Wall Street’s deepest muniland fear
Although credit rating downgrades for municipal bonds are grabbing the headlines, that is not a real worry for Wall Street. Underwriters and traders are used to adjusting their models and formulas for changes in ratings and interest rates; after all, they are extremely skilled at that. However, forces are taking aim at the way they are compensated, and that is Wall Street’s deepest muniland fear. It’s all about how they are paid to underwrite municipal bonds, and the state of Maine is leading the charge.
When states or municipalities issue bonds they use Wall Street banks to underwrite them. Wall Street banks or dealers either compete against each other for these mandates in a competitive process or one bank or dealer privately negotiates the terms of the bond offering with the issuer. A privately negotiated underwriting happens in approximately 80% of municipal bond deals. This often costs municipalities and states more in fees. Bloomberg has an outstanding piece about how the state of Maine is choosing the competitive style of bond underwriting and the political struggle that happened to get there:
Banks promote negotiated sales as letting them offer the lowest cost by tailoring the debt to specific types of investors. Yet academic studies of the municipal market show such sales often raise costs by as much as $4.80 on every $1,000 borrowed, according to Mark D. Robbins and Bill Simonsen of the University of Connecticut in West Hartford.
$4.80 extra in issuing costs across the $4 trillion muni market equals about $19 billion in additional profits for Wall Street. Hmmm… this story is getting really interesting.
Now of course Wall Street will defend this practice, but this quote explaining the practice in the Bloomberg article is very weak. A Wells Fargo muni banker says negotiated sales happen because the issuers want it even though it’s more expensive:
‚ÄúIf you look at the percentages, most are negotiated sales,‚ÄĚ [Craig Hrinkevich, a Wells Fargo banker in New York] said about U.S. municipal bond deals in a telephone interview. ‚ÄúThat‚Äôs not the bank‚Äôs preference. That‚Äôs the client‚Äôs preference.‚ÄĚ
Maine will pay an annual average interest rate of 1.9 percent on the bonds it sold competitively, less than the 2.1 percent it would have paid in a negotiated offering, according to the treasurer‚Äôs office. By rejecting the offer from Wells Fargo, it saved $1.65 million in interest over 10 years, [Maine Treasurer Bruce] Poliquin said.
‚ÄúThis is Maine,‚ÄĚ he said. ‚ÄúThat is a lot of money.‚ÄĚ
I laud Maine Treasurer Bruce Poliquin and other public officials in Maine who are taking back the power from Wall Street. In these days of deepening fiscal austerity, leaving money on the table for Wall Street will not last. We have citizens to tend to and they are more needy than the boys on Wall Street.
Credit ratings roundup
There’s been a hurricane of reporting on credit ratings. Most of these stories are sound and fury; they will have little effect on the fiscal status of muniland because a downgrade from AAA to AA+ is not that big a change. Really.
Bond Buyer: S&P Begins Dropping a Broad Range of Muni Bonds
Bond Buyer: Pros Wonder What U.S. Downgrade Means for Munis
Financial Times: Senate to probe S&P downgrade
Securities Law Practice Center: Sullivan & Cromwell on the Use of Credit Ratings in SEC Rules and Forms
@DavidCornDC: Reminder: Obama pushed for fiscal relief for states, so they wouldn’t fire cops, firefighters, and teachers. GOP didn’t like #LondonBurning
@MillerTabak: those investors who utilize leverage in their municipal bond holdings should fasten their seat belts – buy and hold investors smiling
Hartford Courant: Connecticut Suing Standard & Poor’s Over Credit Ratings
Puget Sound Business Journal: City of Tacoma downgraded by S&P