Issuers are more active, too. Bond volume has been resurging. Where 2011 was a bummer of a year -- issuance was a mere $285 billion (well under the $400-plus billion of 2009 and 2010) -- this year is off to a robust start. In April alone, issuers came to market with $33.9 billion, more than double last year's April total of $15.5 billion. Forecasters talk about a $360 billion year.
But at least half of the 2012 issuance so far is refunding, or issuers refinancing existing debt. There's not a lot of new investment flooding states and localities. Where refundings were up 158 percent over April of last year, new money issues were up only 63 percent.
None of this should be surprising. Given the precarious state of revenue flowing into state and local coffers, a number of would-be issuers just don't want -- or can't afford -- to take on more debt. But there's another reason, too. Some would-be issuers are making an end run around the muni market and borrowing directly from banks. Almost everyone in the municipal finance world has anecdotal evidence that suggests this is a fast-growing trend, but no one seems to have any exact data. Even the Securities Industry and Financial Markets Association (SIFMA), which makes it its business to accumulate and analyze statistics on almost every aspect of the securities industry, admits to not having a solid figure. Michael Decker, managing director and co-head of municipal securities for SIFMA, is following the direct-loan trend closely. Here are some of his observations about the trend and what is driving it:
"Based on many conversations with bankers and borrowers, it is clearly a growth trend with regard to banks either providing loans to state and local governments or being the private placement buyer of bonds (where a government issues a bond but the entire issue is bought by a bank in a private placement). Economically, the loans and placements are similar, but legally, they are different. "This trend got started in 2010 when many governments had variable-rate bonds outstanding. Those kinds of bonds often require a letter of credit from a bank as a liquidity backstop to support the transaction. So, both banks and government looked at those transactions and asked, 'Rather than the bank providing the letter of credit and the issuer selling the bonds in the capital markets, wouldn't it be more efficient if the bank just owned variable rate bonds?' Once banks were comfortable with those, they began buying other kinds of bonds, such as regular fixed-rate bonds. That trend has really taken off. "Banks usually don't lend for very long periods. It's not really possible to place a fixed-rate loan for 20 to 30 years with a bank. States and localities that want to issue for that long still have to go to the capital markets. But banks are very active in the maturity range of 7 to 10 years or less. They often get better borrowing rates by going to a bank directly as opposed to an offering in the open market."
The problem with the direct-loan market is that there is little guidance out there on the risks and rewards of using the method, says Susan Gaffney, director of the Federal Liaison Center for the Government Finance Officers Association (GFOA). "We need to understand what they are and why they've become a big part of the market. We need a 'bank loan 101' course," she says.
One of the big questions facing issuers is whether they have to file disclosure information about these loans on the Municipal Securities Rulemaking Board's (MSRB) Electronic Municipal Market Access (EMMA) service. Currently, MSRB does not officially consider direct loans to be municipal securities. However, the board issued an advisory notice last September that said some of the loans "may, in fact, be municipal securities." The advisory notice took note of a 1990 U.S. Supreme Court case, Reves v. Ernst & Young, in which the court ruled that a loan is presumed to be a security unless its note is a type identified as a non-security, such as a consumer financing note, business loan or home mortgage.
In keeping with that line of reasoning, MSRB recently made a request for voluntary filing on EMMA of direct bank loans, arguing that "the availability of timely information about bank loan financing is important for market transparency and promoting a fair and efficient market."
On the disclosure issue, SIFMA's Decker adds:
"If borrowing is structured as a private placement bond or as a loan, issuers do not have to produce official statements and provide information to EMMA. That's raised concerns among investors who hold other bonds issued by a municipality. As an investor you might think, what are the implications of this additional borrowing for the debt I already own? Are there acceleration clauses that may have some bearing on the borrower's ability to pay me back? Is the bank borrowing more senior to my position with regard to the borrower in case of default or bankruptcy? Sometimes it's difficult for existing bondholders to find answers to those questions. There is a trend toward encouraging state and local governments to voluntarily disclose through EMMA some material terms of borrowing so that outstanding bondholders have the ability to gauge the effect of additional borrowing on their investment. MSRB has made it clear that EMMA is set up to accept that kind of disclosure. "Market participants or their representatives are working on a recommended disclosure scheme for state and local governments that engage in direct bank borrowing. SIFMA is active in those discussions, as is GFOA and other representatives of issuers and investors. Before long that group will produce voluntary, recommended guidelines for state and local governments with regard to the terms for bank borrowing."
