Muni Days are Here Again
A reinvigorated municipal bond market is attracting investors, as well as helping issuers lower their costs.
Nasdaq's nosedive is good news for the municipal bond market. Jittery traders are now looking for safer places to park their money.
And there's more good news: U.S. Treasuries are en route to being zeroed out. That means muni bonds--particularly triple-A rated government obligation bonds--could become the object of the fixed- income investor's affections.
The municipal bond market may be short on cachet; but when risk rises in the glitzier, high-profile markets, the Plain Jane starts looking like a pretty good place to be.
Moreover, during the decade in which other markets captured all the attention, the old-fashioned and tradition-laden muni marketplace updated itself.
Muni bond investors can now buy some bonds over the Internet, click on Web sites to check out the fiscal stability of an issuer and go online to get a handful of real-time bond quotes. In other words, e- trading is underway, disclosure is faster and more widely available, and price transparency--well, it's still in the fledgling stage, but it's moving forward.
This is all well and good for investors. But what does it mean for issuers?
In general, by making munis more investor-friendly, the modernization effort should bring more individual investors to the market, and increased activity usually translates into lower interest rates issuers have to pay to borrow money.
Beyond interest rates, though, other changes in the $1.3 trillion marketplace are bringing down issuance costs dramatically, even while some of the evolutions are creating more responsibility for issuers.
Two major forces have been converging to lower issuance costs. One is the seemingly endless squeeze on underwriting spreads--the profits Wall Street firms make when they bring a bond to market. Ten years ago, underwriters enjoyed spreads of more than 11 points between buy and sell prices; today the average spread is nearly half that.
As fees get squeezed, the industry consolidates. Major and minor firms have been getting out of the business. For issuers, this side effect does not create unalloyed joy. When a bond deal is complicated and the issuer is looking for creative ideas in structuring its debt, underwriter service becomes important. And that's what may suffer when profitability is squeezed. "Having been on the underwriter side of the business myself, I know that if you keep cutting fees, something has to give somewhere," says Frances Walton, the chief financial officer for New York's Empire State Development Corp. "It's not to anyone's advantage to try to keep beating fees down further."
Not surprisingly, as president of the Bond Association, a trade group that represents municipal bond dealers, Micah Green points to another negative scenario. If large Wall Street firms or major regional companies leave the marketplace, it could result in an issuer having fewer purchasers and bidders for its bonds. "If there's overcapacity, the market has to adjust," he says. "To the extent the marketplace has to be more efficient to be profitable, the marketplace is doing what it can."
In addition to consolidating, the muni market is also turning to technology to hammer down bidding costs. Electronic bidding is where a lot of firms and issuers are moving. With e-bidding, an issuer puts its bond proposal up on an electronic network and underwriters respond electronically with their bids for the business. "It works like a whistle," says South Carolina Treasurer Grady Patterson. "It saves a lot of money and also speeds things up."
Instead of the day or two it used to take for underwriters to hand in written bids and then have the issuer calculate the offers to determine the winner, it now takes only two or three hours for the whole shebang. "I can remember six or seven years ago when a bond sale tied up the county's computers all day to analyze the bids," says Tim Firestine, finance director for Montgomery County, Maryland. "Now we know almost instantaneously who the winner is."
The savings for issuers are considerable. When Firestine thinks of the salaries that were tied up in the traditional bidding process and the amount of printing and mailing of documents that went on, he estimates that his county's bidding costs have dropped by as much as 90 percent.
Several Wall Street firms have formed joint ventures to develop e- trading platforms, for both the primary market of new issues and for trading in the secondary market. There are currently dozens of these e-trading systems functioning, although only three or four are expected to survive. Most of them are for broker-dealers to buy new bonds from issuers and to sell to each other; few, if any, of them are designed to provide a marketplace for individual investors to buy or sell tax-exempt bonds.
As to systems that give issuers a chance to sell bonds directly to investors, that's been happening but not as widely and not with as much momentum as the issuer-dealer system. Still, most jurisdictions that have tried it--Pittsburgh was the first in 1998--have gone back for more. G. Louise Green, chief of Baltimore's Bureau of Treasury Management, reported that when her department issued bonds where individuals were allowed to purchase them online, it found a whole new market of investors who were now attracted to the city's bonds.
Direct-to-investor e-trading doesn't work for all bonds--it's most effective for the plain-vanilla, general obligation issues that have strong credit ratings. In other words, bonds that stand to do well online are those that don't need a sales pitch to sell.
Technology is also bringing issuers savings on the disclosure front. During Arthur Levitt's seven-year chairmanship, which ended in February, the Securities and Exchange Commission pressured issuers to provide investors with more and better information about the issuer's fiscal situation--the ability to repay a bond, be it from general revenue funds or a more narrowly targeted revenue stream.
If all that additional information--official statements and updates on fiscal events within the issuing jurisdiction, for example--has to be printed and mailed, it runs up quite a tab. And when disclosure rules were first being promulgated in the early 1990s, issuers were concerned about the additional costs the new demands would create. But then came the Internet and the ability to send documents to underwriters, investors and government regulators electronically.
While that's made compliance easier and cheaper, it can sometimes be overwhelming for the receiving end. "We're getting so many Official Statements by e-mail, it's overloaded our printing capacity," says Hyman Grossman, managing director for public finance at Standard & Poor's Corp. Credit-rating agencies and others who need to pore over disclosure documents are also having to use the World Wide Web to gain access to such items as state budgets. Most states are posting all their financial, budget and audit information on Web sites and disseminating notice of that information through e-mail. The state of Florida, for instance, no longer provides S&P with a hard copy of its documents.
The Web certainly saves on printing bills, but it also raises some legal and regulatory issues. One of those is how to deal with hyperlinks imbedded in Web sites. That is, if an issuer refers a potential investor to another Web site in which one of the issuer's documents resides, is the issuer incorporating all the information in that Web site into its disclosure documents or just referring someone to the specific information as a common courtesy?
While neither the SEC nor its muni market arm, the Municipal Securities Rulemaking Board, has yet to rule on these kinds of Internet-disclosure issues, there's no shortage of suggestions for solutions. Jeffrey Green, general counsel for the Port Authority of New York and New Jersey, would like to see rules for electronic disclosure synchronized with those for paper disclosure. On the question of hyperlinks, for instance, an issuer could put a pop-up screen on its Web site so that when investors click on a hyperlink, the pop-up alerts them to the fact that they are leaving the issuer's site, going somewhere else and that the issuer doesn't vouch for all the information on the other sites. "We need to have appropriate disclaimers and warnings and segregate information intended for bond holders from other information," Green says.
Given that and other concerns about electronic access to information, many issuers are wary of 100 percent e-distribution of disclosure documents. That's the case in Montgomery County. "We're not quite there yet," Firestine admits. "We're still concerned about the regulatory environment."
One other area that the muni market hasn't mastered yet is price transparency: letting individual investors know what the price of a bond is on any given day. Even state-of-the-art technology has not been able to come up with a full-fledged, stock-exchange-style ticker tape. That's not too surprising, given that the trillion-dollar marketplace has hundreds of millions of outstanding bonds.
Right now, price transparency depends on prototype buy and sell prices. The MSRB runs a reporting system of actual muni bond transactions and that information is available through several sources, including the Bond Market Association's site, investinginbonds.com.
The bottom line on price transparency, according to S&P's Grossman, is this: "We're creeping there."
In addition to all of these changes, issuers are now using a new type of collateral to access capital. Securitization has become an important muni bond category and is enabling issuing governments to turn I.O.U.s and expected payments into money in the pipeline. Tax lien bonds, based on bundled collections of unpaid tax bills, were one of the first models. Today, tobacco bonds are the hottest entry. The biggest tobacco deal to date is South Carolina's $935 million tobacco bond, which came to market this past March and was secured by the state's $2.4 billion share of the national tobacco settlement.
Grant anticipation notes are based on a similar theory: Bonds are issued with the promise to repay investors from payments scheduled to be collected in years to come. Massachusetts' grant anticipation notes for the Big Dig, for instance, promised to repay investors from federal payments that were scheduled for the next few years.
An even more recent type of bond is a TIFIA--bonds issued under rules set out under the Transportation Infrastructure Finance and Innovation Act. TIFIA supplies credit enhancement to infrastructure projects that would normally be rated below investment grade. New York's Empire Development Fund is looking to a TIFIA bond to help pay for the redevelopment of New York City's Penn Station. "It fills a gap we might have had difficulty filling," says Frances Walton.
These innovations and enhancements are well and good, but they pale in comparison to the prestige that could redound to the muni market if muni bonds become the benchmark for fixed-income debt--a role that's now played by Treasury bills. As the federal government cuts back on T-bill issuance, the investment markets may look to GO bonds with high credit ratings--North Carolina GO bonds played that role some 40 years ago. "There's nothing safer than a triple-A rated muni bond backed by the full force of a government taxing authority," says Firestine. "It's almost as good as the U.S. Treasury."
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