DPC Data Study Reveals Major Transparency Shortfalls In Municipal Bond Market
Many issuers of municipal bonds, including Jefferson County, Alabama, take a ‘don’t’ ask, don’t tell’ stance when it comes to filing financial disclosures, according to a leading provider of municipal bond disclosure data. Findings from a groundbreaking study, “Estimating Municipal Securities Continuing Disclosure Compliance: A Litmus Test Approach,” reveal startling problems over transparency and disclosure of financial data in the municipal bond market. It’s so bad that investors who hold municipal securities - individually or in a mutual fund - often have no way of knowing when their investments are in trouble.
The study, conducted by DPC Data, shows that more than 50% of the municipal bonds sold between 1996 and 2005 have one or more years of disclosure delinquency. More than 25% are considered to be in the “chronic” stage, failing to file disclosure for three or more years.
The lax attitude regarding secondary market disclosure stems from the fact that issuers of the bonds suffer virtually no consequences, let alone enforcement, for not filing.
For investors, the lack of transparency can have devastating results. As reported Aug. 30 in the New York Times, the failure of municipal issuers to report material changes in their annual filings of financial statements and other reports essentially leaves investors in the dark regarding key information concerning their investments - information like a potential ratings downgrade by a credit ratings agency.
“Our findings indicate that nondisclosure is an established practice and a growing trend,” says Peter J. Schmitt, the author of the study and CEO of DPC Data. “The implications of any failure to disclose are serious. At a minimum, it is a breach of the fundamental principles of investor protection, suggesting hidden problems or potential fraud.”
Case in point: Jefferson County, Alabama. On Aug. 29, county commissioners barely eked out a one-month reprieve with creditors to renegotiate a $3.2 billion sewer debt. Had the commission failed to garner the extension, Jefferson County would have become the biggest municipal default in United States history.
Jefferson County illustrates the problems disclosure delinquency can cause in the municipal securities market. Until Sept. 30, 2007, the Jefferson County filed regular financial statements. After that date, however, filings came to an abrupt halt, according to the New York Times article.
It wasn’t until a February 2008 filing that investors became aware that Moody’s Investors Service had downgraded the county’s sewer credit rating for the second time in less than a month. As a result of the downgrades, Jefferson found itself deeper in debt and facing bankruptcy.
Based on the study by DPC Data, the situation in Jefferson County is hardly isolated. The number and proportion of failures to file are increasing every year. Between 1997 and 2003, delinquencies were in the 16% to 20% range. Beginning in 2004, however, the percentage of delinquencies skyrocketed, reaching 25% in 2006.
Other than taking action against an issuer that fails to meet disclosure commitments, bondholders have few solutions at their disposal. And even taking action is unlikely to make a difference. As reported Sept. 3 in Bond Buyer, the Securities and Exchange Commission (SEC) has never taken action against a broker-dealer for underwriting the bonds of an issuer that failed to file its annual disclosures.
Findings from the DPC Data study are disturbing on many fronts. The municipal securities market has some $2.6 trillion of debt outstanding, most of which is held by individual investors. The fact that any market can operate with ‘voluntary’ credit transparency - and a municipality or other entity has no obligation to reveal its financial circumstances on a consistent and predictable basis so that investors who risk capital, or want to risk capital, on that debt are fully aware of the overall financial situation at hand - is nothing short of ludicrous.
The DPC DATA research report can be obtained for free at www.DPCDATA.com.
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