MuniLand

Muniland’s huge Dodd-Frank win

A huge win for muniland was finalized last week when the SEC approved new rules that will shine light on the municipal bond underwriting process. This Bloomberg headline says it all: “Bond-Disclosure Rules Backed by SEC to Protect States From Banks”:

The rules were proposed by the Municipal Securities Rulemaking Board last year and are aimed at preventing Wall Street underwriters from steering public officials toward complicated debt financing without disclosing the risks. They were approved May 4 by the SEC, which will enforce them.

The disclosures are part of the effort to reshape financial regulations to prevent a repeat of the credit-market crisis of 2008, and stem from Congress’s decision to provide added protections for state and local governments. The economic crisis hit taxpayers with billions of dollars in unexpected costs when complex bond deals, once pitched as money savers, backfired as credit markets seized up.

I spent almost a year on Capitol Hill leading an open-source financial reform project as Dodd-Frank was being written. This is about the only area of the legislation in which there was no pushback from banks. Spencer Bachus, the Republican chairman of the House Financial Services Committee, was the committee’s ranking member at the time the legislation was being developed. Bachus’s home district in Alabama includes Jefferson County, the bankrupt county that has been buried under a series of deals with JPMorgan on interest-rate derivatives deals. Whether the banks explicitly held off challenging tighter municipal bond rules out of deference to Representative Bachus or whether they decided other parts of the legislation were higher priority is unknown.

In any event, the new rules are sweeping. Alan Polsky, the chairman of the Municipal Securities Rulemaking Board, said as much in a statement:

Some interesting municipal bond trading data

A few times a year, the Municipal Securities Rulemaking Board releases its trade data, giving the rest of us a chance to peer into the murky municipal bond market. Yesterday, we got access to the data for the first quarter of 2012, and a few interesting facts jumped out.

Revenue bonds, or debt issued with the backing of dedicated streams of payment from specific operations, trade a lot more than general obligation bonds. This makes sense because revenue bonds accounted for 69 percent of the municipal debt outstanding as of Mar. 31, 2012, according to Bloomberg. From retail-size trades of less than $25,000 to mid-market ones of up to $2 million, revenue bonds trade at about twice the par of general obligation bonds, or bonds with the “full faith and credit” backing of a governmental entity that has the authority to tax. Once trades become institutional, that is, exceed $2 million, demand triples for revenue bonds. Revenue bonds seem to be much more popular among institutional buyers like pension funds, mutual funds and insurance firms than general obligation bonds.

Within the revenue bond category, we can drill down further into the various sectors. For bonds with a fixed interest rate, the most traded sector was education. For floating rate securities, healthcare debt was most heavily traded in the first quarter.

Measuring the municipal bond market

What are the most important metrics for the municipal bond market? There are the daily interest-rate levels, for which the Thomson Reuters Municipal Market Data (MMD) AAA curves are the industry benchmark. There is the annual ranking of the largest new offerings, which was led by a $9.8 billion Texas issue in 2011. The credit rating agencies publish municipal bond default studies and charts of total securities by rating level. But for the macro view you need to turn to the overseer for muniland, the Municipal Securities Rulemaking Board, which recently published its own metrics in its Fact Book for 2011. At the broadest level, the MSRB metrics looked like this:

In 2011, the MSRB received data on approximately 10.4 million municipal trades, more than 130,000 disclosure documents and nearly one million interest rate resets.

Here’s the board’s answer to the question of why it collects this data:

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:

Getting paid for municipal risk

Another great chart popped up on Twitter today that shows the historical performance of the two primary types of municipal bonds: general obligation (GO) and revenue. The Bloomberg chart maps the difference in yield between these two categories, which have different legal rights to public revenues. Generally, revenue bonds pay more interest than GO bonds because they only have access to the revenue of the project that issues them. GO bonds (the white line in the Bloomberg chart) are currently trading at an average of 4.12 percent annual interest; revenue bonds (the orange line) are trading at an average of 5.09 percent at present.

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November 14: Muniland Snaps

 

The Municipal Securities Rulemaking Board prepared the map above to show how many municipal advisers have registered in each state. Idaho has zero and New York state has 107. Their debt loads probably mirror that ratio, too.

Good Links

NYT: Federal government shores up military contractor pension plans

Bloomberg: Municipal derivatives are muniland’s subprime

MSRB: Fitch and S&P to distribute real-time ratings on MSRB’s EMMA website

Bond Buyer: Huge $12 billion week for municipal bond issuance will set yearly high

Muniland’s dynamic living entities

This is an absolutely perfect muniland discussion between Matt Fabian of Municipal Market Advisors, Tom Keene of Bloomberg Television and David Kotok, chief investment officer at Cumberland Advisors. For people unfamiliar with the muni market it really shows how fluid and dynamic conditions are for state and local issuers. It’s really worth listening to several times.

Matt Fabian is one of muniland’s brightest stars and really does an excellent job debunking some common myths about muniland. For example, some predicted there would be hundreds of billions of dollars lost in municipal defaults this year; so far there has been $1.2 billion. For a year Fabian has been saying we would not have a lot of defaults.

It’s at minute mark 6:50, though, where I would challenge Fabian. Contrary to conventional wisdom, as well as the signals from credit ratings and credit-default swaps, he says he would buy the state bonds of California and Illinois. These two are considered some of the worst of state issuers with very heavy debt burdens. Fabian’s rationale is that there are “structural protections for bondholders,” meaning that state law has deemed interest and principal payments to bondholders more important than any other payments the state is required to make.

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.

Meredith Whitney’s anniversary

Two big events happened on Tuesday in the municipal bond market: it was the annual conference of SIFMA, one of the industry trade associations; and it was also the one-year anniversary when Meredith Whitney began her campaign of predicting the collapse of the muni market. Whitney was of course way off-base with her prediction of hundreds of billions of dollars in bond defaults. In fact less than $1 billion of muni bonds have defaulted so far . But many believe that she did cause substantial damage to retail investors, mutual funds and insurance companies, all of whom were caught up in the downdraft of selling that followed her words of doom.

The reason that her words were so damaging to muniland was that there is little natural elasticity in the ebb and flow of the market structure — or, in market jargon, there is little liquidity. When large sell-offs happen in the equity or U.S. Treasury markets there is always a ready pool of buyers standing ready to pick up those securities at lower levels. These markets are favorites for traders and fast money because they encounter little friction, meaning the price rarely moves against them when entering and exiting the market. In contrast, there are few pools of buyers that understand the muni market and are able to do quick credit analysis of bonds for sale, not to mention the lack of shared pricing data that would let participants see if they are transacting at updated, fair-market prices. Because muniland is not really liquid, when Whitney yelled “fire” there was no orderly way for the crowd to exit the theater.

There are structural reasons why little liquidity exists in muni markets. For example, over 50,000 local and state governments have issued over 700,000 different municipal securities. On a given day only about 15,000 of these individual securities change hands in about 40,000 trades. The Municipal Securities Rulemaking Board stated in their annual fact book that about 10 million muni bond trades happened for the year 2010. In contrast, the New York Stock Exchange had 95 million trades in month of December 2010 alone.

Disclosure is the beat

Disclosure is the beat

On Tuesday at the SIFMA Muni Bond Summit in New York, much of the discussion by bond market participants related to transparency and disclosure issues. A lot of this was in response to new requirements in Dodd-Frank, but there was also an acknowledgement that many problems in the crisis of 2007-2009 came from a lack of information and data in many parts of the market. For example small municipal issuers had more trouble accessing the bond market to issue new bonds if their public reporting was deficient or out of date.

The heavy hitter of the bond summit was SEC Commissioner Elise Walter, who appeared by video link and broke news that the SEC would not ask Congress to overturn the Tower Amendment, a 1975 law that bars the SEC from interfering in the fiscal affairs of state and local governments. She discussed current legislation that would skirt the Tower Amendment and give the SEC authority to require municipal issuers to file disclosure, though it would grant no authority to review and approve those filings. From the Bond Buyer:

Walter repeated her call for Congress to increase the SEC’s authority so that it could set “baseline disclosure requirements.”

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