.v.
 termination expense. Including a
call typically costs between 0.15 and 0.35 percent, but could be a cost
worth spending upfront for more long-term savings.

Conclusions

As the markets return to some semblance of
normality
 in chemistry: see concentration.
, and the
lessons of the crisis are absorbed, governments may wish to cautiously
wade into swaps. Important regulations could help prevent governments
that shouldn’t be in the market from entering it, and provide
important safeguards from bankers and advisors who now have a regulatory
framework from which to work One area in particular that might be worth
reviewing is restructuring old swaps to replace weakened banks with
stronger ones. Others are harvesting gains where they are available and
hedging in the commodities market. The commodities market is different
from the securities market but could yield savings for governments by,
for instance, locking in the low cost of natural gas for future transit
or heating use.

The swap market must be approached with
mindfulness

n the capacity to maintain nonjudgmental attentiveness to the present moment.
 of risks both
real and remote. The importance of developing appropriate policies and
procedures for your jurisdiction–and understanding the new
regulations–has never been greater. But for investors with the

sophistication
  
v. so·phis·ti·cat·ed, so·phis·ti·cat·ing, so·phis·ti·cates

v.tr.
1. To cause to become less natural, especially to make less naive and more worldly.

2.
 and appropriate policies in place to use it, a review of
available opportunities may be worthwhile.

* My firm, Swap Financial Group, is in the business of helping
public agencies better understand and mitigate risks, and ensure fair
pricing, when they are up against banks in the swap market.

PETER SHAPIRO is managing director of Swap Financial Group.

JONAS BIERY is debt manager for the
City of Portland

, Oregon. ERIC
JOHANSEN is a director at the PFM Group and the immediate past chair of
the GFOA’s Governmental Debt Management Committee.