A bond contract is an agreement of terms and covenants set between a municipal issuer, the underwriter, and prospective investors. A bond contract includes legal documents such as a bond resolution and/or trust indenture applicable to state and federal laws. When a municipality authorizes sale of securities, it produces a bond resolution that contains a description of the new issue.
A bond indenture serves as a contract between an issuer and a trustee appointed to protect bondholders. A municipality is not required by law to have a bond indenture; however, a bond indenture provides a better protection to investors. A bond indenture; also called a protective covenant, contains the priority of payments to be made by a facility’s revenues.
Similar to a corporate prospectus, a municipality issues an official statement of full disclosure on every bond brought to market. Some of the official statement information includes the purpose of the issue, source of funds for payment of interest and principal, economic trends, and demographics of the municipality and its surrounding community. An officer of the issuer must sign the official statement to confirm validity. Documents found in the official statement normally include the followings: offering terms, purpose of issue, bonds’ authorization, summary statement, description and security of bonds, economic and financial summary of issuer, project feasibility statement, construction plans, regulatory procedures, legal proceedings, tax status, and legal opinion. The official statement also details provisions such as investment of funds, additional bonds’ test, insurance, reserve funds, and events of default. Before investing, an investor needs to read the official statement of each fixed income security in order to determine the risks associated with a municipal bond purchase. A municipality may issue a preliminary official statement for analyzing the attractiveness of the new issue. The preliminary statement does not include interest rates or offering prices. Next, a legal opinion is written and endorsed by a bond counsel. The bond counsel is a group of attorneys retained by the municipality, entrusted to verify compliance by the municipality with all applicable laws. The bond counsel issues either a qualified or a non-qualified opinion. A qualified opinion means there may be some uncertainty with the issue such as pending lawsuits. A non-qualified opinion means there are no pending issues that could harm investors. Normally, smaller municipalities don’t retain a bond counsel; hence, in this case the bond certificate includes an “ex-legal” disclosure.
The following process describes the sequence of events a municipality engages when deciding to launch a new municipal bond issue. First, an investment banker and/or underwriter is retained. Second, the investment bankers together with the issuer, price the new issue and set interest rates to match sound funding for debt service. Third, in a competitive bidding a municipality publishes an invitation to all investment bankers to bid. Last, investment bankers respond in writing, and the bid representing the lowest net interest cost to the issuer wins the right to underwrite the issue. A bid solicitation of an underwriter is published in The Bond Buyer (publication for primary market of municipal bonds), and local newspapers. The official notice of sale does not include the bond’s rating or the underwriter because they are yet to be determined. An official notice of sale may include: time and location of sale, name and description of issuer, type of bond, interest payment dates, restrictions on bidding, maturity structure, call provisions, dated date, first coupon payment date, good faith deposit, name of trustee, bond counsel for legal opinion, issuer rights, details of delivery, and note on final official statement to be delivered. Investment bankers use the official notice of sale to analyze the issue, and decide if they want to participate in the bidding process.