PHOENIX - A new paper from the National Association of Bond Lawyers aims to help bond lawyers navigate the increasingly popular bank loan and private placement landscape and contains a section on what to take into account when considering disclosures.
The paper, titled “Direct Purchases of State or Local Obligations by Commercial Banks and Other Financial Institutions,” was released on Wednesday. Drafted primarily by Juliet Huang, a partner at Chapman and Cutler in Chicago, the paper is a detailed look at the mechanics of direct purchases of state and local debt and the thorny issues that often surround them. Bank loans and private placements have flourished in recent years as alternatives to public offerings of municipal bonds.
“NABL thought that it would benefit NABL members in particular, and maybe others as well, to have a white paper that takes a deep dive into the mechanics of direct purchases, frequently negotiated terms and provisions, loan versus securities issues, rating agency and disclosure considerations and that touches on tax considerations,” Huang said. “We worked hard to provide a balanced view from both the issuer’s counsel perspective and the lender’s counsel perspective as to these points. Given the large number of direct purchases done in the market each year, we think practitioners and market participants will find this paper to be a helpful resource.”
As the paper notes, commercial banks were historically major purchasers of tax-exempt debt but lost incentive to buy munis after 1986 when federal tax reform restricted the benefits banks could get from them. This changed again in the first decade of the new millennium, when the American Recovery and Reinvestment Act of 2009 offered temporary favorable tax provisions for financial institutions to buy tax-exempt bonds again. But those provisions lasted for only two years -- 2009 and 2010.
Since that time, private muni placements with banks have represented a small but meaningful portion of the market, estimated to be roughly 7% of issuance in 2014, Chris Mier, managing director of the analytical services division for Loop Capital, told members of the Government Finance Officers Association last year.
Of significant concern to many market participants is the lack of disclosure for many direct purchases. Unlike municipal bonds, they are not subject to the requirements of Securities and Exchange Commission Rule 15c2-12 on disclosure.
Rating agencies and regulators warn that the lack of disclosure can mask an issuer's true financial condition and can leave investors in the dark about transaction terms that could hurt them, such as a requirement that debt payment be accelerated when certain events occur.
The NABL paper notes that rating agencies have threatened to take negative action or suspend ratings for inadequate private placement disclosure, and recommends that that be taken into account in a transaction.
“Consideration should be given to whether the issuer’s rating agencies are aware of the direct purchase transaction and any potential concerns of the rating agency with the issuer’s plan of finance,” the paper reads.
The paper also tackles the somewhat complex analysis of whether a transaction is a “loan” or a “security,” an important distinction for determining whether it is subject to federal securities laws and Municipal Securities Rulemaking Board regulations. There are also applicable state laws that can affect that calculus, too. The waters can be further muddied by bank accounting practices, which may classify a direct purchase as a security or a loan.
While the NABL paper says that issuers and their lawyers generally don't need to worry about accounting practices, there are potential pitfalls involved.
“Problems can and do arise, however, when a direct purchaser requests that the issuer structure an obligation in a manner inconsistent with applicable law,” according to the paper. “For instance, applicable state or local law may require that the obligation be documented as a registered bond rather than as a promissory note. Counsel to all parties need to be mindful of applicable state or local law requirements.”
The project started about two years ago, and included the efforts of eight lawyers besides Huang. The paper is available on NABL's website: https://www.nabl.org.