The Muni Market's New Look

State and local bond issuers are in a high state of alert. The Securities and Exchange Commission is grumbling about its inability to regulate disclosure in the muni bond market. While this has long been a low growl, the commission has been fired up of late by problems unearthed in its investigation of the San Diego City Employees Retirement System. SEC Chairman Christopher Cox is proposing the possibility of repeal of the Tower Amendment, a change to the 1975 Securities Exchange Act that precludes the SEC from requiring issuers to file municipal securities documents with the commission, as corporate issuers do. In a recent interview with the Bond Buyer, Cox noted that "despite the increasing growth and complexity of the municipal bond market, it remains subject to minimal regulation."

Moody's Investors Service is also reacting to the growth and complexity of the market. The credit rating agency is giving each municipal bond it reviews an equivalency grade on its Global Scale Rating. The idea is to make it easier for potential investors to compare muni bonds, which have a different rating scale than other debt, to corporate bonds and other investments.

The change is driven by the growth of "crossover" buyers in the muni market, investors from all over the world who are buying muni bonds for portfolio diversification and other purposes not linked to the bonds' tax-exempt status. They are also investing in the increasing amount of taxable debt muni issuers are selling.

A NEW DEAL: LOUISIANA LAUNCHES A FORWARD-LOOKING BOND

Louisiana will be selling a $485 million muni bond at a low interest rate of 3.6 percent. But it won't be marketing the debt soon. The issuance date is two years away.

The state's deal is something of a muni-market trailblazer. Two of the tools it uses--a forward-delivery contract and a competitively bid interest rate swap--are more familiar in the corporate market.

The state was able to use a forward-delivery contract because it knew what it planned to do with the bond money--repair highways and build bridges--and had bid out the projects. "We knew what they would cost," says Whitman Kling, director of the state's bond commission. "But we wanted to know what that money would cost us." By having underwriters bid now on the forward-delivery contract, the state was able to assure itself that it had a buyer for the bonds at a competitive rate.

The swap, on the other hand, allows the state to hedge that rate. While many states are allowed to use interest rate swaps to protect themselves from rate risk, Louisiana tested a variation of that technique. Instead of negotiating the rate of the swap with the firm underwriting the bond--the common practice in the muni market--it bid the swap competitively among half a dozen underwriters and ended up saving about 1 percentage point on the rate.

The Louisiana swap deal comes at a time when the U.S. Justice Department and Securities and Exchange Commission are investigating muni-market underwriters for alleged bid-rigging and price-fixing in swap transactions. The competitive bidding for Louisiana's deal provides some much-needed price transparency to swaps.