No matter who wins the presidency next year, the urgency around public infrastructure renewal and replacement will remain. Similarly, the infrastructure supporting the primary capital raising mechanism for public infrastructure is alarmingly weak and outdated. Fragile structures lurk beneath the surface, and action is required. Even with well-intentioned efforts, our municipal finance industry is falling further and further behind other markets, and other industries, in how the daily work of market professionals — including issuers — are impacted by increased requirements, junior resource recruitment challenges, decreasing financial resources and technology underinvestment. We know the challenges, and it’s not too late for bold solutions.
As backdrop, the public municipal market makes up 12,000 to 13,000 new issues per year with $300 billion to $400 billion of volume, from less than $1 million to more than $1 billion. Thousands more transactions take place in the private market through bank loans and leases, and other credit arrangements. Private market investment has cooled, as corporate tax rate changes have made bank pricing relatively less attractive versus the public market. Underwriting spreads for new issues have collapsed in certain regions, in some cases less than $1 per $1,000, while much of the work of preparing a transaction has by necessity migrated to municipal advisors. Sell-side research is often too costly to support at many underwriting firms.
The inconvenient truth is that for many years the sustained investment required to originate, propose and then execute, municipal finance transactions has been cross-subsidized by better margins from other ancillary products and services that allow for otherwise marginally profitable new-issue bond origination operations to be justified. This has resulted in a concentration to larger, diversified institutions, which derive a competitive advantage when competing for new business, and to those that benefit from highly developed wealth management units.
Other than in niche specializations, only these firms can afford to make appropriate and necessary investments in people and technology. Empirical evidence suggests that more industry volume has been concentrated in fewer, large institutions, which should be of concern to issuers, particularly smaller issuers that rely on middle-tier underwriters and MAs to focus on their needs.
Industry veterans have observed a migration of workload, and responsibilities, to MAs, elevating their importance while also substantially raised the cost of doing business for them. Most advisors are independent, boutique firms. Of the more than 600 MSRB-registered independent MA firms, the majority make up three or fewer registered MAs. They face substantial costs from Dodd-Frank MSRB regulatory implementation, while being chronically underinvested in technology, data access and appropriate cybersecurity defenses. Further regulatory requirements are sure to follow, bringing more cost to a stressed business model. Regulators pay some attention to the costs of implementation, but these additional costs are rarely fully studied and appreciated. I believe these costs will surely accelerate a trend toward consolidation among independent MA firms as these costs need to be spread out over larger platforms.
I’ve had the opportunity to inhabit many Zelig-like professional roles in more than three decades in the municipal market: investment banking, municipal advisory, structured solutions, industry committees, bond insurance and others. From those varying perspectives, there are several consistent takeaways that are concerning.
· First, the industry remains highly resistant to automation and standardization. For example, California Gov. Gavin Newsom just vetoed the XBRL bill. XBRL is one mechanism to create standard, digitized financial report formats that reduce industrywide data collection costs, and enable cost-effective value-added analytics for smaller and medium-sized users.
· Second, current procurement practices by governmental issuers are simply too expensive for the service providers. Each bespoke RFP represents thousands of dollars in cost per firm just to respond. Those costs represent an uneconomic trade-off versus the potential “risk adjusted” revenue. Consequently, fewer firms choose to compete, ironically reducing choice for the issuers. More automation and standardization must be part of the solution.
· Third, technology innovation is severely hampered by lack of investment interest from professional investors who view the municipal bond market as a niche industry without scalable opportunity, particularly acute in raising early-stage capital. Many newer municipal-specialty companies fail from lack of capital, not lack of good ideas. Upgrades have occurred on the investor-facing sales and trading side of the market, where it is easier to adapt technology solutions from the other capital markets. The procurement, origination, and execution components, though, remain well underinvested.
· Fourth, we have evolved into an industry that is struggling to recruit and retain junior professionals. Some of that is due to the grind of too many repetitive manual processes, focus on process over innovation, reduced earnings potential, and work-life balance. The daily allocation between inspiration and perspiration has moved dramatically in the wrong direction. Further, young professionals benefit from fewer opportunities to establish deep and lasting relationships with their peers across the industry, since in-person deal-related working group meetings have become a rare occurrence. We applaud initiatives such as The Bond Buyer’s Rising Stars program and a vehicle to drive younger industry leadership.
· Fifth, issuers seem to be unfocused and/or indifferent to the poor health of their most important capital raising mechanism. Credible, transparent, and candid information is rarely presented that suggests how we can all work together in our collective best interests. Participating in industrywide efforts to standardize processes can reduce the cost of doing business, driving lower costs for both service providers and for them.
We founded Otaras nearly two years ago to be part of the solution by developing “smart” technology that is built from the ground up to meet the specific, idiosyncratic needs of the municipal marketplace. Our long-term goal is simple — a more efficient, cost-effective and better-connected marketplace.
The time to act is now, before it is too late, and the next economic downturn makes unprofitable business segments too expensive to cross-subsidize. Municipal departments will, once again, become easy targets for layoffs, and closures are all too certain. In the end, the losers will be issuers that need competent, diverse ideas when they are facing their most challenging times.
Here are some straightforward recommendations to get the ball rolling.
Establish an industrywide task force that comprises representatives from GFOA, SIFMA, NAMA, MSRB, NABL and others that are going to undertake an honest, transparent assessment of the health of the market. Set up task forces to address specific areas, including but not limited to:
· Costs of regulatory compliance
· Standardizing and digitizing information for downstream use
· Technology/automation
· Junior professional recruitment and retention
· Cybersecurity
· Procurement processes
· Workflow standardization
Let’s start thinking out of the box. Why not aspire to a “Common App” for RFPs? How about a technology incubator, funded by the industry, that develops innovative technology specifically for the municipal market? What about pursuing federal funding or grants to offset XBRL-type initiatives? Why not incentivize technology players to integrate their products and solutions better? We can develop industrywide not-for-profit utilities that can handle some of the basic, industrywide functions in a shared cost model.
All stakeholders have the same goal — protect and promote the most important capital-raising mechanism that we have that finances the vast needs of our country in transportation, education, health care, energy, clean water and much more. It’s easy to act in a silo and accept the trend toward “fast fashion,” where everything is disposable. Infrastructure investment affects all citizens and taxpayers. Let’s all work together to make those dollars count.
