JPMorgan fails to disclose

Charlie Gasparino of Fox Business News seems to have scooped a muniland story yesterday when he reported that JPMorgan had failed to include material facts in a municipal bond offering on which it was the lead underwriter.

Lead underwriters have a special role in muniland. The Tower Amendment, passed in 1975, prohibited the federal government from requiring issuers of municipal debt to make specific disclosures to investors prior to offering securities for sale. Underwriters, however, do not enjoy the same protection, so the law has evolved to make them liable for the contents of the offering document for municipal debt. This requirement is administrated by the Municipal Rulemaking Board through Rule G-17, or the fair-dealing rule.

MSRB’s Rule G-17 is the Ten Commandments of muniland (emphasis mine):

Rule G-17 precludes a dealer, in the conduct of its municipal securities activities, from engaging in any deceptive, dishonest, or unfair practice with any person, including an issuer of municipal securities. The rule contains an anti-fraud prohibition. Thus, an underwriter must not misrepresent or omit the facts, risks, potential benefits, or other material information about municipal securities activities undertaken with a municipal issuer.

Gasparino’s reporting, which seems to be based on sources inside JPMorgan, nails the G-17 violation. He cites the omission of risks related to the Massachusetts state pension in a $469 million general obligation bond offering in May 2011. As the lead underwriter on the deal, JPMorgan carried out an internal study on pension risks but did not disclose those risks within the Massachusetts bond offering document:

Yet, J.P. Morgan didn’t include its pension fund analysis in bond deal disclosure materials that are made to investors, known as the deal’s “official statement,” according to current and former executives at the firm. Case in point: a $469 million bond issue by Massachusetts in May of last year, two months after the pension report was published.

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.

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.

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.


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.

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