Responding to secondary market disclosure needs: Tallahassee's annual report to bondholders.

• Author: Inzer, Robert B.

The changing marketplace and needs of municipal bond investors have placed new responsibilities on issuers for continuing disclosure. Tallahassee city officials have found that providing secondary market disclosure through their annual report to bondholders makes sense and serves their own best interests.

Dramatic and sudden changes have reshaped today's world, but the changes that reshape communities often develop over longer periods of time, are more subtle, and their impact - while just as deep and lasting - is softened by its gradual onset. Whether subtle or dramatic, shifts in things like population growth and mix, industry expansion and decline, social and political values, have transformed many local communities and their governments.

As the world, the nation, the states and the local communities all change and grow constantly, the local government official has a professional responsibility to not only observe, but to sometimes influence these changes. Those responsible for public-sector debt management, for example, cannot in good conscience ignore the changes in the municipal bond market in recent years, nor the changes in the political, financial and regulatory environment that have an impact on their debt and other financial instruments.

The Changing Bond Market

Like the rest of the world, the municipal bond market is undergoing significant changes, some with elements of drama and excitement like the "well-loved" arbitrage rebate rules in effect now, and some with the massive proportions of the 1983 default of the Washington Public Power Supply System (WPPSS) on $2.25 billion of its bonds. These, plus the more recent Colorado dirt bond defaults and the decline in credit ratings of major bond issuers such as the States of California and Massachusetts have permanently altered the way the municipal bond market is viewed.

The municipal bond market also has undergone pervasive changes of a more subtle nature. One of the most important is the shift in bond buyers in the past 10 years. In 1980, approximately 27 percent of all outstanding municipal bonds were owned by individual investors; today they own about 60 percent. Banks, which before 1981 held close to 40 percent of outstanding municipal debt, are generally no longer allowed to deduct the costs they incur to purchase and carry most municipal debt. They now hold only approximately 14 percent of the outstanding bonds. The participation of insurance companies in the municipal bond market also has been steadily declining over the past 10 years.

It is clear that municipal bonds are not being purchased today by the same groups that purchased them in the past. As the customers change, it is reasonable to assume that their needs also will change, as will the protection they will be afforded by the politicians and regulators.

Another change in the municipal bond market is in the type and volume of municipal bonds being brought to market. In 1970, general obligation (GO) bonds comprised 66 percent of the long-term bonds being issued (by volume) and revenue bonds the remaining 34 percent. By 1975-76, the ratio of GO to revenue bonds being issued was around 50/50, and by 1989, GO bonds comprised only 30 percent of the volume of long-term municipal debt being issued. When one considers the plethora of variable rate instruments that have been marketed in recent years - and the array of calamity and other nontraditional call features, innovations in parity tests, refunding techniques, security substitutions and rate covenants - it becomes clear that the municipal bond market is much different than it was just 10 years ago.

There has been a dramatic increase in the sheer volume of municipal bond financings in the past decade, as much of the responsibility for funding infrastructure-related capital projects has shifted from the federal government to state and local governments. In 1981, federal government grants funded 41.7 percent of state and local government infrastructure projects, with 35.7 percent being funded by municipal bonds, and the remaining 20.8 percent by current receipts. By 1989 federal grants had fallen to 26.1 percent with debt financing picking up the slack at 53.9 percent and current revenues continuing to fund approximately 20 percent of these projects. The amount of state and local government debt outstanding has grown rapidly in the past two decades from $133.1 billion in 1969 to $320.1 billion in 1979; $784.0 billion in 1989 to $1.1 trillion in 1991.

The municipal bond market, despite a spotted history with high levels of default in the 1840s, 1880s and 1930s, has enjoyed an enviably low default rate marked by a strong record of financial soundness since the Great Depression. There have been some very visible and highly publicized defaults, including the $2.25 billion WPPSS projects 4 and 5, Mutual Benefit Life secured variable-rate demand bonds, Colorado "dirt bonds" and the taxable bonds backed by Executive Life guaranteed investment contract. But overall, since the depression, defaults have averaged 0.3 percent per year of the face value of bonds outstanding, as against a rate of 3.0 percent for corporate bonds.

The accolades deserved by the market as a whole are not necessarily shared by each of its components. Over the past five years, certain private-activity bonds (those called "conduits") for industrial development, housing, nursing homes and hospitals have accounted for three-quarters or more of the total dollar amount of payment defaults of all municipal securities. In 1987, the GFOA estimated the default record for governmental obligations, excluding WPPSS, to be 0.1 percent. It is clear that while conduit issues are not a major portion of the total municipal volume, they have produced a disproportionate amount of the problems attributed to the municipal market as a whole.

The foregoing brief review underscores the fact that the municipal bond market has undergone significant changes in the past decade. Changes in purchasers, types of debt, the covenants and features of the instruments, and the increase in volume of municipal bond financings have created "a whole new ball game." Gone forever are the days when a significant portion of the municipal bonds were issued without an official statement being prepared. No longer can a local government issue bonds and blithely assume that they will be held by large banks and insurance companies who have the sophistication and resources to...