The Securities and Exchange Commission announced yesterday that bank loans and direct placements will be added to the list of events that municipal borrowers must report under Rule 15c2-12 if they could materially impact existing bondholders. The changes will improve transparency in the municipal debt markets, and may significantly alter the playing field for some banks.
In March 2017, we discussed the SEC’s proposal to add bank placements and other financial obligations to Rule 15c2-12 of the Securities Exchange Act.
The Rule requires municipal borrowers with public bonds outstanding to disclose “listed events” including publication of annual reports and posting of notices for various events such as failure to pay principal and interest, defeasances, and rating changes, within 10 business days of their occurrence.
Bank loans and direct placements were previously exempt from the Rule and are under heightened scrutiny by regulators because they can compete with the rights of existing bondholders, yet as private debt, their terms are undisclosed, leaving those bondholders in the dark.
With yesterday’s announcement, bank loans and direct placements will be added to the Rule, along with interest rate swaps, guarantees related to debt, leases entered into as vehicles to borrow money, and related events reflecting financial difficulties.
The amendments will apply to continuing disclosure agreements for bonds sold to the public after the compliance date. Existing agreements are grandfathered, so until a borrower goes to the public bond markets, disclosure of new listed events will not be required.
New events will not require disclosure if they do not materially impact existing bondholders, but the SEC declined to provide a standard for materiality, leaving it to borrowers to figure it out.
In the case of financial obligations, the borrower will also have to decide between posting a summary of terms, or posting the actual documents.
If a borrower goes with a summary of terms, the SEC says that should include a description of the material terms of the financial obligation, such as: date of incurrence, principal amount, maturity and amortization, interest rate if fixed, or formula if variable, and any default rates.
There is no question that these amendments will improve disclosure in the municipal markets. They could also impact market participants differently.
Bondholders, typically mutual funds and institutional investors, should be pleased as they have long complained about the lack of disclosure associated with bank placements.
Borrowers may be less enthusiastic, because limited disclosure and lower costs of issuance are some of the major benefits of direct placements when compared to public bond offerings. However, it’s hard to imagine that a one-page summary of key terms is going to cost anywhere near as much as the Appendix A to an official statement, so the additional disclosure burden is unlikely to tip the scales in favor of public debt.
A greater concern is is that some underwriters may require borrowers to disclose all obligations regardless of materiality, which will turn future public bond offerings into “disclosure fests” and add significant costs to underwritings.
But the biggest impact of the amendments may be with lenders. Once pricing and other key terms are posted on EMMA, borrowers are in better position to negotiate, particularly those who do not go to the bank markets often and are less up to speed on market terms. This improved access to pricing and other prevailing terms could increase competition, drive down credit spreads, and may cause some lenders to back out of municipal lending, particularly given the impact of the Tax Act on taxable equivalent yields.
The compliance date for the amendments is 180 days after they are published in the Federal Register.