April 17, 2018
The muni bond market has been impaired to some degree over the last two decades due to the lack of disclosures around various financing structures. Think of interest rate swaps and auction rate securities.
Issuers embraced these less-than-vanilla structures as low-cost alternatives to plain-vanilla, fixed-rate bonds, jumping right in for the cheaper financing. It proved profitable for Wall Street, but bond investors were generally kept in the dark in terms of the disclosure of their existence and the legal provisions underpinning them.
Since the Financial Crisis, the new exotic structure has been so-called direct placements, which are private loan agreements between a bank and an issuer. Like swaps and auction rates, issuers have used them extensively. Market participants estimate that more than $60 billion in private placements are currently outstanding. In most cases they don’t meet the definition of a federal security, therefore they generally fall outside the disclosure requirements of the SEC and MSRB, and it’s been hard for investors to receive timely disclosure of these debt-like structures.
The credit risk? That the private agreements may contain acceleration provisions that push the bank acting as the lender in front of all bondholders.
The Governmental Accounting Standards Board (GASB) last week released new guidance “designed to enhance debt-related disclosures in notes to financial statements, including those addressing direct borrowings and direct placements.” This is valuable and important guidance to issuers. But because the vast majority of muniland bond issuers conduct only annual audits, GASB’s guidance to outline these agreements in the notes to the financial statements – literally the footnotes of documents that can run over 200 pages – is only a half-step because it does nothing to spur contemporary disclosure.
Why? The key is timely disclosure.
Imagine an investor analyst who is responsible for the credit surveillance on 100 or more issuers. If one of their issuers comes to market with robust primary market disclosure for its once-per-year issuance, chances are that analyst won’t get fresh, timely disclosure for another year – when the issuer comes back to the bond market. Even then, the investor probably wouldn’t get full access to all of the terms and provisions of these agreements.
What’s the solution? Market signals from investors.
Short of a change to 15c2-12, issuers won’t be required to provide these agreements to investors. But some will do so voluntarily – those that “get it” when it comes to the importance of timely disclosure and those that follow GFOA and NFMA best practices. Those are the issuers that should get access to the lowest cost of investor capital.
We think it’s a good thing if investors can send signals to issuers about disclosure practices. It may be an unavoidable growing pain for the market’s future if issuers are bucketed into those that disclose and those that don’t.
