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Exemption allows Stephens to advise, buy school bonds.

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 & Beardsley 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 haying 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 Huckabee'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.
School Bond Fiscal Agents

Fiscal Years 2001-2003 *

 No. of Total Total Average Average
2001 issues value Fees Value Fee (%)
Morgan Keegan 1 $1,583,880 $21,700 $1,583,880 1.37%

Raney & Beardsley 36 $89,735,572 $850,0651 $2,92,655 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%

2003 *
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%
Stphens Inc. 40 $165,45,057 $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

RELATED ARTICLE: Lake View Requires Districts to Reorganize Debt

IN ADDITION TO FINDING THAT THE state's system of public education is inadequate and inequitable, the Arkansas Supreme Court's ruling the Lake View case dropped a bombshell concerning school district millage rates.

Amendment 74 to the Arkansas Constitution requires school districts to levy at least 25 mills for maintenance and operation (M&O). However, state law allowed districts that had pore than enough mills dedicated to debt service to use excess mills to satisfy the M&O requirement, and most of the state's districts had taken advantage of that law.

The Lake View decision found that law to be unconstitutional. As a result, 246 of the state's 310 school districts have until Jan. 1 to bring their M&O millages to at least 25 or face a mandatory increase by the county quorum court.

As property values tend to increase, the dollars raised by each mill of a tax levy also tend to grow. As a result, the mills dedicated to a fixed debt typically generate significantly more than necessary to make the debt. payments. Districts have used the excess generated by debt service mills to satisfy the M&O requirement, so the total number of mills being levied in any district is generally enough to pay for the existing facilities and educational program.

But turning a debt service mill into an M&O mill not a simple matter of labeling. Each mill has been adopted by the voters of a district for either debt service or M&O, and only another election can change them. What's more, the debt service mills have been pledged as collateral on specific bond issues, and that collateral cannot be officially dedicated to another purpose as long as the bonds are outstanding.

The best way for a district to comply with Amendment 74 depends on in current tax structure. If a district already levies almost 25 M&O mills, the simplest -- and cheapest -- solution is ask voters for a small tax increase for maintenance and operations. Some districts may even opt to let the quorum court impose the additional levy.

But some districts levy far fewer than 25 M&O mills, and persuading voters to approve such tax increase is unlikely. Those school boa boards, then, may ask their voters to reduce the number service mills being levied while increasing the number of M&O mills to 25.

Or a school board may, ask voters for a combination of the two: reducing the number of mills dedicated to debt M&O mills by an even greater number.

Exemption Includes Multiple Safeguards

STATE OFFICIALS SAY THEY have built sufficient safeguards into an exemption granted Stephens Inc. to protect other bidders on school bonds and the taxpayers whose school millages are pledged to pay off the bonded indebtedness.

Among the safeguards included in state Securities Commissioner Michael Johnson's order:

* Stephens must disclose from the get-go that it has reserved the right to submit a competitive bid on a bond issue it is managing;

* The client school district has to be informed whenever Stephens intends to become a bidder as well as an adviser; and

* If Stephens is the only bidder on a bond issue that it has managed, the securities commissioner must review the bid before the school district can accept it.

In addition, the state Department of Education -- which has no official authority over the bond business -- has gotten Stephens to agree to a couple more hoops, according to Patricia Martin, assistant director for public school finance.

Rather than simply giving their client districts notice that Stephens intends to bid, as required by Johnson's order, the DOE has asked that Stephens get written authorization from the district, Martin said. And, she said, "If they are acting on both sides of the market, they must give me a copy of every bid submitted."

Stephens has not promised to bid only in those cases when the district would not otherwise receive competitive bids. Mark McBryde, manager of Stephens' public finance department, sent a memo to other potential bidders saying that it would begin exercising its exemption with last Wednesday's bond issue by the Conway School District -- an issue that would undoubtedly have received multiple bids even without Stephens.

McBrycle said Stephens won't always be sure of how many bids will be received before the deadline.

Other bidders are protected," he said, because Stephens will be making all of its bids through a third-parry bidding service called Parity, and other bidders can also choose to use Parity rather than. sending their sealed bids to the Stephens office.

Johnson said he could find no other state that has a similar rule prohibiting fiscal agent to bid on the bond issues they manage, arid he isn't sure the rule is needed in Arkansas.

"I'm often stuck with rules that we wouldn't have if I had my druthers, and that's one," the commissioner said.
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Comment:Exemption allows Stephens to advise, buy school bonds.
Author:Moritz, Gwen
Publication:Arkansas Business
Geographic Code:1U7AR
Date:May 12, 2003
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