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SEC Muni Chief: More Disclosure

ORLANDO - The Securities and Exchange Commission's municipal securities chief urged bond attorneys meeting here yesterday to disclose more information about the underlying borrower in certain conduit deals that are sold with short-term interest rates.

The bonds, often sold as variable-rate industrial development bonds, are exempt from many of the disclosure requirements for most longer-term debt. Issuers of the short-term IDBs have historically secured them with letters of credit or insurance.

While issuers provide brief disclosure information about the insurers or the letter of credit provider for bonds, they include no disclosures about the credit of the actual borrower - typically private businesses that do not wish to make their financial information public. Since 1998, about $22.9 billion of $36.5 billion of IDBs sold were variable-rate demand obligations, according to Thomson Reuters.

But the lack of disclosure on the underlying borrower is no longer adequate given the economic crisis that has strained issuers and toppled bond insurers and banks, argued Martha Mahan Haines, the SEC's muni chief. Since 1994, she said, the SEC has pushed issuers to disclose more information about underlying obligors.

"My concern is look around you and look at what's been going on for the past year and a half," said Haines, who spoke at a panel on primary market disclosure at the National Association of Bond Lawyers' Tax and Securities Law Institute. "You've got nothing much in [the offering documents] about the bank, you've got nothing much in there about the bond insurer, you've got nothing much in there about the credit enhancer, but you've got the issuer's name spread out across the front page."

Acknowledging that investors historically have purchased these securities based solely on the rating of the LOC provider, Haines said: "Investors realize that there are risks that were discounted or ignored before that are now recognized as being real."

"We've got issuers who are being downgraded, we've got insurers that are essentially going out of business, we've got banks that are horribly downgraded ... and that are essentially going out of business," she added.

Haines' remarks were met with skepticism from several of the attorneys, including Fredric Weber, a partner at Fulbright & Jaworski LLP in Houston, who moderated the panel and noted that the securities law only makes it unlawful to make untrue or misleading disclosure statements in offerings of such credit-enhanced VRDOs.

"It may be good for the market to have disclosed more or it may have been good for the issuer to get better pricing to have disclosed more, but if disclosure is not made, it's not a violation of the securities laws," Weber said.

Another bond attorney who asked not to be named was more pointed, stressing that no one anticipated the collapse of the banks LOC providers.

"It's the same with my 401K," the attorney said. "This sounds like more of a market problem than a disclosure problem."

At a separate panel on rating agency and credit issues, two senior rating agency and bond insurer officials said they are deeply concerned that the liquidity-related financial stresses of states and localities may lead to an impact on their ratings.

"What really is going to break an issuer certainly on the government level is not going to be declining revenues, it's more likely to be liquidity issues," said the rating agency official, who did not want to be identified.

The liquidity concerns revolve around a few hypothetical scenarios. In one, an issuer's VRDOs fail to be remarketed and become bank bonds, after which the debt service on the bonds must be paid on an accelerated basis.

In another scenario, the bonds fail to be remarketed and the LOC provider is unable to take them on its balance sheet, requiring the issuer to purchase them because it has contractually agreed to a "hard put." For some issuers, such as higher education institutions with large endowments, the prospect of having to accept tenders of their VRDOs may not pose a large financial challenge. But certain governmental issuers may be unable to meet debt service payments on their other outstanding bonds if all of their free cash is used up on the tendered VRDOs.

The rating agency official said issuers must carefully assess their liquidity risks, and in determining if they want to refinance VRDOs, they need to calculate termination payments tied to any swaps used to hedge the variable-rate debt.

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