The past is prologue in Muniland: Hallacy & Ciccarone look back, ahead


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Mike Scarchilli (00:03):
Hi everyone and welcome to the Bond Buyer podcast, your go-to source for everything related to municipal finance. I’m Mike Scarchilli, Editor-in-Chief for The Bond Buyer. And this week we’re taking you on a journey through time with a discussion that bridges the past, present, and future of the municipal bond market. With us this week are two distinguished veterans of the space. We have Richard Ciccarone, President Emeritus of Merit Research Services, who has more than 40 years of municipal bond investment management and research experience. He was the first project manager of Merit research’s predecessor software and database product, the Merit System in the mid 1980s, and was a co-owner and co-publisher of muni net, a website devoted to municipal related matters. Joining him is John Hallacy, president of John Hallacy Consulting. John’s lengthy tenure in the municipal bond industry was spent primarily as head of municipal research for Bank of America Merrill Lynch.

He also spent time as an analyst and manager at s and p Global Underwriter and marketer at four bond insurance companies, served as the head of Magni, the president of the Society of Municipal Analysts, and once upon a time even spent several years programming and hosting bond buyer industry events. This episode is a treasure show for anyone interested in understanding how the municipal bond business has transformed over the years from summer Lowell’s and 25 page official statements to the era of digital platforms and 350 page disclosures. John and Rich share their firsthand experiences of the market’s growth, the impact of regulatory changes and the advent of technological innovations that have reshaped how we approach municipal finance today. But this isn’t just a trip down memory lane. Our guests also look into the crystal wall discussing the future trends and innovations that are poised to further transform the municipal bond market from the role of artificial intelligence to the shifting landscape of investor demographics and the ongoing challenges of market liquidity. So sit back, relax, and let’s dive into this enriching conversation hosted by Bond Buyer senior reporter, Chip Barnett.

Chip Barnett (02:10):
I guess the first thing I’d like to know or to hear about from you is some of the things that you’ve seen since you first started in the business and maybe some of the topics that you find to be important that you’ve seen in the past. And maybe you can first give a little bit of background about yourselves and then go into what you think people really should know about the muni bond business, public finance.

John Hallacy (02:43):
Alright, well I guess I’ll take the first slot. John Halley here. Rich and I both started around the same time in the late seventies and it was a very different world back then. I started at s and p, went on to the sell side and then went to a couple of the bond insurers and tried to stay involved in the business for years and basically had an interesting career overall. I mean the hard part was I never got to the buy side like Rich did. So that was the one side of the business I didn’t get to, but certainly knew and worked with people closely on the buy side for years and years. Two quick things that come to mind and then I’ll ask Rich to chime in.

The volume has leaped incredibly over the years. I mean, when we started, the annual volume was around 40 billion a year and there was something we used to call the summer low. There wasn’t much issuance in the summer so people could actually take vacations. Now, of course, volume is well when excess of 400 billion a year or thereabouts. So it’s been a big change issuance wise. Also, when we started, disclosure was just coming to the forefront and official statements were relatively thin, as we used to say, 25, 50 pages. Now we have official statements that are 350 pages or more depending on the complexity of the credit. So we’ve had a lot of improvements in disclosure over the years, including secondary market disclosure and many other innovations over the years, if you will. So Rich back to you.

Richard Ciccarone (05:04):
Yeah, John. I mean, gee, this is so difficult to talk about because there’s so many memories that flood into your mind and I’ve had a lot of good memories even working with John over the years. I think that I came into the business on the heels of the New York City crisis and so did John and they were hiring up municipal bond analysts and believe it or not, to those that are younger and newer to the business, it was the banks, not the new style banks, the old style banks that were really the titans of the industry. Everybody from Chase Manhattan to actually names like you wouldn’t even have heard of today, continental Bank, first National Bank of Chicago, Harris Bank. And I started at the Harris Bank, which was always one of the top 10 if not top five underwriters as a municipal bond analyst. And it was an exciting position to be in.

It sort of captured all of my interests that I had getting into the business. I loved just the idea of thinking about how cities grew and how they prospered, how they were broken, et cetera. And then I found out that municipal bond business was much more than just state and local governments and that made it even more interesting. But in terms of, we talk about how volume changed, which John brought up there was because the market changed a lot while we were there, we were witnesses to seeing municipal bonds go to an all time high tax exempt municipal bonds went all the way up to 11 and 12% depending on whether they were geo or revenue bonds. By 19 80, 82, so about the first few, several years of being in the business, we saw this rapid climb on the roller coaster to the top of the hill before it started to roll down on that roller coaster. And when it went up, it was during a period of inflation. Nothing like we see today when we worry about it, I guess I would think John would probably agree with me on this. It doesn’t feel that interest rates are that high when you’ve been where we’ve been over the years. There’s

John Hallacy (07:24):
A lot of truth to that.

Richard Ciccarone (07:25):
Yeah, yeah. And you real return expectations on your bonds were 3% or more at times, whereas today the expectations are lower, but going up squeezed out a lot of firms and it changed the nature of the business. It changed to became the dominant investors. We went from banks and insurance companies being the investors primarily to by 80 in the early eighties with those high interest rates. And then you figure in the tax exemption that it brought in individuals who suddenly became the majority of the market. And it wasn’t until later that mutual funds were really took off. Predecessor to that was the unit investment trust, which were the dominant players for a time and nobody knows about ’em today, but they would package long municipal bonds and have double tax exempt yields on them. What an attraction. And they were a good deal even though they might’ve been a high duration product that worked out for us and worked out for the industry in generally.

But I think that transformed the industry as to who the investors were and the volume, which is interesting that it went up as John talked about gradually I think was interesting given interest rates were already so high, the dealer side became more dominant in the eighties over the banks as the new, I think the new wave of municipal bond financings were in the revenue bond area, like public power bonds. And we can come back to that later when we talk about public power. But you have new deals that were all coming in that banks were no longer were not allowed to invest in after the depression, and therefore the dealers took over the dominance in the industry and that changed things. I would say that in terms of disclosure, which John talked about, I too very much impacted, influenced by the issues involved with disclosure.

It was a horrendous problem When we first started, John, you talked about a 50 page document. Then I actually have copies in my basement from Texas, a four page prospectus, and most of them were pictures which occluded always the water tower in the town. And they weren’t all like that, but was the extreme is it was very hard to get disclosure on the new issue side, no less secondary market. On the secondary market. We had to prove that we own the bonds in order to get hospital financials. So accessibility to the documents was a real big problem. Not to mention the consistency of the presentation, the completeness of them. And then of course, which is still a problem today is the timeliness of them. So that is an issue and I hope we can come back and talk to us, but it led to the first technology introductions, including the merit system in the early eighties or the mid eighties, and I’d love to talk to it about it, but disclosure has improved if you’re around like us, we’ve seen it improve a lot. Although today as we get into improvements, there’s always an expectation that things can get better and even more timely and that is the case today.

John Hallacy (10:48):
Well, you hit on a lot of good points there. I was actually listening to Kramer on CNBC the other day. He was talking about how when he started he had to look at microfiche. I remember what microfiche was. I don’t even know if anybody knows what that is anymore. But sometimes we had to go to that because everything else was print. If you didn’t have the print, that was the only document you could refer to your other point about rates. I remember working on an LA county one year note that sold at over 12% in 82. I mean, it was just incredible what was going on then. And the other thing we didn’t mention that was an important development. It really grew in the eighties and had its sort of zenith in the nineties, although it’s still an active factor of course, is the whole world of bond insurance.

There was a time when the underlying credit became less of a concern and which insurer did you have? I mean, you were always concerned about the fundamental credit, but the insurance companies were dominating the activity at one point and the penetration rate was very high. And that of course has changed, although it’s growing again. So that really altered the market for a while and kind of changed the perception of credit analysts in particular. I think now they’re more important than ever. They’ve always been important, but more important than ever. And Rich talks about the data provider explosion. Bloomberg was an incredible development when I first got one on my desk and before that we had to look up CUSIPs in the CUSIP book to figure out which credit we were talking about. And just to be able to punch in the CUSIP into a machine that told you what bond you were looking at was just an incredible innovation.

Of course, it’s gone well beyond that, but that was important. And of course the MSRB when they came in with the Emma system, being able to find documents relatively quickly that maybe you or your firm had not been involved in the deal and you needed to find it fast because sometimes you had 10, 15 minutes to do a trade and you had to check something pretty quickly. Both those data developments were just fundamentally changing the way the business was done. There’s a lot more of that to come. There’s a lot of innovation going on out there. Back to you Rich.

Richard Ciccarone (14:05):
Well, John, I have to continue your discussion on the information technology and how that was introduced. There was this eagerness to get into that on one side, but it would quickly be subdued by the elders of the business in terms of who was spending money. So the young people that were coming in, like John and I, were interested in quantitative analysis of some sort. We never used it. We may have learned it in graduate school and didn’t use it, but it really wasn’t until the personal computer was invented that that chance really started to take off. I mean there were occasions of computers going on before the mid 1980s, but not much really material in 1985, Van Kampen on buy side I was working in, which was one of the top five investors at the time because of their heavy play in UITs and like Naveen and Merrill Lynch and our people decided because they were earning a surveillance fee to watch these unit investment trusts and sell the bonds if they were in danger of default or traumatic to climate price.

So in order to do it, and there were so many bonds just like there are today, staffs then, and even today, not as much today, but still are. But they were more so then they were understaffed. And in order to try to even think about doing the surveillance, you were promised you were going to think, well, could we do this on a computer somehow? At least run the numbers. So I was asked to, as part of my other duties is to start up the merit system, which was, I believe it was launched in 86 to the market as a subscription database and software product was the first and longest running database there is for municipal bonds. We started with hospitals, but when we first sold it, I had to do some selling on this too as well as try to create it and working with the staff.

But the interesting thing is that I couldn’t get the subscription, which was relatively expensive, $11,000 a year basically at starting point hospitals to really to be getting off the ground very well until I threw in a personal computer free of charge if they bought the subscription because a lot of municipal analysts didn’t even have a personal computer and it was a way to get it into the office. And so our subscriptions went up. So that’s how bad things were. And I know the young people in the audience, if there are any listening, and I hope they are, is that gives hope to. The fact is that things do come around to new technology and they did, but it took off and it began a long, long process and it’s still evolving today to cover the market. Now they say they cover 50,000, everybody says, well, we cover 50,000 credits, we cover a lot.

There’s no question about it. But I don’t think in way we’ve studied the numbers even today that we really, there’s 50,000 credits or actively trading bonds. We cover 12,000 today as opposed to a fraction of that back in those days. And it covers almost all of the indexes and that’s pretty critical point. But the technology where we are, we’ll come back. I know you’ve asked us, Chip that you want to talk about the future, we’ll come back and talk about where we think that’s going, but I think it was really tough getting this off the ground. A lot of resistance from analysts who thought we were going to take away their jobs and we would tell ’em, and we purposely did not put a model score in those days because there was that fear that we were taking all the subjectivity out. I think John, you would agree with me on this, is that municipal bond credit analysis was considered then to be as much of an art as a science. And I think to some extent today, a large extent today that’s still true. So I don’t think we’re headed in the direction of elimination of the human mind in the process, but I think we’re trying to do is to cover this world of massive numbers of bonds in a quick way rather than having to have armies of analyst.

John Hallacy (18:15):
Well, I do agree with that. Having a matrix is a wonderful thing to get a lot of information in an easy format that you can absorb quickly, but that’s only part of the story. You have to assimilate it into everything else you’re thinking about. You still have to read the footnotes, the financial statements to get the real nuts and bolts of what’s going on. But one of the things I wanted to talk about in that regard is the role of management by crisis in municipals. We’ve had a lot of crises over the years and Rich and I have lived through them. He mentioned New York City. I was involved very much in Rerating New York City when it came back to market when I was at s and p. And that was quite an achievement. And they had to continue to comply with the quote control period, which also came up again in the early nineties, which was almost triggered again.

But that was a whole other world. We also had other crises, and I’m sure Rich will have a few. I remember Cleveland, Cleveland defaulting on Muni notes, muni Light and Dennis Kch who was the youngest mayor in the country at the time. And that caused quite a stir because the banks, their hearts skipped a beat at that time given what was going on. And eventually there was a workout, but basically the banks got together and figured out a way to bail ’em out. But there were many others over the years, Detroit. It wasn’t just the recent one. There was one back in the eighties when we did Detroit fiscal recovery bonds and there were 10 years and basically got ’em out of the hole. At that time there was Orange County, which nobody talks about much anymore because Orange County is quite an affluent area and from an economic perspective it was always well thought of.

But of course they ran into trouble back in the nineties. And there have been many others over the years. I mean, rich might have a couple of examples from the hospital world or what have you, but we tend to have these crises and they cause a stir. They hit the front page of the newspaper and eventually we bail it out either by issuing new debt or taking other actions. Certainly trying to cut the budget at the same time and rework everything. But people in other markets say, Hey, Munis don’t default, which is basically true. We have infinitesimal default rate, but when it happens, it’s big.

Chip Barnett (21:28):
Yes, and I would not agree with Meredith Whitney who said everything was going to default. I really believe there was a lot of problems during the great recession from municipalities like Vallejo and other places. But generally munis don’t default and the credits are usually or almost always very strong. Rich, what do you think?

Richard Ciccarone (21:54):
Well, I think that I’ve always been of the feeling that we don’t want to take ’em for granted. And so we’ve always been cautious. The people I started with at the Harris Bank considered every go one that’d be concerned about. And because many of them were still around about the time of the depression, and so they didn’t want to dismiss that During the depression, 16% of all munis defaulted, but less than 1% never fully repaid according to the Hempel study. And I think that set the stage for the culture that I had. So we took ’em all pretty seriously. But if you look at the picture, and we’re going to talk about Meredith Whitney in that it’s pretty important what you brought up. I mean, she gets the blood curdling in a lot of municipal bond analysts when you bring the name up. I’m afraid because of the radical prediction that she had.

But in every decade that John and I have been in a business written at least one big deck credit focal point, which was either a default or a near default, and in most of the decades there were more than one. We talked about the seventies with New York in the eighties. The big one that taught some real big some lessons was what we called whoops, the Washington Public Power Supply System. And that was the biggest bond issue that was ever sold at the time, the municipal bond market in which the federal government was involved on part of the projects, which is why bond salesmen would go around saying that these are government guaranteed, which they weren’t all, and that caused a problem in itself. But whoops taught us something about here is an essential purpose, electricity and the rates in the Washington and Oregon area were extremely low because of hydropower, and yet these people had a rate shock in which they all rebelled and didn’t want to make payments on these anymore.

And they found a way out in the courts. So we learned some lessons. One is just because your rates are low doesn’t mean nobody’s going to care if they go up. Two is that when you have a massive project with a whole lot of debt and you have heavy debt burden, you got to worry about it. And three, I think the idea that the courts of the law, they might find ways to unravel what you think is the iron class security. I think we learned that that was the case there too. So when you have an unpopular project, don’t put too much emphasis on security provisions. So that’s an example. We also had in the eighties, some other individual issues in the beginning of the high yield market in Munis, which when you talk about low to fall rate, you don’t necessarily see it there.

Over the years, although we’ve had a string of really good years, in more recent times in the nineties, you had Orange County as John mentioned, which was AAA credit that blew up because of its investment program. And then you had the Denver airport, which didn’t default, but everyone was concerned that it would because of the massive amount of debt in the two thousands you had of course the big 2007 eight crisis, which is where we’ll get to with Meredith Whitney. And during that crisis, which really began to unravel in oh seven and every default that happens and it will happen in the future, it’s not just because of one thing. It’s a confluences of circumstances that all come together at one time that are not favorable to it. And in the crisis of that time, one of the things that was most unraveling was the fact that there was this taking it for granted idea about general obligation credits.

They don’t default in essential purpose because there’s so much bond insurance. The default rate was low. And then we had this eternal problem, which is still a problem today. Pensions that came to the forefront as the investment portfolios blew up at that time. And then they took a big dip in their funding ratios. Pension was called pensions. When John and I first started, it was called a time bomb. Then just like infrastructure was a time bomb problem, and it still is to some extent, although much, much, much less worse than it was then. But Meredith Whiney made this massive prediction of that billions and billions were going to all default. Now, she had some modicum of truth in her prediction. It just that and why we would hold back is that she was missing some of the really nuts and bolts of what analysts look at.

There was more to the story than what she said. She looked at the big picture and saw this unraveling taking place in the mortgage loans. And mortgage loans are where a lot of property taxes are tied to in real estate and on general obligations are mostly secured by general obligation by property taxes. When that market and subprime blew up, you say, well, shouldn’t there be a shock in property tax collections? And there should have been. However, what she did not know is there was it never brought up, is the fact she didn’t understand that when they blew up that one thing good about the structured finance deals that had been created in the subprime area is that they had been built to require advances or payments from Fannie Mae, Freddie Mac for property tax collections. And when that happened, it mitigated that tax collection problem that would’ve caused a shock to governments at the first year on making those payments into ’em to cover sufficient monies to cover the death service on the bonds for the GOs.

So the fact that the federal government bailed out Fannie Mae, Freddie Mac meant that these Fannie Mae, Freddie Mac and the banks along with them were able to make the collect property tax collections, which held the majority of municipal bond geo defaults to a very low number. She didn’t mention that. She didn’t know that she was taking the big picture. We said that if there’s going to be default, there’s going to be three things that happen. And we always said that first of all, you have a significant amount of debt, but you would have a liquidity crisis, no cash on hand. Second, you would’ve lost market access or a third party like a state government to come in and bail you out. And then fourth, is that just politics in general? I say third or fourth, some of those are the same things. So I could have put ’em into three buckets.

But I think that the final straw is that when the politics breaks down and the politics broke down during those years in Detroit because as John mentioned, they had had kind of a chronic problem with financials in Detroit, but the state of Michigan continued to support them. But the state pulled its support during those years and when that happened, they had no liquidity, they had no market access and they had no political support to be bailed out at any level. So we would see these things individually. So even though Meredith Whitney was right, that pensions created a very serious risk to them at that time. The financial crisis carried a severe risk to it, which did see default bankruptcies in three counties in California. What she didn’t go through is the process that analysts do is analysts are not just skimming the service, they’re looking at a lot of details. And bond insurance wasn’t necessarily there to help because they were in a crisis their own because of the subprime from another angle. I could go on with that, but I think you

John Hallacy (29:29):
Get the general picture comment on a couple of things, rich, that you talked about liquidity here, we’re not talking about market liquidity, we’re talking about liquidity of the credit and really what we’re talking about is cashflow, available fund balances other available cash, just to be clear about that. Yes. And when cash goes on the wane, that’s one of the first early warning signs that there’s trouble ahead. Not necessarily borrowing short term. That’s not always a flag. Sometimes that’s just true cashflow borrowing, but if there’s a need above and beyond sort of the normal practices, that’s a real warning sign. The other thing is pensions grew in concern over time. When we got into the business, a lot of pensions even at the state level, I remember Massachusetts when I started was still pay as you go on their pensions if you can believe that. Now, now we have defined benefit or defined contribution.

Most are defined benefit. And in the private sector, of course, pensions have pretty much disappeared. They’re mostly 4 0 1 Ks, but in the public sector we still have real pension liability. And then we talked about opep, other post employee benefits, which also have to be paid and should be funded on an actuarial basis as well. So those were areas that became increasingly important On the pension side, New Jersey had quite a history with pensions. If you go back and take a look, there was a concept of taking a pension holiday in terms of not making a contribution for a year, which in that case, the contribution was folded into a long-term bond issue. But pensions still remains very much a focus because it’s considered another long-term obligation that has to be funded by law. So that will be ongoing. And just one funny aside, when the Meredith Whitney show happened on 60 minutes, I happened to be in my kitchen preparing dinner and I was chopping some onions or something.

And when she made the statement about the defaults, I think I almost cut my hand off, but it was quite a shock at the time. But we’ve come back from that now. We have a lot of other ongoing concerns. One of the softer concerns, not softer in terms of non-financial is the consider of crime and public safety. I’ll let you crime. When we got into this market in the seventies was kind of front and center and then several mayors including Giuliani cracked down and was more law and order and things got better and now we continue to struggle with it. So public safety is always a big concern. Public health, transportation, clearly we could talk about transportation on its own for an hour and there are so many segments of municipals where we could take deep dives individually, but that’s not the intent of this session. So Rich, you want to add anything here?

Richard Ciccarone (33:23):
Well, those are good. I’m glad you brought those up and clarified the point on the liquidity. But yeah, there’s truisms that we all, as analysts have learned over the years. I know I grow each year I learn something new. And I think that’s one of the attractions of the profession is that you’re called to be a generalist and have a mind that’s trying to always get a little extra antennas out there for what are the trends and that are going on what might cause a problem with the Achilles heels of each type of credit, whether it was a hospital or an airport or a public power bond or today higher education. And those are just so important.

Chip Barnett (34:10):
Okay, and we’re going to be right back after this important message and we’re back talking with John Halley and Rich is her own. Well, it’s time to step back into our time tunnel and head off into the future. We talked a little bit about technology and where we’ve gone from the Dow Jones ticker tape to printed muni facts and tolerate Dow Jones News Service from Monroe calculators to computers. Where do you think we’re going to be headed in the future? Technology wise? We have artificial intelligence being talked about all the time. What’s up?

John Hallacy (35:00):
Well, I’m sure that AI has many applications. There’s not an industry that’s not being affected by it. I don’t think we should rely on AI to write credit opinions. I don’t know how rich feels about that. Certainly it could help. It’s a tool, but you wouldn’t want to rely on it completely. Where I see AI working in municipals has to do with the trading and bond selection, and we have 1.6 million CUSIPs out there with all kinds of bond issues. And I think AI could really be helpful with portfolio management and bond selection and things like that, tasks like that, not solely, but given the multiplicity of names and maturities and coupons and what have you, I think it could be incredibly valuable to have a tool like that to assist in constructing portfolios and in trading Rich, I don’t know.

Richard Ciccarone (36:17):
Yeah, John, I think that we’re in it. This has been transformative as the way that the world is moving to become more dependent upon electronic technology and not only in trading and in the market, but also in credited analysis. It’s come a long ways since the days in which we introduced the merit system. And my current role right now is to work with the investor tools who bought our merit research services company that we had back several years ago. And part of the reason we decided to go with investor tools is because we were able to integrate our credit system with their trading portfolio applications. And I think that’s we’re going towards, I mean, Bloomberg’s been a very dominant force, almost a utility in our market, and that would be not something we’re talking about replacing them on, but we’re a major force in the industry and providing an alternative approach and doing some things they can’t do.

And I think that what we’re seeing with many other companies that have come and merged into the business they become, which are used. You see this electronic trading going on and now the SRB is talking about reporting trades within one minute. I mean, this has just been timeliness we’ve talked about in credit was a problem, still is. But timeliness in terms of market information and having the right market information in order to make transparent decisions is a critical issue. And I think that what we’re doing is taking advantage of what the MSRB is doing, but it’s the private companies in which are creating different characters characterizations of how that information is deployed, shown, displayed. And when you can integrate it with credit information, you have something we’ve talked about in visioning for a long time, you can do quantitative analysis. I don’t think as a final judgment.

I didn’t think back then in the eighties that you could do it that way. And I still don’t think you would be very smart to rely totally on it. However, it can simplify the process dramatic if you’re able to filter and to screen and to narrow down the choices or to identify strengths or weaknesses you hadn’t thought considered before. And so that’s what these products will do. We’ll be able to look at relative value positions based on model scores and then tie it to their pricing in the market versus the indexes that’s happening. It’s not perfected yet. It’s on the way and it is going to be critical for the future as we are in the midst of doing that now. So I don’t think that people should feel the jobs will all be taken away. However, what you’re going to see is your job will be different.

So instead of time spending all the time adding a functional statement to a spreadsheet, now that part might be done for you, but allowing you to read these 300 page documents that John referred to earlier, and you need to have that time to do it because how many people can you have on your team? So I’m very bullish on the future of financial technology. It began to take off in the nineties and now we’re at full throttle and I just will fall short saying that it’s a final word. I don’t believe it will be. That’s what caused the problem when the financial crisis of 2007 eight came into play. I think the underlying root cause of it when the subprime is, is they had input that was in there. The assumptions they had were based on data for low default rates in mortgage loans, but it was based upon old fashioned underwriting standards of mortgage loans. And when that changed to subprime, the system wasn’t equipped to identify that and it allowed deals to go through that should have never gone through,

John Hallacy (40:26):
Hey, and

Richard Ciccarone (40:26):
We just can’t have that happen again.

John Hallacy (40:28):
Yeah, no, I appreciate that. One thing kind of lurking in the background that we haven’t talked about yet, the matter of rating agencies ratings of course are incredibly important to the market, but they’re not the end all be all anymore. I think the financial crisis oh 7 0 8 more than amply demonstrated that ratings are not infallible and that tavi eter on the part of buyers, they have to do their own credit research and go beyond what the rating agencies say. Now, the market still very much functions with rating agencies. I don’t think the role of could ever be eliminated for any reason. When Rich and I started, it was primarily two rating agencies and then it became three, and now we have four at least in municipals, and we thrive on differing opinions about credit. And that gets the whole market debating what is this bond worth? Is it really worth a single A, is it a real single A, is it a high single, a low single A? Is it a single A that’s going heading towards aa or is it a single A that’s headed towards triple B? So we have all these discussions in the market. So I think rating agencies will continue to be important, but of course the SEC and others have been pretty plain that participants in the market should not just rely solely on ratings.

Richard Ciccarone (42:28):
Yeah, John, I’m so glad you brought that up about rating agencies, the way we benchmark credit to begin with, and not only for pricing but to even analysts try to benchmark off of the rating agencies. So they play an important role. I have watched, and I think you’d agree, even though they were good then, but before in terms of the individuals that were doing the job, really were putting a first class effort into it. I think that what the rating agencies to do today is far more intensive than it even was earlier. Just like rest of our business buy-side as Southside analysts. Same way is that you have more information to go on. But one thing I found is I like the fact that when we recalibrated the industry in 2012, it started to do that in 10 was just on the heels again of the financial crisis.

That was in the oh 7 0 8 period started. Then they wanted to say that and they were pushed along by Barney Frank in the house in the Congress who was quite upset that during the freeze in municipal trading activity in 2008, that where were the rating agencies or why are they rating these so low? Why are they causing these bonds to freeze in the market? And what he required them to do when he put new rules of regulation in for rating agencies is to document everything they had based on real experiences. Well, here’s the problem with that is if you base everything on the past, you’re not allowing for as the environment in credit changes and the assumptions change that you’re not allowing it to make big bolder moves in terms of what the prediction should be because you have to tie yourself to the old history and rules of thought.

So when they recalibrated, they raised all the ratings up and they had generally when you go on GOs, almost everything is in aa, but AA is the biggest and then a one to AAA with nothing below. So it’s not true. If you look at AA and you look at our metrics and you compare it to, if you’re looking at it from a correlation standpoint, so many of the metrics, whether they be debt ratios or cash ratios or anything else you want to pick, don’t really align with AA median for the rating agencies. And that means that the rating agencies are recalibrating them to reflect doing that, to reflect the effect as they’re taking in the security and the history of the low default in that area or some subjective factors. So I guess I’m going along, I’m going to get lost in the weeds here, but I think the idea is they play a role but they’re not perfect. And right now I think there’s room for us to disagree.

John Hallacy (45:26):
Yeah. The other item I would add is that we used to talk about what is the half-life of a rating ratings were supposed to be longer term in nature. We have a prevalence of 30 year bonds out there, and the rating was supposed to withstand the test of time, but I think over time that Horizon has contracted. I think if you talk to a lot of people just informally, they would say it’s probably more like five years now versus like a 30 year window. So that’s been a big change too.

Chip Barnett (46:11):
Okay. Do you guys have some last thoughts for our listeners today?

Richard Ciccarone (46:16):
Well, to take a cue from my old good friend Jim Spiro, he used to always say, may we live in interesting times, and I think we have lived in very interesting times, and I have a hard time exiting from the business because I enjoy the challenges that the world of municipal finance provides every year to it, and we’ve got so many changes that are going on today that will influence us in the future, and we want to see how they play out, whether it be climate control, whether it be, if we ever, we’ve been talking about infrastructure since the earliest days I was in the business. My first conference was on infrastructure and how it was a time bomb. We still have that problem because we don’t fund to the service life of a project and we don’t fund to the service of pensions, and therefore this means we’re always late that we want to pass it along in the grandchildren and the other problems that are occurring and how they’ll play out here is in the federal arena with federal deficits.

Will the support we get from the federal government or have gotten in the past, will it be there today? What’s going to go on with disclosure in issues in that area? What will the new FDTA come in and what will that mean to the business? Demographics is another one that I think that is an interesting challenge as not only America Grays, which it has been ruling for some time. The birth rate is slowing the number of people available, the issues of paying for college, all of these things, and the number of people available to go to colleges to pay the bills and hospital arena, how that all plays out with a very high cost relative of healthcare growth. All of these things are going to be big challenges that we’re going to have to deal with, and I think that it’s made it a very interesting time for myself and I’m sure for John,

John Hallacy (48:19):
Yeah, I echo a lot of those thoughts. I mean, I think that the needs out there are great and the market’s still poised to address them when there’s a will to do it and when there’s capacity to do it. One of the things I do worry about in Rich mentioned this federal policy in general and federal tax policy. We kind of take the tax exemption for granted and we assume it will be around, but we have a federal government that’s hungry for revenue, and I just never know if there’s going to be a test of that in the future. But in the near term, it looks like it’s relatively secure, but longer term, who knows. Speaking to that, again, there are so many topics, the Build America Bonds, when those were around in 2009 and 2010 as sort of a response to the oh 7 0 8 fiscal crisis, to get munis out there that were taxable and the Feds provided credits, that really gave me a chance to talk to buyers who were not traditional muni buyers all over the world. I mean, I talked to folks in Indonesia and the UK and whatever, and they were really interested in purchasing the Babs and ultimately did because of course they didn’t care about tax exemption.

But it proved to me that there is a demand for these credits out there and that they can be delivered at a relatively strong price that ultimately benefits the citizens. That’s what this is all about, providing a service, making it as efficient as possible, and seeing that the needs of the citizens are served.

Mike Scarchilli (50:41):
We hope you enjoyed this episode. A big thank you to John and Rich for joining us and to our own Chip Barnett for conducting the interview. Let’s review some key takeaways from this conversation.

One, the municipal bond market has undergone a significant transformation and evolution over the past several decades. In the late 1970s, annual volume of muni bond issuance was around 40 billion, a far cry from the more than 400 billion issued annually today. Disclosure statements have also transitioned from thin official statements to 350 plus page documents, enhancing transparency and the introduction of technologies like the Bloomberg Terminal and the MSRBs system have revolutionized access to data making, trading and research more efficient and informed.

Two, federal policies and economic factors have long wait on the muni market. And in an election year with the federal government in constant need of revenue, the municipal tax exemption could find itself in the crosshairs.

Though it has remained in place since 1913, despite many threats and challenges to its status in the more than a century, that has elapsed since. Additionally, the muni market has a history of responding innovatively to federal policies and economic downturns as it did during the 2007-08 financial crisis. With the introduction of Build America Bonds and

Three, future technologies and technological trends are poised to not only influence but further transform the muni bond business in the coming years. In particular, there’s potential for AI and machine learning to transform portfolio management and bond selection and aid in dealing with the vast number of QIPs and complex market data a muni professional deals with on a daily basis. Additionally, the continual integration of credit systems with trading and portfolio applications points toward a future where technology enhances decision-making processes without completely replacing human judgment. Thanks again for listening to this Bond Buyer podcast. This episode was produced by the bond buyer. If you enjoyed this episode, please hit like and subscribe on your favorite podcast player, and please rate us, review us and subscribe to our Until next time, I’m Mike Scarchilli signing off.

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