Exemption Allows Stephens to Advise, Buy School Bonds

by Gwen Moritz  on Monday, May. 12, 2003 12:00 am  

An exemption granted by state Securities Commissioner Michael Johnson will give Stephens Inc. of Little Rock more opportunities to profit from the many new school bonds that will be issued in Arkansas this year.

Johnson said the primary beneficiaries will be school districts who can count on finding a buyer for their bonds during the stampede of financial restructuring that has followed the state Supreme Court's ruling in the Lake View case.

"The bottom line is we're benefiting the school districts, or that's the intent of the (exemption)," Johnson said. "My concern is for the school district, not any fiscal adviser. Stephens is the only one who asked."

Stephens serves as fiscal agent for about 70 percent of the state's 310 school districts, with the remainder of the work being divided between Raney & Beards-ley of Little Rock and Memphis-based Morgan Keegan Inc.

Mark McBryde, manager of Stephens' public finance department, said his company requested permission to bid on school bond issues it is managing after becoming concerned that a two- or threefold increase in the number of bonds being issued this year might outstrip demand.

"I think what it does, pure and simple, is it increases competition in the bond market. It's going to ensure that some of these small districts receive bids," McBryde said.

A bond attorney who does work for Stephens and the competing fiscal agents agreed.

"If a school wants to issue bonds and no one bids on them, they are in a world of hurt," said Robert Beach of the Friday Eldredge & Clark firm in Little Rock. "If you really represent the school district and want what's best for the school district, what you really don't want is for one bidder to throw out a really high bid just because he knows he's the only bidder."

On April 25, Commissioner Johnson issued an order exempting Stephens Inc. from Rule 302.01.F, which normally prevents a fiscal agent representing the interest of the borrowing school district to then become the lender by buying the district's bonds.

The rule applies to all public bond issues, but Stephens Inc.'s exemption extends only to school bonds. And the exemption will expire at the end of 2003 — a year in which there will be an unprecedented number of school bond issues resulting from the Lake View order concerning minimum millages applied to school maintenance and operations. (See sidebar below.)

Raney & Beardsley is strictly a fiscal agent and never bids on bond issues. Morgan Keegan is both a fiscal agent and a bond investor, but it has not applied for an exemption like that granted to Stephens.

"We at Morgan Keegan are still assessing the situation and have no comment at this time," said Kent Douglas, vice president for public finance in Morgan Keegan's Little Rock office.

The school bond market has been fairly vigorous, with tax-free interest rates typically just under 5 percent for 25-30 year bonds.

"Typically, school bonds are considered to be the Cadillac of tax-free bonds in our state ... There has always been great demand for this product," McBryde said.

But the large number of school bonds being issued this year has the potential to disrupt the balance between supply and demand. And that, McBryde said, could have resulted in some of Stephens' client districts, especially the smaller ones, being either unable to sell bonds or having to pay too high an interest rate because of a lack of competitive bidding.

Then again, it might not have.

According to Patricia Martin, assistant director for public school finance at the Arkansas Department of Education, most of the new bonds issued this year will be used to buy back existing bonds. So while Lake View has definitely increased the supply of new bonds, the fact that existing debt has been refunded may also be expected to create additional demand.

The timing isn't perfect, however. First the new bonds must be issued in order to buy back the old bonds, McBryde said.

Coming and Going

When Raney & Beardsley or Morgan Keegan manages a school bond issue, Stephens frequently bids on the tax-free bonds and, when successful, eventually markets them to other investors, McBryde said. In those cases, the investment bank may profit from brokerage commissions, changes in the price of the bond or both, McBryde acknowledged.

The number of school bonds that Stephens will be eligible to buy and resell will be vastly increased by the exemption since Stephens was previously prohibited from bidding on most districts' bonds.

Meanwhile, 2003 was shaping up to be a bumper year on the advisory side of the business as well. While no one has a firm count of the number of school bonds that will be issued this year, the Department of Education's Martin said 246 districts will be doing some sort of debt refinancing, and many of those will issue new bonds.

McBryde said he expected at least 100 of Stephens' school district clients to issue new bonds — more than double the business Stephens typically does in a single year.

This month alone, McBryde said, there will be two or more school bond issues every Monday through Thursday. Similar rashes of school bonds are being anticipated in June, July, October, November and December, he said.

By contrast, the number of school bond issues in fiscal 2001 and 2002 was in the low 80s, and only 62 bond issues were completed during the first 10 months of fiscal 2003, according to data released by the Department of Education. (See table above.)

Fiscal agents, who help school boards determine the need for bonds and then handle all the details, are paid a fee based on the size and complexity of each bond issue. Department of Education data indicates that Stephens has received more than $1.1 million in fiscal agent fees in each of the past three fiscal years.

Stephens' average fee, as a percentage of the bonds issued, has generally been lower than those of its two competitors. However, Stephens also tends to handle larger bond issues than Raney & Beardsley or Morgan Keegan, and the fee as a percentage of the bond issue tends to be lower on larger issues.

McBryde bristled when asked if the fallout from the Lake View ruling would be particularly lucrative for Stephens.

"This is just a completely honest statement: We're not concerned with being lucrative or not. We're concerned with helping our clients get in compliance with the Supreme Court order," McBryde said.

Advising districts on the best way to comply with the Lake View ruling, he said, has made the current round of bond issues particularly complicated and time consuming.

"When you look at the amount of time we've had to spend on these issues, I'm not sure I'd characterize it as lucrative," McBryde said.

McBryde acknowledged that Stephens had lobbied against an amendment to the state Constitution, proposed by state Sen. Jim Argue, D-Little Rock, that would have required the state to assume all the bonded indebtedness of the state's school districts.

The amendment was not referred out during the regular session of the Legislature.

Argue said the windfall of school bond business Stephens will enjoy this year because of Lake View and the exemption to Rule 302.01.F "is a case study in how inefficient our school finance system for facilities is. We would achieve significant economies if the state could issue school facilities bonds as opposed to issuing bonds in 310 different districts."

Stephens has also joined its school clients in opposing Gov. Mike Hucka-bee's proposal for widespread administrative consolidation of school districts.

"We represent a lot of districts around the state. We believe it is important to have local control of these districts," McBryde said.

More on School Bonds
Click here and here for more on school bonds and the the Lake View case.

School Bond Fiscal Agents Fiscal Years 2001-2003*


Institution — No. of issues — Total value — Total fees — Average value — Average fee (%)

Morgan Keegan — 1 — $1,583,880 — $21,700 — $1,583,880 — 1.37%
Raney & Beardsley — 36 — $89,735,572 — $850,051 — $2,492,655 — 0.95%
Stephens Inc. — 43 — $282,083,143 — $1,227,237 — $6,560,073 — 0.44%
Total — 80 — $373,402,595 — $2,098,988 — $4,667,532 — 0.56%


Morgan Keegan — 6 — $19,961,068 — $123,718 — $3,326,845 — 0.62%

Raney & Beardsley — 35 — $123,228,915 — $889,790 — $3,520,826 — 0.72%
Stephens Inc. — 43 — $187,828,095 — $1,219,146 — $4,368,095 — 0.65%
Total — 84 — $331,018,078 — $2,232,654 — $3,940,691 — 0.67%


Morgan Keegan — 4 — $11,499,900 — $80,862 — $2,874,975 — 0.70%
Raney & Beardsley — 18 — $48,758,002 — $420,795 — $2,708,778 — 0.86%
Stephens Inc. — 40 — $165,454,057 — $1,108,993 — $4,136,351 — 0.67%
Total — 62 — $225,711,959 — $1,610,650 — $3,640,515 — 0.71%

*State fiscal years end on June 30. Data for 2003 fiscal year includes bond issues through May 6.

Source: Arkansas Department of Education



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