Over the past several years, the municipal debt market has shrunk from $3.7T to $3.5T. No, the municipal market did not take a dive into the deep end of the pool. There are several reasons for the reduced municipal debt issuance, including lack of debt capacity, debt aversion and an increase in direct loans. We want to highlight the increase in direct municipal loans because of their lack of required reporting and the associated risks. For clarification, direct municipal bank loans are debt obligations that a municipality enters directly with a bank. A municipality may enter into a direct loan because it is locked out of the municipal market or finds the cost of debt to be cheaper after underwriting fees than the market is willing to offer. There are number of reasons why it’s important for municipal bond holders to account for direct bank loans: (1) bank loans may increase the issuer’s debt outstanding; (2) covenants and events of default may differ for a bank loan versus bonded debt, the risk being bank loans may be senior to bondholders in the capital structure; (3) certain assets previously available may be pledged without bondholder knowledge; and (4) the bank loan may be structured with a balloon payment or in some other manner detrimental to the bondholder. Fortunately, the municipal bond market is acquiring some much-needed transparency through the encouragement of the National Federation of Municipal Analyst and the Municipal Securities Rulemaking Board (MSRB). The MSRB also offers a useful online tool for gaining municipal information called EMMA (Electronic Municipal Market Access). While direct bank loan disclosure is not mandatory, we are seeing a push for voluntary reporting, and the reports are become more accessible with EMMA.
Source: National Federation of Municipal Analyst and SNWAM Research