WASHINGTON — The National Federation of Municipal Analysts on Wednesday released updated disclosure recommendations for issuers of variable-rate demand obligations and other short-term securities.
The 60-page best practices document, which replaces a 2003 version, was revised in response to changing market conditions, including the increasing use of new language in letters of credit, standby bond purchase agreements and other kinds of credit enhancement.
Letters of credit are agreements by banks to pay principal and interest on an issuers' debt, and standby bond purchase agreements guarantee that banks will purchase tendered bonds if the bonds can't be resold.
Karen Flores, managing director at Charles Schwab and co-chair of the NFMA committee that prepared the paper, said that after the 2008 financial crisis, banks began to make changes to standby bond purchase agreements and other documents.
"Many market participants were looking at things differently, and all parties were trying to find a way to limit potential losses," Flores said.
SBPAs now often include "most-favored nation" clauses, which apply when issuers enter into another SBPA for a new issue with another bank, and allow the original bank to change its terms to match those of the new bank.
The NFMA said that most-favored nation clauses, if used, should not be able to alter "termination events" that allow banks to terminate credit-enhancement agreements without first paying bondholders.
Any changes to termination events should require consent by 100% of the bondholders or should trigger a mandatory tender, the group said.
The NFMA paper includes a list of acceptable termination events, which are associated with an issuer's credit.
Acceptable events include defaults when issuers stop making principal and interest payments, issuer insolvencies, credit downgrades and instances when courts rule that bonds are invalid or unenforceable.
Flores said it's important for such events to be tracked by money market funds. Money market funds are required by the Securities and Exchange Commission to be able to monitor termination events.
"We, as investors, need to make sure we are comfortable with these events, and we must be able to track" them, Flores said.
The NFMA also recommends that a bond indenture be written so that a failure of a bank that is providing credit enhancement would be considered a default. Such a provision would allow bondholders to seek remedial action.
The best-practices document addresses the trend toward increased issuance of so-called self-liquidity debt, such as VRDOs supported by an issuer's credit rather than bank agreements. Issuers of self-liquidity debt, which tend to have strong credit ratings, agree to fund repurchases with their own credit.
The NFMA said investors must carefully evaluate the issuers' ability to honor demands. They should study the issuers' liquid assets, ability to generate operating cash and management experience, as well as ensure issuer officials are familiar with a process to liquidate funds and pay bondholders.
The NFMA recommends that issuers of self-liquidity debt file timely quarterly financial statements and disclose changes to investment policies, sources of liquidity, or the process or timing of access to assets.
"We want to make sure [investors] have adequate resources available," Flores said. "Quarterly disclosure is critical in making [self-liquidity] bonds more marketable in the short-term market."
Self-liquidity debt has increased in recent years as issuance of credit-enhanced variable-rate demand obligations has declined, Flores said.
She estimated that outstanding par of variable-rate bonds has fallen 20% since 2008, partly because credit enhancers are harder to obtain. Also, many of variable-rate bonds issued before 2008 were tied to interest-rate swaps. Risks associated with swaps have made those types of deals less desirable to issuers.
According to a report issued by the Municipal Securities Rulemaking Board in June, VRDO new-issue volume continued to decline this year, averaging $858 million per month during the first four months.
At that rate, new VRDO issuance for the year overall will reach roughly $10.3 billion, which would be down 27% from last year, when it totaled $14.2 billion.
Flores said the document was created with industry input by a diverse committee of investors, lawyers, remarketing agents and bankers.