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Address Scrutiny of Municipal Securities With More Disclosures
Recent municipal bond defaults in Detroit, Michigan, Jefferson County, Alabama, and Harrisburg, Pennsylvania, have increased the public and investor scrutiny of the state and local government municipal debt market.
With a rising number of municipal bankruptcies, focus on unfunded pension obligations, and an economy that continues to grow at a very slow rate, many investors are questioning whether municipal securities are still a relatively safe and secure investment vehicle. Some are also calling for more financial statement disclosures around the risks inherent in owning these securities.
Issuers of municipal bonds already face numerous disclosure requirements outlined in the Securities Exchange Act (SEA). These “continuing disclosures” generally fall into two categories: those meant to update financial or operating information, and those meant to disclose specific events. Event disclosures are generally very prescriptive under the SEA; however, the financial and operating information update disclosures require much more nuanced judgment.
These disclosures focus on specific events that may have an impact on the issuer’s securities. While many would seem self-evident (e.g., payment delinquency or nonpayment, rating change, and bankruptcy), there are other events that many municipalities are beginning to employ (e.g., mergers, consolidations, acquisitions, sale of assets).
Governments are increasingly using these types of transactions for a one-time infusion of cash to help with an immediate budget crisis or to fund projects, such as major capital acquisitions. There were 55 such material event disclosures during 2012, according to Electronic Municipal Market Access (EMMA), a service of the Municipal Securities Rulemaking Board. Since most events of this type require considerable debate and approval by the municipal legislature, there is typically ample public information for the issuer to use in creating the disclosure, so there is no need to recreate the wheel.
Financial and operating information update disclosures
Most are familiar with the requirement to provide annual financial information and operating data — which is usually a budget document of some sort — and annual audited financial statements to the EMMA. There are three types of update disclosures that will likely be more prevalent in the future.
Change in accounting standard — Municipal governments have been working with their actuaries to determine the impact of GASB Statement 68 on accounting and financial reporting for pensions. Once that information has been prepared — even well in advance of the implementation date — if the implementation results in a material liability to be recorded (which it likely will), then it should be disclosed to EMMA.
Changes in capital or other financing plans — Many governments have responded to the slow-growth economy by significantly revising their long-term capital budget plans. These changes often involve deferring or eliminating major capital improvements or maintenance efforts. Both such changes may have short- and long-term impact on the municipality. Accordingly, changes from previously adopted policies should be disclosed to EMMA.
Changes in investment/debt/financial policy — As a result of the economy, many municipalities have altered some of their fundamental investment and debt management policies, allowing them more flexibility to respond to today’s challenges. These changes may allow for the government to assume more risk under the new policies. Furthermore, many governments that had previously adopted “rainy day funds” to use in the event of significant fiscal distress have found that the “rainy day” has, in fact, arrived. They have already used these funds to cover budgetary shortfalls. Such usage of emergency funds and changes to investment and debt policies should also be disclosed to EMMA.
Be transparent and ask for help
The following tips on disclosures may also be helpful:
- Transparency is the big buzzword today; when in doubt, err on the side of disclosing more information rather than less.
- Always consult with your counsel and advisors for guidance on disclosure.