Change is coming to the U.S. municipal bond market, and issuers, bankers and others are worried that some of the moves could fundamentally alter the process for financing capital and operating needs.
Regulators, armed with new powers under the Dodd-Frank Act, are pushing for greater financial disclosures by states, cities and other issuers, while redefining responsibilities of key players in the market.
At the same time, the core of the market -- tax-exempt debt -- is under siege.
"Unless the municipal market is strong and people feel confident (in it), state and local governments are not going to be able to finance their needs," said Richard Ravitch, who along with former Federal Reserve Chairman Paul Volcker, is heading a task force on the state budget crisis.
With more than $1 trillion in federal spending on the chopping block and possible changes in the federal tax code looming to deal with the U.S. deficit crisis, Ravitch, New York's former lieutenant governor, told the Securities Industry and Financial Markets Association's Municipal Bond Summit on Tuesday he has not seen any analysis of how these moves would affect the state and local government sector.
Meanwhile, the American Jobs Act of 2011, which President Barack Obama unveiled earlier this month, targets annual incomes over $200,000 for individuals and over $250,000 for families by limiting tax deductions to 28 percent of their income starting Jan. 1, 2013, from the current 35 percent.
Panelists at the SIFMA summit said the limitation would cause yields on tax-exempt bonds to rise, boosting borrowing costs for states, cities, schools and others in the $3.7 trillion municipal bond market, where wealthy investors have traditionally turned to reduce their taxable income.
George Friedlander, Citi's senior muni bond strategist, called the proposal, "an awful idea," even though he said it was extremely unlikely the bill would pass.
"It's an early warning," he said. "It is now on the list and once it's on the list, it won't go away."
Securities and Exchange Commissioner Elisse Walter told the SIFMA audience that regulatory staff was preparing rules to improve the timeliness and quality of issuer disclosures. For details, click on
ADVICE AND CONSENT
Also roiling the market is the SEC's new oversight of issuers' financial advisers.
Issuers and banks alike have worried that the definition of who is a financial adviser that the SEC is considering may be too broad, forcing people with little involvement in a bond sale to answer to a host of new regulations. A strict definition, too, could shrink the pool of underwriters who also serve as advisers.
For example, Carol Kostik, New York City's deputy comptroller for public finance and a SIFMA panelist, said fewer broker-dealers than normal applied during a recent request for proposals process for advisers.
Ken Gibbs, president of the municipal securities group at Jefferies & Co, said the bond underwriting process may be transformed because advice is an "integral part of underwriting services."
"Every time you discussed the structure of an escrow or some other topic, you would be deemed an adviser," he told the SIFMA summit.
Connecticut Governor Dannel Malloy also sounded a warning, pointing out debate about issues that have spooked investors, such as allowing states to file for bankruptcy, may continue to pop up in Washington.
"I want to argue here we need to be vigilant," he said, adding that the average citizen does not understand the municipal market.
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