Muni Funds Back Cox On Disclosure
The recent call by SEC Chairman Christopher Cox for increased disclosure in the municipal bond market has been applauded by several top muni bond fund managers.
They say more disclosure from issuers will help them figure out where to put their money, and are backing calls for higher standards.
On July 18, Cox said the Government Accounting Standards Board should be strengthened and called for increased SEC oversight of the muni bond market. Municipal bonds are spared oversight by the SEC except in cases of actual fraud.
The Government Finance Officers Association, which represents the interests of state, county and city financial officers, has come out against any changes, saying the SEC should just enforce existing rules. Munis have been remarkably free of problems, notes Jeffrey Esser, the association’s executive director. In June, an association panel told the SEC that more oversight by the SEC and the cost of fuller disclosure would be onerous to muni issuers.
Rafael Costas, co-director of muni bonds at Franklin Templeton Investments, which manages $58.9 billion in munis, notes that many small towns don’t have big legal budgets. Higher standards and fuller disclosure could be a big burden.
But fund managers say several issues need addressing, and preferably before they become serious.
First is the difference in standards between issuers. One city might count pension obligations to its workers when figuring future outlays, while another may not. That can make a big difference when assessing credit risk.
The SEC last year sanctioned San Diego for not properly disclosing the effect of pension and health obligations in 2002-03.
“A lot of items surrounding pensions differ,” says Tim Ryan, head of muni funds at State Street Global Advisors, which runs $1.5 billion in muni bonds. “The rules are inconsistent.”
That makes it tough for Ryan to decide between bonds that may have similar credit ratings.
Big Growth
The expansion of the muni market has brought the issue to a head. Once muni bonds were a relatively quiet corner of the fixed-income world. But the amount of outstanding muni debt has grown.
Last year, about $430 billion of new bonds and notes were issued. Over the last decade, the amount of debt outstanding has grown from about $1.5 trillion to $2.4 trillion.
According to the SEC, 36% of muni bonds are held by individuals, directly or via bond funds. Trading volume has also grown.
Cox said $6 trillion in munis changed hands last year, comparable to the corporate bond market. More importantly, most of those trades 87% were less than $100,000. The median trade size was $25,000. That indicates involvement of smaller investors, who may not have the time and all the tools that pros do for assessing risk.
One reason for the growth is low interest rates, says Dan Solender, director of muni bond management at Lord Abbett. The firm manages about $9 billion in muni securities.
Smaller governments have gotten into the act. They tend to disclose less than big cities, counties and states, Solender says, not out of a desire to cover up but for lack of experience with the market.
Increased demand for munis also has come from such nontraditional buyers as hedge funds. For many such buyers, disclosure matters less.
“They just want to get their yield and they get out,” Costas said. That provides little incentive to improve the information given to investors.
Then there is the expertise of the issuer or lack thereof. Investment banks might advise towns and cities to use such complicated instruments as swaps and repurchase agreements. Local officials don’t always understand what they are dealing with, especially in smaller cities that can’t hire a lot of advisers and consultants.
“Sometimes they’re tough for even me to get my head around,” Costas said. “And then in a small school district you have a finance board made up of a bunch of retired teachers.”
Swap and repo contracts are more common now than in the mid-1990s, when Orange County lost $1.6 billion in the repo market.
Solender described a number of issuers that said they could refinance or use the repo market over and over again.
Swaps can lock in rates for a time, but many municipalities don’t have a plan for what to do if interest rates move the wrong way. In a swap, two parties agree to pay interest on each other’s obligations. Usually one agrees to pay a fixed rate while the other agrees to a floating rate.
Both Ryan at State Street and Solender at Lord Abbett choose which bonds to buy by looking at the structure of the deal and underlying credit quality. A complicated structure has bigger potential for problems.
Standardized disclosure would go a long way towards figuring out which muni bond will offer better performance for the risk taken, Solender says.