Report 93016 Summary - January 1994

A Review of the State's Bond Sales for 1991 and 1992

Chapter 1434, Statutes of 1990, added Section 5703 to the California Government Code, which specifies that the state treasurer is the sole authority for selecting the underwriters to negotiate state bond sales, except for California Housing Finance Agency (CHFA) bond sales. Section 5703 of the Government Code also requires the state treasurer to use a competitive process in selecting underwriters for negotiated bond offerings and requires the state treasurer, financing authorities, and the CHFA to maintain records of the costs of issuance of negotiated bond sales. In addition, this section requires the state treasurer to maintain certain records related to bond issues that are sold by competitive bid.

We reviewed the cost records of negotiated bond sales that the State Treasurer's Office (STO), CHFA, and state financing authorities maintained and reviewed the records of competitive sales that the STO maintained. In addition, we determined whether Government Code, Section 5703, was being fully implemented and compared costs with similar initial bond offerings in other states.

During our review, we noted the following conditions:

From January 1991 through December 1992, the STO selected the lead underwriter through a competitive process for all except one of 83 negotiated bond issues we could review. According to the Government Code, Section 5703, a competitive process may be conducted on an issue-by-issue basis or may be used to establish one or more pools of underwriters for various types of negotiated issues. For one bond issue, the STO did not competitively select the lead underwriter because staff believed the relatively small sale would provide a good opportunity for a Target Business Enterprise firm to obtain the experience of being a lead underwriter.

The Government Code, Section 5703, requires that the state treasurer establish a competitive process for the selection of underwriters. However, the law does not specifically state that the state treasurer is to establish a competitive process for comanaging underwriters (co-managers) as well as lead underwriters in a negotiated bond sale. In view of this, the state treasurer interprets the statute to allow for the selection of only lead underwriters through a competitive process. When the state treasurer selected only lead underwriters through a competitive process, a portion of the State's underwriting business was awarded without the benefit of competition. This is because the state treasurer, in certain instances, did not select comanagers through a competitive process. This primarily occurred from January 1991 until April 1992, when a new policy was implemented.

Under the new policy, the state treasurer uses its competitively-established pools of firms to select co-managers for all negotiated sales, other than short-term interim notes and revenue anticipation notes (RANs). Instead, the RANs, which accounted for 9 percent of the amount that co-managers earned during the two years we reviewed, are selected based on various factors including past performance on RANs financings.

However, because the state treasurer does not interpret the law to require competitive selection of co-managers, the current policy of selecting comanagers for the other negotiated sales could change. Thus, in spite of the recent policy change, we believe that more needs to be done to ensure a competitive process is used to select all underwriters. We believe the Government Code, Section 5703, is vague in one of its key provisions, which could keep the objective of attaining competition in the selection of all underwriters for state bond sales from being fully realized. While we realize that state departments are generally afforded broad latitude in interpreting those laws that they administer, we feel that excluding co-managers from the competitive process for selecting underwriters is not in the best interests of the State.

If in the future a state treasurer does not select comanagers through a competitive process, the State could award millions of dollars of underwriter's discount annually without the benefit of competition. For the two years we reviewed, the total underwriter's discount earned by all co-managers the state treasurer selected was $21.4 million.

Three of the five entities we reviewed did not collect all of the cost information the Government Code, Section 5703, requires to be maintained for negotiated bond sales. During 1991 and 1992, the California Educational Facilities Authority (CEFA) did not maintain all the cost information required by the Government Code, Section 5703(e), for bond issues sold by private placement. We reviewed nine files at CEFA and found that three of the files were missing records documenting $11,000 to $22,000, or from 18 to 28 percent, of the total underwriter's discount and costs of issuance. The STO and the California Pollution Control Financing Authority maintained most of the required cost information, although 2 of 12 files reviewed at STO were missing items documenting $57,000 to $60,000, or 1 to 2 percent of the costs, and 2 of 5 files reviewed at the California Pollution Control Financing Authority did not sufficiently identify certain costs. We reviewed 29 files at the California Health Facilities Financing Authority and 8 files at the California Housing Finance Agency and found that both agencies maintained the required cost information in the files we reviewed.

During 1991 and 1992, only the STO sold bonds by competitive bid. We reviewed 18 of 24 bond issues sold by competitive bid during 1991 and 1992 and found that in all 18 bond sales, the STO maintained records of all bids and bid verifications as required by the Government Code, Section 5703(f). In addition, the STO awarded the bonds in each sale we reviewed to the underwriter who submitted the bid with the lowest true interest cost.

We compared the true interest costs of ten bond issues sold by other governmental entities with the true interest costs of nine California bond issues. We found no indication from the information obtained in this limited review that California is paying more than necessary for interest costs on state bonds. Seven of the nine California bond issues had lower true interest costs than the comparison bond issues. In the other two bond offerings, the true interest costs differed by .0184 and .226 percentage points. The differences in the true interest costs may be attributable to the different features of the bonds or to differing market conditions at the time of the bond sales.

We recommend the Legislature consider amending the Government Code, Section 5703, to specifically state that comanagers as well as lead underwriters be selected through a competitive process.


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