A nine-member working group of banks, underwriters, financial analysts and attorneys released a white paper this week to provide guidance to states and municipalities on disclosure for bank borrowing – a small but significant sector of muniland. Since there is no requirement to disclose bank borrowings by public entities, no one knows what the total size of the sector is. I’ve heard numerous estimates in the $200 to $300 billion range, which would mean the sector is about 5.4 percent to 8 percent of the $3.7 trillion municipal bond market.
It’s pretty astounding that a community or a state has no legal responsibility to notify its citizens or bondholders when it takes a loan from a bank. Securities laws give authority to the Municipal Securities Rulemaking Board to only regulate municipal bond underwriters and not cities or states. Since a bank loan does not require a securities underwriter, the MSRB has no authority to compel disclosure. There is a lot of commentary trying to parse if and when a bank loan is actually a bond and hence subject to securities regulation. From Richards Kibbe & Orbe’s Brian Fraser and Paul Devlin:
The MSRB acknowledged that it is difficult to distinguish between loans and securities and pointed to the multi-factor test established by the U.S. Supreme Court in Reves v. Ernst & Young, Inc., 494 U.S. 56 (1990), which we discuss in more detail below. In essence, the MSRB warned the market in the September 2011 notice that there is no “one size fits all” solution to the questions posed by the loan/security distinction and emphasized that the analysis is dependent on the facts and circumstances of individual transactions. The MSRB issued its third and most recent notice on April 3, 2012. In that notice, the MSRB encouraged state and local governmental issuers to voluntarily post information about their bank loan financings on EMMA in order to promote market transparency and efficiency.
Why would the MSRB, credit rating agencies, bondholders and now the nine-member working group encourage public issuers to disclose bank borrowing? Because it potentially affects the rest of the issuer’s capital structure and its bondholders. From the white paper:
• The bank loan may increase the issuer’s debt outstanding;
• The covenants and events of default for the bank loan may be different than those for the bonds, potentially allowing the bank to assert remedies before the outstanding bondholders;