Muniland retail bond buying is getting more attention

A little-known provision in the Dodd-Frank financial reform law expanded the board of directors of the Municipal Securities Rulemaking Board (MSRB), the self-regulatory organization that oversees muniland. The board used to be composed of employees of municipal bond dealers and big banks, and many would say privately that MSRB rulemaking favored industry players rather the public. Dodd-Frank radically altered the board’s composition to balance representation from the municipal industry and the public. The law firm Duane Morris explained the change (emphasis mine):

The [Dodd Frank] Act alters the composition of the MSRB so that a majority of the minimum 15-member Board are independent of municipal securities brokers, dealers or advisors. The new composition of the Board meets the stated goal of the Act, to ensure that the public interest is better protected on the Board. The Board has a new charge to protect the public interest in addition to municipal entities and investors. The Board will consist of eight individuals known as “public representatives,” independent of any municipal securities broker, municipal securities dealer or municipal securities advisor. At least one of the public representatives must be a representative of institutional or retail investors in municipal securities. At least one of the public representatives must also represent municipal entities, and another of the public representatives must have knowledge or experience in the municipal securities industries.

The remaining seven “regulated representatives” will consist of individuals associated with a broker, dealer, municipal securities dealer or municipal advisor. At least one of the regulated representatives will be a “broker-dealer,” representative of nonbank brokers, dealers or municipal securities dealers. At least one individual must be a representative of banks, and at least one individual must be associated with a municipal advisor. The number of public representatives on the Board must always exceed the number of regulated representatives.

To keep the statutory balance, the board now has 11 members representing the public, 3 members representing securities firms, 3 members who are municipal advisors and 4 members representing banks. With these 21 representatives, the board exceeds the statutory requirements of a minimum of 15 members and a majority of public ones. Some of the public members do have previous ties to the municipal bond business, but if they remain “public-minded,” their past experience can be very useful.

In my view, all this public representation at the MSRB is bringing about a more open and transparent municipal bond market. What I’ve seen so far is an expanded focus on information flow to investors via enhancements to the EMMA system, the publication of an investor toolkit, a vast increase in continuing disclosure by issuers of material events (continuing disclosure documents totaled 39,549 in the first quarter of 2012), and a soon-to-be-released MSRB study on pre-trade transparency, or the market information made available before one buys a muni bond. Recently, the MSRB has announced that it is turning its attention toward online retail investing platforms to understand how investors are directly participating in muniland without going through a broker. The Bond Buyer had a great article on the issue:

Massachusetts sets the bar for transparency

For openness in finances, debt management and budget process, Massachusetts is the gold standard among states. The legislature and executive branch have collaboratively embraced a five-year budgeting process and committed to sharing the results with taxpayers and the public. Because of the state’s efforts to reach out to the investing community, I predict that its transparency will lead to lower borrowing costs and more stable funding sources in the future. The state is rated AA+ by credit rating agencies for creditworthiness, but I’ll assign it the highest rating, AAA, for transparency.

Several weeks ago, the state treasurer, Steven Grossman, launched a new Twitter account (@BuyMassBonds) that keeps the public informed about new financial filings and bond offerings. It’s a model of excellence for muniland in terms of keeping municipal bond investors informed through social media. Here is a recent tweet about an upcoming bond issue, the Massachusetts Water Pollution Abatement Trust State Revolving Fund Bonds:

Here comes a whole new municipal bond market

How do you shake up the sleepy old municipal bond market? Gather up the most important data, organize it into an easy-to-search format and make it available to retail investors for free. It’s this blogger’s dream, and it is on its way. Muniland’s overseer, the Municipal Securities Rulemaking Board (MSRB), today released its long-range plan outlining the expansion of its free, public-facing disclosure system called EMMA.

The current EMMA system (EMMA 1.0) is already a vital resource for the municipal bond market. It was modeled broadly on the SEC’s EDGAR system for public companies. EDGAR and EMMA both take in public disclosure documents, categorize them and expose the documents through a free Internet portal. EMMA 1.0 is a much richer platform than EDGAR because it provides trade pricing for municipal bonds in addition to document disclosure. The MSRB recently enhanced EMMA 1.0 with credit ratings, making it the most complete public platform for any fixed-income class.

Now it’s time to roll out the plan for EMMA 2.0. Here is how MSRB describes their purpose:

Untimely data will cost muniland potential investors

If municipal bonds lose their tax-exempt status, as some in the corridors of power in Washington are suggesting, municipalities will increasingly be competing with corporations for investors. As this competition intensifies, municipalities with poor accounting and disclosure practices could find it difficult attracting capital.

Let’s say you’re an investor looking to buy the bonds of either Goldman Sachs or New York City and to help guide your decision, you seek out their most recent financial statements. As a public company, Goldman Sachs is subject to the SEC’s disclosure regulations which mandate the filing of audited annual financial statements 60 days after the end of the year. If Goldman does not file within the 60 day window then the SEC has the authority to restrict certain simplified securities offerings and the New York Stock Exchange, which lists their securities, can take action too.

Contrast that with the Municipal Securities Rulemaking Board, New York’s regulator, which encourages municipalities to make public their audited statements, which are called CAFRs or Comprehensive Annual Financial Report within 120 days of the end of their fiscal year. Unlike the SEC, the MSRB has no authority to discipline issuers who file late, other than suggesting the municipality issue a notification of late filing.

Muniland is the most transparent bond market

Agnes Crane, a columnist for Reuters Breakingviews, wrote an interesting column today about ending the municipal-bond tax exemption. This tax exemption, granted at the federal level, makes the interest earned on municipal bonds free from taxation on the local, state and federal level if it’s owned by an investor residing at the place of issuance.

The “triple tax” exemption is baked into the structure of the municipal market. There are several proposals floating about how to modify the muni tax exemption. Agnes Crane, in her column, calls it an “accident of history.” Accident or not, there are 50,000 muni issuers who will actively resist any legislation to change the tax code. It’s hard to imagine any lobbying group with more clout since state and local officials are deeply embedded in the political web of every federal legislator’s district. But politics being what it is, every legislative term brings new possibilities.

But what I really wanted to write about was Agnes’ idea that repealing the muni tax exemption would make the muni bond market more transparent and efficient. The municipal bond market is already miles ahead of other bond markets in transparency. Since the Municipal Securities Rulemaking Board made their EMMA system operational, transparency in muniland is an order of magnitude better than other any bond market, including the U.S. Treasury market, which is liquid but not transparent. To see individual trades in the Treasury market you need an expensive Bloomberg or Reuters terminal. But for the muni market all you need is an internet connection to reach EMMA. At EMMA you can easily get all the documents for an issuer and their individual bonds, credit-rating downgrades, annual issuer reports and more.

The declining welfare rolls

The ever-shrinking welfare rolls

Stateline has done some very good reporting on the decline of the welfare rolls. Welfare funding was switched to block grants in 1996, and the funding level has remained the same since then. From Stateline:

Welfare is not a big budget item for most states, taking up less than 2 percent of all state spending, according to the National Association of State Budget Officers (NASBO)…

…When Congress overhauled that system in 1996, it changed welfare from an “entitlement program” guaranteeing coverage to everyone who was eligible and instead created the Temporary Assistance for Needy Families (TANF) block grant that hands out lump-sum payments for welfare. States are essentially given a set amount of money and allowed to use it as they wish. The amount has stayed level since 1996.

Bank backstops for municipals

There is a very interesting class of municipals that you may not know about.

They are called “variable rate demand obligations” (VRDOs).

Moody’s estimates the market size at about $380 billion or 13% of the $3 trillion municipal market.

Moody’s issued a report today saying that this class of munis is finding its sea legs. This is good news for muniland. The health status of VRDOs was a big concern for market participants and Moody’s is cautiously optimistic.

VRDO’s are bonds issued with longer maturities (up to 30 years) that you can put back to the trustee or tender agent with a little notice.

Improved muni supermarket coming

Shopping for municipal bonds is tough.

Investors generally don’t know if the issuer is financially healthy or spiraling down to default. The media does not have useful data.

But the information is out there.

Towns and states, that issue municipal debt, are responsible to create thorough, audited documents such as annual financial statements and offering documents for new debt issues.

The Municipal Securities Rulemaking Board (MSRB) has a nice surprise coming for retail investors. It’s an expansion of the EMMA document repository system. And it will make bond shopping much easier.

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