By Heather Gillers 

Wall Street's longstanding hold on the $4 trillion municipal-bond market faces a challenge from an onslaught of small, independent firms known as municipal advisers.

The Securities and Exchange Commission is considering allowing these advisers to arrange private bond sales to skilled investors without the involvement of the large banks and midsize brokers that have for decades dominated the market for high-grade local government debt.

Though private sales make up only a small portion of the overall market, broker-dealers -- as these banks and brokers are known because they price and sell new bonds and trade existing ones -- aren't eager to face further inroads.

The firms that sell municipal debt include some of the biggest U.S. banks. Last year the top five underwriters were Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co., Morgan Stanley and Royal Bank of Canada, according to Refinitiv.

"We're pushing for this whole thing to be killed," said Mike Nicholas, CEO of Bond Dealers of America, a trade group.

Advisers that hire themselves out to local governments now participate in three-quarters of muni-bond issues, up from 52% in 2004. They pitch governments on the benefits of having a fiduciary at the table to evaluate prospective deals.

Today there are around 500 municipal-advisory firms scattered around the country, more than 70% made up of fewer than five advisers, according to Municipal Securities Rulemaking Board data. They often work out of small shops or sometimes home offices, logging hours on the road to visit rural towns and schools that make up their client base. Some are affiliated with bond dealers.

The SEC proposal, which was released last month, came in response to a letter from the nation's largest muni advisory firm, Philadelphia-based PFM, which advised on $47.3 billion in bond deals last year, according to Refinitiv.

Broker-dealers are alarmed at the SEC proposal, reflecting broader shifts occurring in the municipal market alongside the postcrisis regulatory squeeze on both major banks and regional brokerages.

Regulators are increasingly focused on the interests of not only investors but also local governments pledging taxpayer dollars to build schools or dig sewers. At the same time, money managers and other institutions are displacing individual bondholders as the biggest holders of munis and forming closer relationships with governments.

For towns or school systems that already prefer to sell a few million dollars in debt to a bank over issuing bonds publicly, the SEC proposal could simplify the process. Allowing larger sales to a wider range of investors could have a more significant market impact, however, rerouting private deals away from a longstanding network of dealers and -- if it makes private debt sales more appealing -- further reducing bonds available to traditional buy-and-hold retail investors. The scope of the SEC proposal surprised dealers and advisers alike.

"It could be a significant change for how borrowers access capital," said Matt Fabian, a partner with Municipal Market Analytics.

Private placements total between about $5 billion and $20 billion a year, according to Refinitiv data that excludes some smaller deals. But they are growing, according to the SEC. Though they are typically small debt sales to banks, some recent deals have included higher-priced, more coveted securities. Dallas-based Preston Hollow Capital in 2018 directly purchased a combined total of about $1 billion in municipal debt from universities and other borrowers.

The SEC proposal would allow such deals to be handled by municipal advisers alone so long as the debt is placed with a bank, insurance company, investment firm, any other institution with at least $50 million, or a registered investment adviser who could represent multiple investors.

Mr. Nicholas of the Bond Dealers of America said investors will suffer if deals don't include a broker-dealer with SEC-mandated investor protection duties. He said municipal advisers who don't trade bonds lack "the market intelligence" and other qualifications to handle even small rural bank placements. The SEC proposal would require municipal advisers to disclose to the investors that they don't represent investors' interests.

"Just by definition these are qualified sophisticated investors so they really don't need another layer of protection," said Howard Cure, director of municipal bond research at Evercore Wealth Management, which invests in munis.

Jonas Biery, a Portland, Ore., finance official who spent nearly five years as the city's debt-program manager, said he might want a dealer's assistance in a private sale to investors, but that sales to banks would become simpler and more efficient for many small issuers. While one-fifth of the muni debt issued through October came from deals of more than $500 million, 56% of bond issues produced $10 million or less, according to Municipal Securities Rulemaking Board data.

Robert A. Tijerina, a municipal adviser with San Antonio-based Tijerina Galvan Lawrence, said if the proposal takes effect he will no longer bring in a dealer when he sells Texas town and school debt to local banks, and the total cost to the borrower will drop.

Municipal adviser Tim King with Kings Financial in Monticello, Ill., does his private placements without a dealer. But in an effort to avoid running afoul of current rules allowing only dealers to solicit investors, he stays out of initial talks between the borrower and the bank, assigning that outreach to mayors or school superintendents more experienced in public safety or student achievement than municipal finance.

If the proposal takes effect, Mr. King said "it'll be a whole lot easier because now we can directly contact these folks."

The SEC is seeking comments on the proposal by Dec. 9.

Write to Heather Gillers at heather.gillers@wsj.com

(END) Dow Jones Newswires

November 13, 2019 08:06 ET (13:06 GMT)

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