If The Bond Buyer journalist Dan Seymour is correct, litigators may soon be even busier. According to “Headline Risk Drains Muni Bond Funds” (Money Management Executive, January 31, 2011), the week ending on January 19, 2011 saw investors withdraw an unprecedented $4 billion from mutual funds that invest in bonds issued by municipalities. In context, this is roughly 1% of the $470+ billion market and about $1 billion more than the former exit record of $3.1 billion for the week ending on November 17, 2010. Seymour adds that “Muni bond funds have now reported $29.3 billion of redemptions in the past 10 weeks” or “65% more than the previous record for outflows in a 10-week period of $11.5 billion established in 2000.”His conclusion is that investors are scared. With credit spreads not moving out as would be expected during a flight to quality path, investors just want to leave the asset class altogether.
Another journalist with The Bond Buyer cites several muni bond portfolio managers as saying “not so fast.” Headlines about bankruptcy risk grab attentions but may lure investors away from “solid, safe investments because of distorted opinions in the media.” See “Don’t Let Headlines Overshadow Buys: DWS” by Christine Albano, Money Management Executive, January 31, 2011.
A hat tip to the “Securities Arbitration and Litigation” blogging team. Their February 8, 2011 post entitled “Enough Transparency in the Municipal Bond Market?” cites a recent study from DPC Data about the paucity of financial disclosures by municipal bond issuers. According to “DPC Data Issues New Study on Transparency in the Municipal Bond Market” (February 3, 2011):
- Issuers of 60 to 70 percent of 17,000 municipal bonds file information “too late to be of practical use in credit risk analysis.”
- For the bonds issued from 1996 through 2003 that were still outstanding between 2005 and 2009, “56 percent of issuers/obligors did not file annual disclosures for one or more years; 19 percent did not file for any of those years.”
- “At least a third of the expected disclosures were never filed in the designated official repositories.”
As DPC Data CEO Peter J. Schmitt suggests “there is no way around the fundamental need for timely financial statements to obtain critical information that can warn investors of impending problems.”
Pension plan IOUs are another drain on municipal coffers. With unfunded retirement plan liabilities estimated at $3 trillion, state, city and county issuers with employee benefit funding gaps (excluding healthcare obligations), the last thing a municipal bond investor wants is a nasty surprise heretofore not disclosed in a timely and complete manner.
Late last week, U.S. Congressman Devin Nunes and U.S. Senator Richard Burr introduced the House version of the Public Employee Pension Transparency Act, H.R. 567. The goal to “amend the Internal Revenue Code of 1986” and “provide for reporting and disclosure by State and local public employee retirement pension plans.” Failing to comply with this proposed rule, if approved and passed into law, could push the cost of borrowing up for numerous public entitities since they would be denied federal tax exemption status. This means that investors in turn would not be able to exempt realized bond income and would likely rethink the risk-return profile of muni bonds.
Having done a lot of work in the area of performance metrics and risk measurement, I will be the first to tell you that numbers can be misleading. Investors must look beyond reported data to have a solid understanding of the economic exposures they face when deploying assets. The problem is that one cannot even begin a proper analysis without access to information.
As the U.S. Securities and Exchange Commision begins its exploration of the disclosures made (or not as the case may be) by state and local bond issuers, expect a lot of questions from unhappy investors about the due diligence conducted by their advisors and consultants if no one has sufficiently granular information to do a good job of default risk assessment.