Contributing Factors and Potential Solutions to New Issuance Pricing Inequities

Numerous studies have concluded that inefficiencies, information asymmetry, and illiquidity create pricing inequities in the municipal market. This session will examine price dispersion and volatility for new issuance municipal securities and causes of variance. The presenter will also explore the effects of the consolidation of the underwriting industry on the issuer–underwriter relationship, how technology may remove barriers to more transparent pricing conversations, and the relationship between improved disclosure and better pricing outcomes.

Transcription:

Robert Berry (00:10):

With that, let's get started with our first session, contributing factors and potential solutions to new issuance pricing inequities. I'm thrilled to welcome Dr. Justin Marlowe. Dr. Marlowe is a Research Professor in the Harris School of Public Policy at the University of Chicago, where he also serves as the Director of the Center of Municipal Finance. His research and teaching are focused on public finance with an emphasis in public capital markets, infrastructure, finance, and state and local budgeting. He also serves as the Editor in Chief of the Municipal Finance Journal and the Co-Host of the Public Money Pod produced by the Center of Municipal Finance. He was elected to the National Academy of Public Administration, is a senior fellow at GFOA, and he contributes a regular column in the government finance review. So please welcome Dr. Justin Marlowe.

Dr. Justin Marlowe (01:17):

Thank you very much, Robert. I'm tall, but I'll take that down just a little for that. So it's a pleasure to be here and thank you very much to the CDIAC for putting all this together. Thank you to the Bond Buyer, of course, for hosting. And before I begin, let me just say thank you first and foremost to all of you for all the great work that you do. Debt management is an important job, but often a thankless job and one that goes unnoticed. It's a lot of hard work to try to shave a few basis points off your next bond deal, and so we really appreciate everything that you do to make that happen, even if it goes unnoticed and even if people don't necessarily see it or appreciate it. So I want to encourage all of you to keep doing what you're doing.

(01:58):

Know that some of us really appreciate it and we'll try to do what we can to try to make it that much better or that much easier for you. So I have a couple quick commercials that I wanted to mention. As Robert mentioned, I'm fortunate to serve as the director of our Center for Municipal Finance at the University of Chicago. This is a sort of multifaceted entity. We do work primarily in public capital markets. We also do work in property taxation, budgeting, fiscal policy, all kinds of other areas. So if you have a look, we have some interesting data, including some things that I'll talk about here today. If we can be of assistance to you at any time, please don't hesitate to say so. We have lots of great resources, including many eager students who are always willing to go to work on behalf of the debt issuance community.

(02:45):

So have a look. munifinance.u chicago.edu is our center. We also have, as was mentioned, a podcast strongly encourage you to have a look. It's called the Public Money Pod. We were fortunate to have treasurer ma on the podcast a couple of weeks ago, which was great that, excuse me, at this point, something like I think 11 state treasurers, lots of CFOs, lots of dead issuance folks. So have a look. It's as we say in the business, like subscribe and leave a five star review. If you have interest in being on the pod, don't hesitate to let us know. We think it's a great resource, one of the few dedicated podcasts that's focused on issues related to state and local finance from the practitioner's perspective. Then finally, I would say a lot of what I'm going to talk about today is coming out of a book that is forthcoming with Cambridge University Press.

(03:39):

It's called Public Debt Management Strategy and Evidence, and it's designed to be kind of a soup to nuts look at the municipal bond market from the issuer's perspective. So a lot of the things that we're talking about here today, what does it mean for issuers to get good pricing? Who buys these bonds? What are ways to think about disclosure? What are ways to think about some of the strategic debt management questions? It's all there. It's all based on what we know from the mountain of academic research that's been done in this space over the years. It should be out in roughly six months. If you'd like to look at any part of it before then please don't hesitate to reach out. I'm happy to share any and all insights that I can offer as a result of that research. So as was mentioned, we want to get into today is this question of in effect, what does fair pricing mean for issuers?

(04:24):

And so to do that we want to unpack a couple different questions. Certainly one of them would be what does fair pricing mean? We want to get into the question of how pricing happens and where it comes from. Again, we're all probably a little bit familiar with some of these questions, but we want to make sure that we're clear on them, at least from a research standpoint. What does inqu mean when we have pricing inequities? Where do they come from and what can be done to try to address those inequities? Now I would say I'm going, we could talk about inequities in lots of different ways. What I'm going to focus on here today is inequities from the standpoint of issue and issuer size. So a lot of what I'll show you is based on comparing smaller issuers to larger issuers, breaking the market into quartiles by issue size or by issuer size.

(05:07):

There's lots of different ways we could look at it. We could look at it from the standpoint of credit quality, different types of issuers, but we're going to focus on issuer size because that seems to be the place where we get the most divergence in the way that bonds are priced from one issuer to the next. But again, happy to answer any questions or get any more detail about how we might unpack the market differently based on the findings that we have. To start with the takeaways, as Robert mentioned, I think it's fair to say that all the data, all the research tells us that pricing has gotten better, that it is more reliable, it's more transparent, it's more competitive than it's ever been. Again, the question of is it good enough? Is there more work to do? The answer is no. And yes, there's absolutely a lot more work to do, which is a big part of what we'll get into here today.

(05:52):

But I do think it's important to put it in historical context and see that in fact, it's gotten a lot better with time. One trend we see is that smaller issuers have both advantages and disadvantages, some real advantages in terms of certain dimensions of pricing and some real disadvantages. And I'll try to unpack those. And I think a part of what we want to get to with the panel discussion later is what can issuers, particularly smaller issuers do potentially to try to mitigate some of those concerns? And a lot of that has to do with disclosure, investor relations, debt management practices. I'll tell you what the academic research has told us about that, and I'm sure there'll be a lot to say in terms of the on the ground reality. So the first part, where does new issue pricing come from In the academic literature we tend to think of this in terms of three buckets. When we think of the components of a yield spread, there's three different parts of that we might call tax risk. The risk that the exemption will become more or less valuable. A lot of that has to do with how tax exempts trade relative to taxable's. Some of it is about credit risk. What's the risk that the bonds are going to be repaid on time and in full? And some of it is liquidity risk, and we're going to think about liquidity a couple different ways. One of them is from the buyer's perspective. As an investor I might say, if I buy these bonds and I need to sell them, will there be willing buyers? And a lot of that comes back to the notion of segmentation. Robert mentioned in his introductory remarks, the fact that the muni market is so very segmented, so many different kinds of issuers, so many different kinds of buyers who buy specific types of credits at specific moments in time, that can have some advantages.

(07:20):

It can also have some real disadvantages in the event that you're trying to find buyers at a given moment in time. And so a lot of that segmentation will unpack as both an advantage and a disadvantage. And then there's also, of course, just the broader market technicals. What's the supply in the market at any given moment? Who's coming to market? What does volatility look like, particularly on the treasury yield side. Those are all important factors. We'll talk about those as well when we think about where pricing comes from. It's really a combination of those three different factors at any moment in time, tax credit and liquidity risk. Talk about, we'll take them one by one. Let's talk just for a moment about where yields are today generally. And what I have here for you is sort of a 3D graph of the MMD. This is the municipal market data AAA yield curve going back to 1990 and plotted in sort of three dimensions.

(08:11):

So you can see both the levels and the slope of the curb. And one of the things I think jumps out right away is that where we are today, we can think of today as having been the result of a historic runup in yields a real aggressive yield tightening that the Fed did starting in early 2022. But even with that, as jarring as that was, that has put us back in terms of levels that are pretty much on par with historical trends. Even with that big runup we are today where we have been looking back over the last 25, 30 years pretty much on par, this follows as you see, a very long slow slide of very steep yield curves with very low short end and very high long end. Right? That's absolutely something that was particularly in the post financial crisis environment, we saw that long period of very stable, very steep yield curves.

(09:04):

And then today after the yield tightening, we see a much flatter curve that's returning more to normal levels. The slope of course matters. One of the things we find in research is that a higher slope, a steeper slope tends to benefit issuers. That's a more normal, more predictable yield environment. But I think it's important just at the outset to sort of level set by saying, here's where we are with yields today relative to where we've been at different points in the past. The exemption of course matters. The relationship between tax exempt and taxable yields is a really, really important factor in this market. And I think the key takeaway that you get from here, this is plotting taxable's against tax exempts. And on the bottom chart there, you see the ratio of the two of them, we see the ratio of tax exempt to taxable yields.

(09:49):

When we look at that ratio in the bottom panel going back really from the early 1990s all the way through the financial crisis, and those of you who have been in the market know this, that ratio basically stayed at somewhere between 75 to 80% pretty much all the time. It was pretty predictable. You sort of knew that that's where tax exempts were trading relative to taxable's. The financial crisis comes along and changes that. We have the period of volatility following the financial crisis, then we have covid. And since Covid, there's been just a lot more movement in this relationship, but a lot more just overall volatility and how treasuries and municipal trade relative to one another. And I think that's an important factor, and I'm sure we'll hear about that in our panel discussion later as an important factor that really drives a lot of what happens with pricing, particularly on a day to day, sometimes hour by hour basis depending on when you're going into the market.

(10:37):

But we talk about tax risk. This is an important way to think about tax risk. Let's talk about credit for a moment, and we can talk about credit in lots of different ways. Of course, typically we think about it in terms of credit spreads. So this is just the mmds, aaa, aaa, triple B curves plotted over time. And so we see the spread of the AAA to a bunch of different credit ratings, a bunch of different credit qualities. And again, I think just like we saw with the relationship between treasuries and tax exempts, we see this period of relative stability preceding the financial crisis after the financial crisis. And really up until pretty recently we saw that level off and see a pretty predictable relationship. And then covid happens, credit spreads spike, credit spreads really widen. And now I would argue that we're back today to levels that were really kind of pre COVID.

(11:32):

So in some sense, to the extent that unpredictability or uncertainty about credit has been driving pricing, we're at a point now where we're seeing spreads that are a little bit more in line, much more in line certainly with the recent experience on the market. And again, an important factor to take away from this just is think at a very high level about what spreads mean for pricing. I don't have it in these slides, but we've done quite a bit of work at the Center for Municipal Finance as of late, just trying to understand the broader relationship between credit quality and pricing. Certainly the way that many issuers think about it, which is in terms of just true interest cost, right? And one of the things that we find is that relative to a standard AA unlimited geo credit, you see credit spreads as of late taking a really comprehensive view, looking at all different types of issuance, and we see credit spreads that are a little bit even wider into a degree than what you see here if you are on all else equal Triple B rated credit is trading at about five basis points on a TIC basis above where a double A or even a single A is.

(12:38):

When you get into some of those higher, more high yield credits, double Bs, it's more like 120 basis points. And if you get into the B range, it's more like 165 basis points. So that clear distinction between the high yield versus everybody else space, but within the A double A, triple B rated credits, you see some differences, but they're not nearly as pronounced as they are when you go elsewhere. And I think you see that play out in that chart as well.

(13:07):

So that covers the credit piece. Let's talk about liquidity a little bit. So there's different ways to think about liquidity. Certainly the default is to be able to just talk about how many bonds are trading, right? How many trades and what sort of trade volume do we see in the secondary market? And in general we've seen this is going back to 2010 in general. What you see here is that the number of trades has increased pretty considerably. These are layered in terms of the bottom layer is sales to customers. That's the darkest blue. Then purchases from customers and then inter dealer trades on the top and just the number of trades. The MSRB has put out a couple of recent reports on this that the number of trades in any given time period is now routinely eclipsing a million trades, which was not necessarily the case before, but it has been as of late.

(13:50):

So there's a lot more churn, a lot more trading activity in the market overall, which we can talk about some of the underlying factors for this. I think a theme that we'll keep coming back to throughout today is the role of exchange traded funds, ETFs, which have been a big source of a lot of that liquidity. We can talk about the advent of separately managed accounts, SMAs as a retail force in the market that has some institutional kinds of characteristics. So that's another important consideration. A lot of that is contributing from what we're seeing to this increase in overall trading, just the numbers of trades, we see something similar in terms of trade volume. So just the par value that's traded has also increased, not quite as sharply as the number of trades, but we've seen overall trade volume increase over the same time period as well.

(14:38):

And there's every reason to think that that will continue into the future. An important point however, and this gets to the potential for more work to do or some considerations that we need to be looking ahead on an important consideration is that as much more liquidity as we're seeing in the market, we're also seeing that liquidity really concentrated in a few issuers. So this is a chart that we've been preparing for a while now, and it shows the percentage of total trading activity in the secondary market that is in the 100 most actively traded bonds. So if you take the 100 most actively traded bonds and you say what share of total secondary market trading is attributable to them, that number has grown quite a bit and it's now well over half. So on any given day, half of the trading in the market is in those 100 most actively traded issuers.

(15:31):

And in some days, as you see, it spikes to more like 80 or 90 or even almost close to 100%. So these are in certain trading periods. We see these most liquid bonds, these most actively traded bonds are the ones that are traded way more often. And this creates an interesting almost kind of chicken and egg scenario. Do the exchange traded funds, for instance, trade these bonds because they're the most liquid or are they the most liquid because they're traded by the ETFs? And this is an interesting question, and in terms of positioning new sales on the market, something that we definitely want to be aware of because they are in many ways a real source of liquidity for the market and price discovery for the market as a whole. So it's what we like to call thick liquidity, for lack of a better word.

(16:14):

Robert also mentioned pre-trade activity, which is another area where certainly we've been doing some work and the MSRB has been doing some work on this. By the time we get to looking at trades, of course we're only looking at the most liquid bonds, right? The question is whose bonds are not trading, whose bonds are put up for sale but then ultimately don't actually trade? And this is something that's obviously a lot more difficult to get at. One of the ways we can get at it is by looking at data from these alternative trading systems, right? The ATSs, if you're familiar at all with the ATSs, it's essentially like a Craigslist for municipals. So if I have a bond and I'm looking to sell it, I call my broker, I call my dealer and I say, let's put out a quote, let's put out a bid offer and see what or put out a sale offer, excuse me, and see what happens.

(17:02):

And I want to point out two things that we're seeing when we look at some of those data. We're fortunate to have access to some of that pre-trade data from a couple different a TS providers. This happens to be from MBIS, municipal bond information services, which is now part of SQX securities code exchange. And so in this first picture, what I'm going to show you is that there's lots of different kinds of bonds that are put on sale in any given day, and we see that the types of bonds that are put on sale really don't vary all that much by, in this case, the par amount. So if we're going to break the market into very large issues versus smaller issues, we see that there's really not that much difference in terms of what is put out for sale. Small bonds, small issuers, bonds are just as likely to be put out for sale as large bonds and larger issuers bonds on any given day.

(17:51):

There's between about 180,000 and 200,000 sale offers that are made just on this one particular trading platform. And I think it's representative of the alternative trading systems more generally. But then when we ask what actually does trade, whose bonds are actually put out for sale, and then whose bonds actually result in a trade, we see a very different pattern right here. This is a picture of the bonds that actually, I'm sorry, of the sale offers that actually result in a transaction. And what we see here, and this is just for one year granted, so there's definitely a cyclical effect to it, but what we see here is that the smaller issues are far less likely to be traded, right? The smaller issues under 25 million, 26 to 65 million, rarely trade at all. Those that do trade tend to be the very large issues and from the very large issuers.

(18:43):

So again, that concentration of liquidity in the largest issues and the largest issuers an important factor that we want to keep an eye on. Another important technical factor that's worth mentioning, and those of you certainly who are on the issuer side and have been in the market, have heard conversations, I'm sure with your underwriters and you're amazed about how should we think about the supply demand relationship? What does it look like at any given moment when there are redemptions coming in at the same time that we are going to the market? What does it mean to think about who else is in the market at the same time that we are in the market? The idea being of course, that there's only so many buyers, right? There's so many people interested in buying municipals and we're competing for those limited dollars for investment. One of the things that we've been trying to track, and lots of people do a version of this, but our version of it at the center is we focus on just the ratio of issuance to redemption.

(19:34):

So at any given day, a bunch of bonds are maturing and being paid off at the same time that a bunch of bonds are coming to market. And when we look at that relationship between issuance and redemptions, if we think that redemptions are dollars that are available for investment, what do those trends look like when we compare those two numbers over time? So this is sort of a long run moving average of the relationship between those two different factors. A couple things stand out, right? Again, long decline in this over time, going back to 2010. So in general, as there's been redemptions, there's less issuance coming up to take the place of those redemptions. So in other words, the supply demand stability relationship has been pretty stable, at least from the standpoint of issuers. We also see some differences, again by issue size. So for larger issues, that number has decreased even more than it has for smaller issues.

(20:26):

But for a lot of smaller issuers, the number is actually less than one. So in other words, in any given day, in any given technically three week period, in any given three week period, there's more bonds that are being redeemed than there are new bonds coming to issue, new bonds coming to market. So it raises some interesting questions, and granted there's lots of variation underneath these numbers, but it does raise some interesting questions about what does it mean for there to be, where's the demand coming from? How stable is that demand? And how much underwriting risk is there really in any given moment, given that we see the demand for municipals stay relatively fixed, even though the supply has been shrinking a bit over time, we look at the same relationship by plotting it between yields and the ratio of issuance to redemption. The idea here is that in any given day, if there's a lot more bonds coming to market than there are bonds being redeemed, that's what you see on the X axis there on the bottom axis that you would think that yields would have to increase to compensate for that, right?

(21:30):

If we're having to compete for a limited buyer pool, we're going to have to raise yields, lower prices to make that happen, and we see a little bit of that, but maybe not as much as you might expect, right? We certainly see a little bit of that, particularly during periods where there's a lot more issuance than redemptions. We see that trend play out for larger issues. But in general, again, the downward trend here suggests that the supply demand relationship is pretty stable and has been working to issuers favor. So we think about those as market technicals. That's an important point. I think that's also worth mentioning. And the last point before we move on to talking about what fair pricing looks like and what it means is, I'd be remiss if I didn't say something about headline risk, right? This is a perennial concern in the municipal market, the tendency for bonds to trade on information that may or may not be directly relevant to how we should think about pricing for municipals, but we see it, this is an interesting thing that we do at the center.

(22:29):

It's what we call our CMF Muni index, where we track the secondary market pricing for a bunch of different issuers. In this case, it's for the 33 largest issuers. So we take their geo credit and then regularly go out and look to see how their geo credit is trading in the secondary market. It's indexed to 2018. So we start in 2018 and then move forward. And you see a couple of things happen. Obviously big drop off in prices during covid as the Fed started hiking rates. We see another big downward movement in pricing, and we've seen quite a bit of volatility in the market since then, but one of the things we're able to do with these data is see how individual issuers compare to one another. So what I've highlighted here are three cities, Chicago, San Francisco, and Albuquerque. And when you look at this on the face of it, you think, okay, Albuquerque sort of makes sense, right?

(23:27):

The story, the headline with Albuquerque, like a lot of other kind of medium-sized cities in a post covid world is that a lot of people are moving there to work from home housing's more affordable, et cetera, et cetera, et cetera. And so naturally the trajectory there is upward and the market is responding to that. So you see this for Albuquerque, Corpus Christi, Tucson, places like that, they tend to trade really, really well on this index compared again to where their prices were in 2018 when the index begins Chicago, which in many ways has no business being anywhere near the bottom, and I say that with love to the people who I live with and work with. Chicago has no business being in the top third, and yet there's a lot of demand for Chicago bonds. Some of that is demand among certain kinds of high yield investors for sure.

(24:13):

Some of that is that Chicago's financial fundamentals are actually stronger maybe than what some might think, but clearly Chicago's bonds are trading really well. And then at the bottom we see San Francisco, which in many ways doesn't make a lot of sense. San Francisco's financial fundamentals are as strong as any municipal government in the United States. Some of the most valuable real estate in North America is here, and yet the market's pretty bearish on San Francisco, and one could argue that that has to do with perceptions of crime, perceptions of governance issues, and on and on and on. So we could dissect this all day. I think the simple point is that headline risk matters, that those perceptions and that information that might deviate from financial fundamentals has a role in how we think about municipal bond pricing, whether we would like it to or not, whether it should or whether it shouldn't.

(25:02):

So we talk just for a second then about what we mean by fair pricing. So in the academic world, when we think about fair pricing, we really focus on three measurables, and these may or may not be the same measurables that we talk about, say in the underwriting conversation or in the conversations you have with your municipal advisor, but this is the way we tend to think of it in terms of the academic research on the question. One would be price volatility. So does the same bond trade at very different prices at the same moment in time? Do we see big contemporaneous differences in bonds? The argument being that if the same bonds trades at same bond trades at very different prices, that's a concern that's investors disagreeing about how to value that bond, and that creates some uncertainty that creates some price volatility. Sorry, accidentally went ahead, but that's all right.

(25:47):

Also, price evolution. So are bonds underpriced at issue? If they're underpriced at issue, do we see big increases in price after they've been issued? Of course, that's also a question. And then other kinds of transaction costs, particularly underwriting spreads that obviously has a big impact on how much all of you pay when you go out and borrow money. Why should issuers care about this? Well, in general, we know that with price volatility, price volatility tends to lead to higher yields. When there's investor disagreement, the tendency is for prices to go downward, prices go downward, yields go up. So when there's disagreement, that's a risk that is often passed on to the issuer to the borrower. Price evolution is important because if bonds are underpriced at issue, you can argue that that's money left on the table, right? If we could have priced those bonds higher, we might've had a higher overall takedown from the transaction, in turn lower borrowing costs for our taxpayers.

(26:40):

And so price evolution matters. We want to try to the extent that we can minimize that or at least keep it within reasonable levels. And then of course, transaction costs matter a lot too, just in terms of overall amounts that we're spending to borrow money. So let's take these one by one. So price volatility. I think the story with price volatility that you see here is that it's really declined pretty dramatically over time. If we go back to 2006, and again, this is broken out by issue par amount, we see that these numbers have both compressed with respect to the different types of bonds, and they've also just generally declined over time. There's far less price volatility going back. Really, this is at the very beginning of the MSRB's transparency efforts, and I think there's lots of research. This picture I think bears it out that those efforts have really made a difference that we see far less price volatility than we've ever seen.

(27:35):

It's increased a bit as of late as the fed rate tightening has taken hold, but in general, we see some real improvement in this space. But again, lots of variation by size by type of borrower. I think that's a noteworthy point in thinking about areas for potential improvement. Real important point too with respect to price volatility is that there's dramatic differences between day one and every other day. So on day one, we see comparatively very low price volatility, which of course makes sense, right? A lot of those sales are prearranged, the prices are known in advance, and so you don't see a lot of variation in pricing on day one, but once you get through days two through 14, you get a very different story. And I think this is another important part of the conversation with underwriters about who's buying on day one versus who's buying in the future.

(28:23):

And if we see particularly big changes from day two through day 14, what does that tell us about what we might do to try to improve some of those efforts? Underpricing is interesting, and in that it has declined pretty substantially over time. This has been of course a concern for a long time, the idea that bonds are undersold and that issuers leave money on the table. And there's some evidence that had happened particularly in the post financial crisis era, but today those numbers are lower than ever. We see less underpricing than we've ever seen a bit of a spike as of late. If you look at that gray line, you see that big jump in 2024. We're watching that closely. What I hear when I talk to folks in the market is this is the city exit. This is the UBS exit from the negotiated side of the market.

(29:08):

There's some other sort of factors that have to do with, particularly in the underwriting side, but in general, we've seen less underpricing than ever. But the fact that there is still some, the fact that it's somewhere in the neighborhood of 35 basis points means that on average, a bond that is originally sold at par is then selling at some point in the next 14 days at a price of 100.35%. And we can translate that into real dollars from the issuer's standpoint. And again, potential money left on the table. So I think underpricing really important improving, but again, some areas for potential improvement. And we see particularly for smaller issuers, some real advantages here. Smaller issuers have seen far less underpricing compared to larger issuers, and a lot of that decline that I described is really happening among larger issuers.

(30:02):

The negotiated versus competitive debate, which we can have, this is a quick little picture just to show that this price evolution, this underpricing dynamic plays out differently for negotiated versus competitive sales. We see on the right for negotiated sales, of course, a tendency for price is pretty much always to increase in the secondary markets. It's pretty rare that you see price decreases in the secondary market for negotiated sales, which of course makes sense, right? The whole point of book running is to put together a package of pricing that's going to make some sense with competitive sales where there's some more unknowns. You see a much greater tendency for there to be some negative pricing, right? And so we have to be aware of that in the competitive sale process. This is indeed a unique risk that underwriters are taking that they're not necessarily taking on the negotiated sales side.

(30:50):

And speaking of competitive sales, we've seen a lot more participation in competitive sales as of late. This is just a plot of the average number of bids that are received on a competitive sale going back to 2006, and we've seen, again, just a steady increase, particularly for larger issuers and larger issuances. Again, smaller issuers, sort of less hovering right around where it was in historical levels. But in general, we've seen more participation particularly for larger issuers. And we've also seen a general downward trend in the spread on bids on competitive sales. So when a competitive sale happens, what's the difference between the maximum bid and the minimum bid? That spread has decreased as you see going back. It's really increased after the financial crisis. It's generally decreased with time. Big spike during covid, and now we're back to levels below pre covid, again, with the exception being small issues.

(31:48):

So smaller competitive sales, we see a lot more noticeable variation in bids, a lot more variation in pricing compared to larger issuers. And then one more point about underwriting costs, and these are data from the CDIAC. Thank you to the CDIAC for collecting all of this. Underwriting costs have generally fallen as well, going back in this case a couple of decades, just a long steady decline in overall underwriting fees and underwriting spreads. And again, a bit of a spike lately, particularly for smaller issuers. Again, arguably a good downward trend on behalf of issuers. So to sum that part of it up, we know that we see a market that's more liquid, more competitive, more transparent than ever. We see lots of benefits to smaller issuers, particularly with respect to underpricing and price volatility. And at the same time, smaller issuers do have some disadvantages, particularly on the amount of participation in competitive sales and in higher overall transaction costs.

(32:48):

So what can issuers do? And we could spend the whole day talking about just this issue. There's mountains of academic research on this very question I have summarized in the slide deck, some of the most widely cited research in this space. If you're looking for some sort of classic academic citations, you'll see those at the very back of the slide deck, but there's a few things that jump out right away. Disclosure, timeliness, there is not necessarily a benefit to issuers for more timely disclosure, but there is absolutely a clearly absorbed penalty for bad disclosure, particularly long delays between the end of the fiscal year and the release of your audit. So financial disclosure, timeliness, we know long delays tends to produce pretty noticeable increases in borrowing costs. Disclosure complexity, there's an interesting research set of papers out there right now focused on the complexity of the language that we see in official statements and in financial statements that has a cost associated with it.

(33:47):

We're seeing interesting things around underwriter and advisor selections, so the policies that you have in place for determining who's in your underwriting pool, how do you engage the network of underwriters plus municipal advisors? Having the right mix of stability and change we see makes a big difference, makes an important difference. Investor relations programs, certainly having digital road shows more aggressive disclosure, doing a better job of getting the word out can make a big difference. And then a general focus on debt portfolio management and how do we think about having the right mix of duration to match what the market is looking for? How do we think about having an overall debt service structure that makes sense for us, but is also responsive to where that supply demand ratio that I was describing a little bit ago happens to be at any moment in time. So we can spend a lot more time talking about the different ways to think about how issuers can respond. And I know that's a big focus on the panels that we'll have here a little bit later on. That's what I have happy to have. I think we've got a couple minutes for questions.

Audience Member 1 (34:57):

Good morning, Dr. Marlowe and I would like to start, I'm from CDIAC. I'd like to start off today's questions. At the beginning of the presentation, you mentioned there are advantages and disadvantages for small issuers, and in the discussion you mentioned supply demands, durability, small issuers, sometimes it's less than one. It seems to be an advantage for small issuers. And also you mentioned lower yield spread for small issuers and headline risks. Small issuers might have lower headline risks that might lead to less price volatility, meaning better price, lower yield spread, and also far less under pricing for small issuers. So I had like to ask about do you have any actionable strategies to mitigate or address the tax risk and liquidity risk and credit risk with a focus on small issuers? Thank you.

Dr. Justin Marlowe (36:16):

Very good question. Are we able to go back with this? Do we have to send right now? Sorry. No, anyway. Oh, very good. Thank you. Maybe go back maybe two or three more. Yeah, let's maybe start, oh, sorry. Yeah, I think let's start there. Very good question. So let's talk about the credit side first. What we know from the credit side is that I think one of the reasons that you see some of these issuer advantages for smaller issuers, particularly on underpricing, is that there certainly are a lot of tools out there from a credit perspective that can help to commoditize smaller issuers. When you think about bank qualification, when we think about a lot of the insurance programs, a lot of the credit intercept and other programs that are available for smaller issuers, one of the things I think that the research shows consistently is that those programs make a big difference.

(37:13):

It does make it possible for a relatively unknown issuer to be able to not only mitigate potential credit risk, but to also mitigate some of that potential headline and other risk because those bonds are often sold as part of a larger wrap. We see a similar trend for smaller issuers in the pattern of bonds sold by bond banks versus issuers that go out on their own. So for issuer, smaller issuers, again, I think those programs are not always the right fit for everyone, but one of the things that we have seen is that that commoditizing effect of things like insurance, the commoditizing effect of things like some of the state programs, commoditizing effect of things like bank qualification does make a big difference. And I think that's a big part of what you see in that pattern that we see here.

(38:03):

From a liquidity standpoint, that's the much harder not to crack, and I think the one that a lot of us are frankly kind of concerned about, it's very difficult when you think, I mean there are some of you in the room probably know better than I, you think about how many single state mutual funds we have, and you think about the potential for some broader tax policy or other change and what that would mean for the liquidity, what that would mean for the source of buyers for specific states, particularly smaller states, if in the event that we have to have a taxable market or in the event that there's some sort of a reduction to the value of the exemption. Now though, a lot of those smaller issuers are competing with smaller issuers in every other state, and now a lot of those smaller issuers have other kinds of pricing pressures that they haven't necessarily had.

(38:51):

So we are concerned about that. That is a big question. I shouldn't say concern. I mean, it's the reality that we may live in and smaller issuers will have to deal with that. Some of that's disclosure, some of that's getting the word out. I think a lot of that is developing relationships with folks at the state level. A lot of that is developing relationships with investors, particularly given, I think one of the things that we've seen, I won't ask Donald to go back to it, but if we were to go back to the slides on just the numbers of competitive sales, I think one of the things that we've seen is not only more participation in competitive sales, but we've also seen a greater number of firms attempting to participate in competitive sales, and there's some real advantages to that. A lot of upstart firms that I think through a combination of technology, they think they have better pricing models, they think they have a better read on where the market is, they think they can go out and compete for a lot of these sort of smaller competitive sale deals.

(39:51):

That's a great opportunity for smaller issuers to build relationships with. A lot of those smaller underwriters, a lot of those that are looking to sort of compete and carve out some market share, there's always going to be a place for the larger underwriters. There's always going to be a place for places to do big deals, but for smaller issuers, it may be a relationship with the underwriting community that's not for negotiated sale purposes, but for competitive sale purposes. So I think about that from that liquidity standpoint. Yeah, the tax question, that's really a policy question and that's really a treasury market volatility question. Most of which you could argue is mostly outside of our control. But a great question. There's one here and then the, yeah, come on up please. Ladies first.

Audience Member Monica Reed (40:38):

Good morning. I'm Monica Reed. I'm the CEO of Kestrel. We work on green bonds in the municipal market. I have two questions for you. You could choose either one. The first is I'm curious if you've done any analysis of the performance of green bonds in the municipal market, particularly with regard to liquidity risk? So that's one thing, and I'm also curious if you're doing any work to understand how the market is factoring in or will factor in transition risk with regard to climate change?

Dr. Justin Marlowe (41:10):

Sure. Yeah, good question. So lemme take the second one first. We have started to do some work on this. I think this is an area where certainly our center and others are really thinking about some bigger plans for some bigger research down the road because it is such an important area. And so we should first of course speak to the challenges there, which are largely political in some places. Some places you can't say the words climate change. In some places if you don't say the words climate change, you get in trouble. So it sort of depends on where you are. One of the things that we have observed, put it this way, maybe I can tell an anecdote or two that will illustrate where I think this is and where it's going. So at the University of Chicago, we have in any given summer about a dozen interns who go out and work all over the market, including several on the buy side, and I had a couple of them reach out to me about halfway through the summer saying the task that I've been given to work on this summer is my managing director gave me our AI model, our large language model, and said, go find good buying opportunities for issuers that may not be marketing themselves as green or sustainable, but in fact are doing things that are green and sustainable.

(42:32):

So use AI to go into their financial statements, to their oss, to their websites, to whatever other sources you can find and find buying opportunities there. Just because in so many places, sustainability is a word that is difficult and politically fraught, and in fact, that's exactly what they're doing. And we've actually built up a little research project that I hope we'll be able to publish in the not too distant future that shows that for a lot of issuers, there's a huge gap between what they're actually doing and what they say they're doing. And so I think what we are seeing is a market response to that when you have very large buy-side firms, I won't name names except to say that one is in Chicago and it's owned by TIAA and that kind of thing.

(43:14):

They're doing that and it matters and it might matter mostly at the margin at this point, but it matters. I think that is happening and I think that is incentivizing a lot of activity on the part of issuers to think more carefully about how are we building concerns about climate adaptation into our capital budget? How are we thinking about mitigation in our capital planning efforts on the podcast? I would say this week's episode of the podcast, we had Steve Hagerty from Haggerty Consulting on to talk about the public finance of disaster response. Huge issue right now of course in western North Carolina all over in the southeast and certainly in California you've had your experience with massive wildfires and all kinds of other arguably climate related risks. One of the things that he talks about at a length is the idea that there are huge opportunities to think about mitigation in the rebuild after a disaster, and huge opportunities to think about getting ahead of mitigation and doing it under the rubric of disaster preparedness and not under the rubric of climate adaptation.

(44:16):

It's the same thing, but there's lots of ways to go about doing it and lots of money that's available for it. So we could talk all day about that. I think there's a lot that's happening in that space and I think it's very exciting and in a weird way that the effect of the pressure on the market to think more carefully about climate adaptation is driving lots of other changes that have not been happening up until this point for some good reasons and some perhaps not so good reasons. On the first question, and I hate to say it to the extent that there's been research, it's pretty much a null effect at this point. Bonds that are marketed explicitly as green or sustainable may be a basis point or two premium. There are certainly some anecdotes and some of you are probably familiar with some deals that have gone out where they've been able to say, we've had a small premium.

(45:09):

I think that that's changing. I think as that type of security is normalized and as the data available, particularly from Kestrel and others that are working in that space becomes more sort of normalized, that's going to be a feature of the market. It's going to be a type of bond to sell. And for a lot of issuers selling that bond, even if there's not a noticeable price premium, may be a reason to do it, may not be a reason to do it. At the moment, we're not seeing massive improvements in pricing. We're not seeing big changes in liquidity. But again, I think when you pair that with all the other anecdotes that I just described, it's probably only a matter of time until you start to see some convergence there for better or for worse from the standpoint of issuers. Great question, please.

Audience Member Jim Gibbs (45:56):

My name is Jim Gibbs, I'm a Municipal Advisor. What has been the impact of the Inflation Reduction Act and the bipartisan infrastructure bill on the market?

Dr. Justin Marlowe (46:12):

I think to the extent that there's been academic research on that, I think the jury is still out. I think one of the things that certainly we've been looking at, and I know some others have been looking at, is for better or for worse, to think of a lot of the kinds of taxable and tax credit types of programs that have been made available through the IRA as sort of an extension of Babs or as Babs 2.0. What does it look like? What does it feel like when we try to do taxable issuance? And one of the things we've seen is that the uptake for those programs has been a little slower than some at treasury and elsewhere would hope. And when you talk to folks, it often comes back to that, the experience with Babs having those payments scaled back through sequestration, some pricing uncertainties, et cetera, et cetera.

(47:04):

And that always had I think, a noticeable effect. At the same time, we are seeing some big projects happening. I think it's fair to say that as local governments become more familiarized with the kinds of tools that the IRA makes available, especially for things where you can attach some of those IRA credits to projects that you wouldn't normally think of. We've heard of things like youth sports facilities that have been financed in part through some of the IRA programs because if you have a electric vehicle charging station attached to your soccer fields or your softball fields or whatever, that's a way to move that project forward. So there's been some of that sort of thing happening, and I expect that we'll see a little bit more of it, but at the moment it has not been, and all the research tells us it has not been a game changer per se for municipals. And the question of will those programs be there long enough to have their intended impact, I think is the big question right now, and we'll probably know a lot more about that in about three weeks. It cut me off if we by all means.

Audience Member John Murphy (48:14):

John Murphy, PFM, one question I had for you regarding your index with regard to Albuquerque, San Francisco and Chicago, can you explain the components of that and how it's broken up and would an option adjusted spread kind of graph be more appropriate than that? And I just don't know the components of how it's comprised.

Dr. Justin Marlowe (48:34):

Yeah, yeah, really good question and I hate to ask, but if we could go back maybe to that slide. So this is, let's keep going a couple more, two more, I think. Yeah, perfect. Thank you. Yeah, to be really clear, this is, we call it an index. This is not meant to be a tradable index. To be clear, this is more meant to be just illustrative and to one of the questions that I often get as a professor in this space. The media will call and they'll say, so what do you have that is sort of like the stock price, but for a city, what do you have that is sort of like the stock price, but for a county? And so that's what this is meant to be. It's meant to be just a very high level indicator of broad investor sentiment toward given issuers at any moment in time.

(49:27):

But in effect, what we do is we go out and we take the, it's done on a do yield basis, and then we convert all those yields into prices. So it's not option adjusted. We are generally looking to do non callable bonds, so we do try to deal with some of the callability and negative convexity and other sorts of concerns that follow that. So we do adjust for that a little bit, and we definitely do adjust for, we weight it by trade size. So it tends to be weighted in favor of sort of more medium sized, smaller trades so that it's not dominated by that kind of institutional presence on the market.

(50:15):

Correct. Yeah. It's all geo credited and it's all, again, non callable, relatively short term geo credited, which is why not every city is included a lot that don't have that. So it is, it's a mix of bond characteristics and a mix of investor sentiment. It's far from a perfect capture of pure investor sentiment. And another important point to make is that, again, a lot of it has to do with where you were in 2018. I think this is in part the story with San Francisco, in fact, that San Francisco was trading, has consistently traded well and especially was trading well in 2018. Any decline feels like a really steep decline, and that's certainly been part of the story there. At any increase feels like a steep increase if you've been trading relatively low, which is in part the story with Chicago. So no, this is meant to be, again, illustrative, contextual type of factor. We have had some conversations with some folks about some tradable indices. It's going to be interesting. I think, again, that's another area where technology has made a big difference and will probably continue to make an impact. Certainly the Bond Buyer, there have been attempts at that sort of thing in the past, so we'll see. I think that that's an area where the ability to go long and short in this market probably wouldn't be a bad thing.

Audience Member Fernando Lopez (51:31):

Dr. Marlowe, thank you for your presentation. Fernando Lopez from Loop Capital. My question to you is this, in light of your comments with regards to the developments in the market and in light of the fact that we have the upcoming election and clearly the expiring tax code, your thoughts, and I know it's kind of broad, but your thoughts may be around the potential for the exemption on Munis to be lost and the impact that could have on our markets?

Dr. Justin Marlowe (51:57):

Sure. I think I'm definitely not in the political handicapping business, but we can make a couple comments on that. I think number one, many of you probably read, there was a story in the Bond Buyer a couple of weeks ago about some work that we're doing at the center to try to answer some of the questions that often come up in this debate. For instance, what is the total amount of debt issuance by congressional district? Those sorts of questions that we kind of have an intuitive sense of, but we don't have a solid answer to. Again, we do now, fortunately, given some of the data advances in the market, we're able to, so we're doing some of that work to try to answer those questions, not in an advocacy capacity. The goal is not to sway the debate one way or another, but just to answer questions that we know people on both sides of the debate about the exemption are asking.

(52:48):

So outside of that, I don't necessarily have a view on what is or is not likely to happen. I do think that anybody who's been following this market for a long time, it's pretty remarkable how much innovation has been happening around the taxable space. The fact that Taxables are now a permanent segment of the market these days. Everything that's happening with tenders and a lot of the more sophisticated debt management strategies we're seeing, certainly the potential for the IRA and some of those programs to make a difference. I just think regardless of where the high level policy goes, there has been and will continue to be a movement toward thinking about debt management as a portfolio strategies and not necessarily just tax exempt issuance but as a sort of a broader portfolio of strategies. And that's not a good thing, not a bad thing, it just is. That's the hard work that you folks do every day to try to take advantage of the tools that are available. If there's a change, obviously it will shuffle that portfolio very quickly, but I think it's part of a sort of a longer, broader trend that we've seen. And again, we're all able to adjust to that depending on how that arc sort of unfolds. So yeah, I hesitate to prognosticate, but I think it's fair to say some of these trends have and will continue either way.

Audience Member David Life (54:23):

Hi, Dr. Marlowe, David Life. I'm a Municipal Advisor. Thank you for the presentation. I was just intrigued by the last page of conclusions, one of which in your recommendations to issuers was to note that the composition of your underwriting team and your MA selection could impact pricing by 20 to 30 basis points. I don't doubt that's important. I'm a believer in that, but I'm just curious how you quantify that and what the basis for that was. Thanks.

Dr. Justin Marlowe (54:51):

Yeah, good question. So if you look in the last couple of slides, there's some papers that are cited there, and so that's taken directly from that. The way that it's measured a couple different ways, certainly one of them is the stability of that network. So when you look at the mix of who's on your MA team, who's on your underwriting team, who's on your bond council team, when you look at that over time, one of the things we see is that stability is good up to a point. And then beyond that point, stability becomes a bit of a liability and we can debate why that may or may not be the case. I think the underlying story, certainly with the research from psychology and other fields would tell us is that at some point people fall into a pattern of groupthink. And to be clear, that effect is not the same across all types of underwriters and not the same across all types of MAs.

(55:42):

There is a noticeable difference in the literature on independent MAs versus non-independent fas. So I don't say that too editorialized. That's just a fact. And so that's one of the main ways is in terms of the stability of the composition of the network. Another way to think about it that we have seen a little bit more recent work is on understanding just the selection process. So when there is a more sort of transparent and rigorous and methodical way about thinking about who's going to be in the underwriting, the candidate pool for underwriters, for instance, in the candidate pool for MAs, that more transparency in broadcasting that process in advance tends to produce some noticeable gains. And some of you, I know for a fact do this. I mean, there's been no research on this, but again, anecdotally, I think we're all familiar with situations where one of the preconditions for being in the underwriting pool for negotiated sales is to have participated in our most recent competitive sales and that kind of thing, sort of show your cards, show some love, and then you'll get a different kind of attention when it comes time for the negotiation.

(56:48):

Nobody's done, to my knowledge, systematic research on that, but anecdotally, certainly we see a lot of that. So there's different ways to think about it. Stability, and really in some ways it's about measuring the procurement process for those services that has its own independent effect. Wonderful. Thank you so much. It's been a pleasure.