Public or private? For tribes, access to bond markets carries cost considerations

Municipal bonds are a basic tool of public finance. Local and state governments rely on these debt obligations to pay for an array of capital projects, like roads, schools, and water systems. For tribal governments, however, use of municipal bonds is a different story. For example, as explored in previous Center for Indian Country Development (CICD) research, tribal governments have fewer allowable uses for their tax-exempt bonding than local and state governments have.

Recently, we explored another limitation on tribal bonding: tribes are likely to face higher costs for issuing bonds in the public market than other governments in the United States face. When we ran hypothetical scenarios of different tribal bond placements, we found that if a specific legal exemption that other governments receive applied to tribes, tribal public bond offerings could be more cost-effective. Our work to better understand tribal bonding is part of CICD’s mission to advance economic self-determination and prosperity in Indian Country through actionable data and research that inform public policy discussions. This work aligns with the Federal Reserve Bank of Minneapolis’ broader mission to pursue an economy that works for all of us.

Public offerings vs. private placements

When offering bonds to potential investors, issuers choose between public offerings or private placements. A public offering means an issuer is choosing to sell bonds in the public market, made up of all interested investors. A private placement means an issuer is choosing to sell bonds to select investors or a class of investors.

Local and state governments generally issue municipal bonds in the public market. The interest rate bond issuers pay to investors is lower in the public market; the market itself is larger and more diverse; and unlike in the private market, investors can easily resell the bonds. In any given year from 2009 to 2019, local and state governments placed the overwhelming majority of their bond offerings in public markets and typically only 2 to 10 percent of them in private markets.

In contrast, tribes frequently place bonds with private investors. According to bond industry experts we consulted, in the private market tribes can pay an estimated interest rate premium of 50 to 75 basis points (that is, 0.50 to 0.75 percentage points) over interest rates in the public market. Why do tribes choose to issue bonds in the private market given its higher interest payments and its resale limitations?

Many factors can influence tribal bond placement, including business data confidentiality, bond ratings, and market participants. In this article, we focus on the issuance costs of the public versus private markets—costs that are driven in part by whether a bond issuance has to be registered with the Securities and Exchange Commission, or SEC.

Among governments, tribes are unique in bearing SEC-registration costs

The issuance of bonds in both public and private markets is regulated under the Securities Act of 1933 and the Securities Exchange Act of 1934. Under Section 5 of the 1933 act, all securities offered or sold in the United States, including bonds, must either be registered with the SEC or qualify for a registration exemption. As part of the SEC registration, issuers must provide the public with comprehensive information concerning both the bond and bond issuer. The transparency achieved through registration protects investors from misrepresentation and fraud.

The registration requirement has several exemptions, two of which are particularly important in the tribal context. First, Section 3 of the 1933 act exempts federal, state, and local government bonds from SEC-registration requirements. Registration is not needed for these government issuers because information on these issuers and issuances is readily accessible to investors.¹ Second, Section 4 of the 1933 act exempts certain bond issuances in the private market from SEC registration. The Section 4 exemption arises from the view that the individual or institutional investors that typically purchase these offerings are sophisticated and can forgo extensive protective regulation.²

Tribal governments have not been included in the security-registration exemption for federal, state, and local governments, despite having the authority to issue bonds, including the authority to issue tax-exempt bonds since 1983. To participate in the public market, tribes must bear the costs related to registering their bonds with the SEC. Registering securities with the SEC is a complex and costly administrative process that can require substantially more legal and accounting work than an unregistered municipal bond offering or an unregistered private placement. However, to avoid incurring the higher costs associated with a security registration, tribes may issue their bonds in the private market under a Section 4 exemption. In other words, in the absence of an exemption for tribes in the public market, it may be more cost-effective for tribes to rely on a private market placement.

Figure 1 lists the primary differences between public offerings and private placement with respect to tribal bond issuances and those of other governments.

Modeling three scenarios

To understand whether the SEC-registration requirement may impact tribal access to capital, we modeled the cost to tribes of bond issuances in both the public and private markets. For simpler comparisons of differences, the base public market interest rate is excluded from all our scenarios.

We calculated the average size of a tribal bond using data from Native American Governments’ Borrowing Costs: Evidence from Municipal Bond Markets, a 2022 study by researchers Serena Loftus, Sarah Shonka McCoy, and R.Z. Zhang.³ After adjusting numbers in the study to 2021 dollars to reflect inflation, we found that between 1997 and 2021, the average size of a tribal bond offering was $19.9 million.

In calculating our cost estimates, we used issuance costs from the corporate and municipal bond contexts as a proxy for tribal costs. (See the appendix below for more on these calculations.) We then calculated three hypothetical tribal-bond-issuance scenarios using a $19.9 million offering: first, the cost of an SEC-registered public offering; second, the cost of an unregistered private placement; and third, the cost of an unregistered public offering if tribes were exempt from SEC registration in the same way as other governments. Figure 2 shows the estimated costs that tribes incur in these three scenarios. Within each scenario we show our respective bond-offering cost estimates, which are broken out into four main categories: direct costs of issuance,⁴ underwriting costs,⁵ placement-agent fees,⁶ and—in the case of the private placement scenario only—the cost of the interest rate premium paid over the base public market interest rate over the life of the bond. We use an average tribal bond life of 10.52 years, as calculated by Loftus et al. The horizontal lines that extend from the data bars indicate an estimated range of costs, with the low end of the range on the left and the high end of the range on the right.

The upper two bars of Figure 2 show our comparative estimates of the issuance costs tribes incur for registered public offerings and unregistered private placements. Our comparisons indicate that the registration requirement and associated costs can make public market placement of tribal bonds the most expensive option for the average tribal bond offering.

We estimate the total cost for a tribe to issue a $19.9 million bond in a registered public offering to be $2.3 million, equal to approximately 12 percent of the total amount of the bond. For an unregistered, privately placed tribal bond offering, we estimate the total issuance cost to be (with rounding) between $1.1 million and $1.4 million, equal to 6–7 percent of the total amount of the bond. Thus, private placement may in some instances be more cost-effective than a registered public offering, even when accounting for the interest rate premium of 50 to 75 basis points paid by tribes when privately placing bonds. In fact, we estimate the additional cost tribes pay to issue bonds in a registered public offering instead of an unregistered private placement to be (with rounding) $920,000 to $1.2 million, equal to roughly 5 percent of the total amount of the bond.

Estimating the cost-effectiveness of a registration exemption

The bottom bar of Figure 2 shows our estimate of what tribes would pay to publicly offer bonds if they were exempt from registration in the same way as other governments. With an exemption, we estimate tribal direct costs of issuance to be similar to the costs for a tribal private placement, about $110,000 for a $19.9 million offering. On that same offering size, we estimate underwriting costs could range from $93,000 to $1.4 million. With the exception of offerings with very high underwriting costs, many exempt public offerings could be more cost-effective for tribes than private placements. These estimates demonstrate that a tribal registration exemption, like the exemption in place for other governments, could meaningfully lower the cost to tribes of accessing the public bond market. However, the registration exemption is not the only important factor to consider in this hypothetical scenario. The transparency of issuer finances is important to potential debt purchasers, which in turn matters for the interest rate. If in this scenario tribal finances are less transparent than the finances of non-tribal government issuers, then tribes could pay an interest rate premium.

Viewing the results as a starting point

The estimates from our hypothetical scenarios should be viewed as a starting point for understanding the costs tribes encounter in accessing bond markets. The details of each bond offering, including interest rates and overall offering costs, will vary. And many noneconomic factors can influence placement decisions, including disclosure requirements and the available pool of investors interested in tribal bonds. We cannot definitively determine whether all registered public offerings are costlier than private placements, or whether tribes would systematically choose public over private bond markets if a tribal security-registration exemption existed. Our analysis does reveal that without a registration exemption, the upfront cost of tribal public offerings can be substantial and may be a factor in tribal access to capital markets. Other governments are exempted from security registration, allowing them to access public markets at a lower upfront cost. If the security-registration exemption were available to all governments, public bond offerings could be a more cost-effective option for tribes.

The authors thank Matt Gregg, Townsend Hyatt, Sarah Shonka McCoy, Tavis Morello, John Morseau, and Geoff Urbina for their contributions to this article.

Appendix: Calculation methodology for our hypothetical bond-issuance scenarios

We based our average tribal bond size on data from Table 1 of the Loftus et al. study. We selected this dataset because the authors include both tax-exempt and taxable tribal bonds issued through both public issuances and private placement. The study does not specifically analyze the comparative costs of public versus private issuance in the context of tribal bonds. However, the study does conclude that for the entire set of studied bonds, tribes pay an interest rate premium of 64 to 251 basis points (that is, 0.64 to 2.51 percentage points) more than other municipal bond issuers. This aligns with the experience of the tribal bond experts we consulted, who indicated that tribes pay 50 to 75 basis points (that is, 0.50 to 0.75 percentage points) more for private placements than they do for public issuances. The very high rates observed by Loftus et al. likely reflect both high public bond interest rates and high rates for bonds that are privately placed.

Although Loftus et al. provide tribal bond data going back to 1992, we use data going back to 1997, keeping our analysis to a 25-year sample. To account for the cost of inflation, we adjusted the total amount issued each year to 2021 dollars and used those calculations in our analysis. This approach gives us an average bond-offering amount of approximately $19.9 million. For the average length of maturity, we use a figure of 10.52 years as calculated by Loftus et al.

Scenario 1: SEC-registered public offering

In this scenario, we use the costs of an initial public offering (IPO) of registered securities in the corporate context to estimate the costs of a registered public offering in the tribal bond context. We use data from the corporate context because state and local governments are exempted from SEC registration, leaving corporate SEC-registered issuances as the best analog to a tribal SEC-registered public offering. Public offerings of registered securities in the corporate context are costly, and underwriting is by far the largest single expense. In a 2017 industry analysis of IPO costs, for securities with proceeds between $25 million and $100 million—the smallest asset-size class reviewed—average underwriting costs accounted for about 1.4 times the total of all average non-underwriting costs combined. Using this ratio (unrounded) and the reported average underwriting cost share of 6.9 percent of gross proceeds for deals of this size, we estimate non-underwriting costs at 4.8 percent. Thus, our average tribal bond size of $19.9 million might reasonably be expected to carry $1.4 million (that is, 6.9 percent) in underwriting costs and $960,000 (that is, 4.8 percent) in non-underwriting costs. The estimate of the non-underwriting costs is conservative because it does not include ongoing quarterly and current reporting costs required under the Securities and Exchange Act of 1934. In this hypothetical scenario, our approach yields a total cost estimate of $2.3 million in addition to base public market interest.

Scenario 2: Unregistered private placement

To estimate tribal unregistered private placement costs, we draw on research in the municipal context and assume that the offering costs for a tribal private placement are similar to the offering costs for municipal unregistered public offerings. Based on municipal bonds issued in California from 2012 through 2015, issuance costs on average totaled 1.02 percent of a municipal bond’s principal amount. Of that 1.02 percent, nearly half goes to underwriting fees, with the remainder attributable to non-underwriting costs. This translates to an average underwriting cost of 0.47 percent of the principal. For placement-agent fees, we assume costs of about 2 percent of proceeds raised. This may be a high estimate, as one industry expert we interviewed puts the range at between 0.75 percent and roughly 2 percent of bond proceeds. In using the higher estimate, we show that even with costly placement-agent fees and an interest rate premium, an unregistered private placement can be less costly than an SEC-registered public issuance.

For tribes, we estimate the interest rate premium associated with private placements to be 50 to 75 basis points, as provided by Geoff Urbina of KeyBanc Capital Markets. These estimates are consistent with the findings of Loftus et al., who found that tribal bond issuers pay an interest rate premium of 64 to 251 basis points more than other municipal bond issuers. Although the authors controlled for several bond characteristics, including credit and maturity, they did not control for public versus private offerings. Along with other factors, private placement may account for some of the remaining observed interest rate premium. To model the added hypothetical interest rate cost over a 10.52-year period, we assume a base public market interest rate equal to the average yield for non-tribal governments from Loftus et al. (that is, 394.681 basis points, or 3.94681 percentage points), to which we add the tribal private placement interest rate premium. After amortizing monthly, we find the difference (that is, the premium) over the life of the bond. We do not apply a future discount to the excess interest payments; had we done so, the cost advantage of a private placement would be somewhat larger.

In this scenario of an unregistered private placement on a $19.9 million bond, we estimate $110,000 in non-underwriting (direct) costs, $400,000 in placement-agent fees, and a range of $600,000 to $910,000 as a private market interest rate premium. Thus, the total estimated cost in this hypothetical scenario (with rounding) is between $1.1 million and $1.4 million in addition to base public market interest.

Scenario 3: Unregistered public offering

To estimate the public offering costs and minimum underwriting costs for tribal bonds if exempted from SEC registration, we again draw from the municipal context.

We expect that for non-underwriting-related unregistered public offering expenses, such as financial advising, legal, and accounting fees, tribes would have paid about the same rate as municipalities: an estimated $110,000 on a $19.9 million bond, as noted above. However, in the absence of existing research or publicly available data, we display the underwriting fee for tribal unregistered public offerings as a range. We set the low end of the range at the municipal rate of 0.47 percent, as noted above (equivalent to $93,000 on a $19.9 million bond) and the high end of the range at the expected corporate rate of 6.9 percent, also noted above (equivalent to $1.4 million on a $19.9 million bond).

We expect the tribal underwriting fee to be closer to the high end of this range. As a function of risk assumed by the underwriter, the fee to place a tribal bond with public investors is more like that of a corporate bond than that of a municipal bond. Tribal bonds are less likely to be tax-exempt than municipal bonds, and tribal revenue to service debt is likely tied to commercial enterprises. Tribal bond offerings thus may not appeal to purchasers who desire tax-exempt income or investors who are more comfortable purchasing bonds backed by municipal tax revenue.⁷ For a hypothetical $19.9 million bond, our approach in this scenario thus yields a range of $200,000 to $1.5 million in total costs in addition to base public market interest.

We further assume that the interest rate paid by tribal issuers would be the same as that paid by other governments—i.e., that there is no interest rate premium in this scenario. Of course, actual interest rates could differ based on a number of factors, including the scope of tribal financial disclosure.

Endnotes

1 Tribal inclusion in the security-registration exemption would require compliance with transparency and disclosure standards equivalent to those applicable to state and local governments. Information on tribal issuances is currently available through IRS Form 8038-G for tax-exempt issuances, and also through the disclosures of underwriters and placement agents. Additional information on tribal properties, enterprises, and management would likely need to be available in order for tribes to be included in the security-registration exemption.

2 The Municipal Securities Rulemaking Board (MSRB) is the principal regulator of municipal securities. Although exempt from SEC registration, municipal issuers and issuers of privately placed securities must comply with the anti-fraud provisions of the 1933 and 1934 acts. Official statements of municipal bond issuers are available on the MSRB’s Electronic Municipal Market Access website. Further, certain disclosure requirements do apply to municipal bond “broker-dealers” and underwriters, and disclosures are made for bond issuances to unaccredited private investors.

3 Loftus et al. use the Mergent Municipal Bond Securities Database to search for bonds associated with tribal issuers. Although many tribal bonds are held by private investors, like other securities they receive a unique identifier assigned by the Committee on Uniform Security Identification Procedures, known as a CUSIP number. These identifiers are reported in a way that makes minimal information about tribal bonds available in databases like the Mergent database.

4 Direct costs of issuance include legal fees; accounting costs; financial advisor fees; and, for publicly issued bonds, SEC-registration fees and related expenses.

5 Underwriting and private placement costs can be substantial and are often the largest costs that bond issuers incur. To access public markets, bond issuers pay an underwriter—typically an investment bank—to sell bonds to interested investors.

6 Placement agents serve a similar function as underwriters in finding investors for private issuances.

7 Municipal underwriting fees are lower than corporate underwriting fees due to municipal bond issuers’ use of competitive offerings to find an underwriter, rather than the negotiation-based method used in the corporate context. Tribes could adopt a competitive offering model, but many tribes will likely employ the negotiated-sale method to ensure the underwriter is familiar with tribal bond financing.