3.7.7 Pool Bonds

3.7.7 Pool Bonds

Pool bonds are payable from payments made by governmental entities (participants) on two or more debt obligations. The pool bond issuer purchases each of the participants’ debt obligations (or enters into leases or installment sale agreements with the participants) and issues its own bonds secured by and paid from payments received on the participant obligations (referred to as “underlying obligations”). The bond pool issuer may be a JPA or an entity created or authorized to act in this role for other agencies.

This basic structure includes many different pool bond issue types. The principal distinguishing features of pool bonds are the following:

  • Pool bond issuer

  • Number of participants

  • Types of participant obligations

  • Parity debt flexibility

  • Credit risk sharing

POOL BOND ISSUERS – Under the Marks-Roos Local Bond Pooling Act of 1985 (the “Marks Roos Act,” California Government Code Section 6584 et seq.), JPAs have broad authority to issue bonds to finance public capital improvements and to acquire obligations of local government entities and to enter into leases and installment sale agreements with local government entities. A JPA can be established by the pool participants to issue pool bonds for the participants or can be an established JPA with a broad geographic scope operating a pool financing program. (See Figure 3-6) A “captive” JPA (a JPA created by a public agency and having the same governing board, for example a city and the city’s financing authority) allows the participants greater control of the financing but tends to be impractical if there is more than one pool participant. (See Figure 3-7) State agencies also issue pool bonds in connection with financing programs for local government entities. 

NUMBER OF PARTICIPANTS – Financing pools vary in size, from small to large. The underlying obligations may also be obligations of a single public agency payable from separate sources (e.g., one underlying obligation payable from the revenues of a city’s water enterprise and another payable from the revenues of the city’s wastewater enterprise).

TYPES OF PARTICIPANT OBLIGATIONS – Pool bonds are issued in connection with a large variety of underlying obligations. For a given pool bond issue, however, the underlying obligations are most commonly of the same type, such as TRANs issued by school districts or water or wastewater enterprise revenue obligations.

Figure 3-6

MARKS-ROOS LARGE SCALE POOL
Figure

Figure 3-7

MARKS-ROOS CAPTIVE POOL
Figure

PARITY DEBT FLEXIBILITY – Pool bonds may fund a “closed pool” or an “open pool.” With a closed pool (also known as a “dedicated pool”) all of the underlying obligations are set at the time the pool bonds are issued. With an open pool (also known as a “blind pool”), additional underlying obligations may be added, and additional bonds issued, with the initial and subsequent bonds both secured by the initial and subsequent underlying obligations. An open pool allows for the creation of large pools and the associated diversification can improve the security for the pool bonds. Because the ultimate source of payment of pool bonds secured by an open pool is not known when the initial bonds are sold, an open pool structure requires strict and well articulated requirements for subsequent underlying obligations.

CREDIT RISK SHARING – A pool bond issue can be structured so that each underlying obligation is a completely stand alone obligation, meaning that no participant is required to incur any increased cost or risk any benefit because of a default by another participant on another underlying obligation. The diversification of underlying obligations may provide investors protection against a significant loss on default where a payment default by any participant could result in a payment default on the pool bonds. Pool bond issuers generally attempt to address this “weakest link” concern by unifying the credit through bond insurance or other credit enhancement for the pool bonds.

A pool bond issue can also be structured so that the pool bond security is stronger than the sum of the underlying obligations. This generally requires a degree of credit risk sharing. If the pool bond issuer has “equity” to contribute or put at risk, the risk of loss from a participant default can be borne by the issuer.75 An issuer contribution can take the form of a cash deposit, a pledge of a greater principal amount of loans as security than the principal amount of the pool bonds or, if the pool has been active for a while, the retention of excess in the pool bond indenture. Credit sharing may also be done across pool participants through “step up” provisions that increase other participants’ obligations by amounts sufficient to cover nonpayment by a participant or with a common reserve fund funded by all participants but available to be used in the event of a default on any underlying obligation.

ADVANTAGES – Possible advantages to a participant include the following:

  • Marketing benefits in selling a large issue

  • Spreading of issuance costs

  • Access to the public market for smaller and/or less creditworthy public agencies

DISADVANTAGES – Possible disadvantages to a participant include the following:

  • Loss of flexibility in timing, because the whole issue must move as one

  • Loss of flexibility in debt structure because it is generally preferable for marketing purposes for the underlying obligations to have similar terms

  • Loss of control over the selection of bond counsel, trustee, and underwriters

  • Exposure to the credit of other participants if there is credit sharing at the participant level

In general, public agencies do not use pool bonds for debt issuances of sufficient creditworthiness to allow market access and of sufficient size to support the costs of issuance of a stand alone issue. Pool bond programs may, however, be of great value to smaller public agencies with relatively small borrowing needs.