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Q

Would you please comment on state bond banks and what similarities and differences exist between their offerings and ordinary general obligation municipal bonds?

A

James A. Klotz responds:

Bond banks are state agencies created to provide low-cost financing to small communities that would be forced to pay significantly higher interest rates if they borrowed on their own. At least 12 states have bond banks and each operates differently. The advantage to a community is that ratings on bond bank financings are usually credit enhanced through a moral obligation pledge of the state, a state aid intercept mechanism or a financing structure that allows overcollateralization. None of these “enhancements” are equal to the pledge of a state’s general obligation. However, the bonds are typically secured in such a way as to allow a bond rating between that of the state, and the borrower’s own credit quality.

Bond banks allow the “pooling” of small loans into one larger bond issue, spreading transactional costs over all participating borrowers in the pool. In some states, bond bank issues may be restricted as to length, size of loan, or project type. The rules governing bond banks vary among the states using them. Generally, the borrowers using the bond bank are smaller and riskier and may not have been able to access the capital markets on their own. Since this is the case, loans need to be reviewed carefully by bond bank staff to insure minimal default possibilities after issuance.

Since bond banks are not usually issued with the direct full faith and credit of a state, they usually carry a bond rating below that of the state. This would especially be the case where the financing is structured based on overcollateralization and doesn’t carry the state’s credit or moral obligation. Bond banks have been useful tools for certain borrowers and have generally proven to be successful financing mechanisms with a solid track record.