WASHINGTON – Analysts and others are concerned that some issuers are entering into bank loans and other alternatives to municipal bond financings that could hurt their finances and investors without fully understanding the potential effects.
They raised their concerns during a panel at the National Federation of Municipal Analysts’ annual conference here on Thursday that focused both on the potential credit impacts of bank loans as well as the Securities and Exchange Commission’s recent proposal to require disclosure of bank loans and other alternative financings.
One main concern was that bank loans and alternative agreements sometimes include provisions meant to protect the banks that, if invoked, elevate banks rights' over those of bondholders. For example, an agreement could say that, under certain circumstances, the bank can accelerate payments of the loan, which could be a hardship for the issuer and could hurt holders of the issuer's bonds. These provisions are sometimes written in a way that are not clear about when they might be triggered, the panelists said.
Geoffrey Buswick, a managing director and sector leader with S&P Global Ratings, said the rating agency has reviewed some agreements that contain “material adverse conditions that are completely amorphous.”
Buswick said those provisions give banks power to, through their own determinations, trigger remedies in the agreement that the traditional muni bondholder would not have and that could force the bondholder to be subordinated even though the alternative financing and traditional security are considered parity debt.
He said that while agreements that have vague triggers are “by far the minority” of the total number of aggregate direct purchase bond documents S&P has reviewed, the presence of these “outliers” still make a good case for the disclosure of loan provisions.
Panelists also talked about interest rate adjuster provisions. Paul Smith, a partner and banking practice group chairman at Kutak Rock, said these provisions allow banks to adjust the interest rates that issuers must pay if certain events occur, like a decline in credit rating or a loss of tax exemption.
Smith said the inclusion of a margin rate factor in some agreements “is probably what is getting the most attention right now” among interest rate adjusters. Margin rate factor adjustments use a formula and allow a bank to raise the interest an issuer has to pay if the corporate tax rate decreases so the bank’s marginal benefit from the investment can stay the same.
Smith said margin rate factor adjustments have been in agreements for roughly the past eight years but that now, with the Trump administration considering tax reform, the possibility of a lowered corporate tax rate is becoming more likely.
Buswick noted that agreements with margin rate factor adjustments are also in the minority of the agreements S&P has reviewed, but said that the agreements that do have it can leave traditional bondholders worse off.
“If you as a bondholder are expecting a payment and another investor suddenly has the right to say you need to pay me more, it puts you in an interesting position,” Buswick said.
He also raised a concern about how well issuers understand the margin rate adjustments. He said S&P asked some of management teams that have signed off on agreements with the adjustment how they are preparing for the possibility of the adjustment kicking in and the teams responded that they didn’t know it was there.
The panel’s discussion of bank loans also included a discussion of how the market is reacting to the SEC’s proposal to include two new event notices under its Rule 15c2-12 on municipal disclosure. The proposal, which has been criticized by issuers, dealers and lawyers, but applauded by investors, would require event notices to be filed for a broad range of “financial obligations,” if material, including, guarantees and monetary obligations resulting from a judicial, administrative or arbitration proceeding. It would also require such notices to be filed for actions and events related to financial obligations that “reflect financial difficulties” such as the modification of terms.
Lynnette Kelly, executive director of the Municipal Securities Rulemaking Board, reaffirmed the MSRB’s support for disclosing bank loans while indicating that the self-regulator is considering the proposal from a “high level” and not taking a definite position on it.
The other panel participants noted the competing views about whether the proposal is too broad or not broad enough, depending on which subset of the market is asked. They agreed the proposed changes would force market participants to deal with the gray areas such as how to define materiality. They also said smaller, less sophisticated issuers may have trouble implementing the proposal if it is approved.