The pandemic offers a unique window to solve long-standing problems investors face when comparing securities and tracking down their revenue sources.
The problems, sources say, stem from the fact that there is no single source of data, public or private, that correctly links bond issues to the correct obligors based solely on the security pledge at the individual CUSIP level. There is also not a consistent, uniform methodology to classify issues into relevant sectors. This makes it more difficult for municipal market participants to determine their risk exposure without knowing easily through which revenue source a government’s issue is being paid.
On top of not being able to search by the obligor to find those revenue sources, there is no uniformity among databases in how sectors are categorized. Both issues are separate but are linked — an analyst needs to know the obligor to find the security pledge to find the sector, sources say.
“It’s been hard for market participants to determine what the credit risk exposure is in their portfolios,” said Triet Nguyen, vice president of strategic data operations at DPC DATA.
Analysts are vying to easily be able to compare securities and thus far can’t do it efficiently since there is no central database to compare among sectors and obligors.
“The most practical application is right now for trading purposes,” Nguyen said. “Right now because the definitions are so loose, that they can’t really do it efficiently. They have to do manual adjustments,” Nguyen added.
Many have called for the Municipal Securities Rulemaking Board to take the lead on a project to change that, or organize an industry group to create a public source. Municipal participants can not search by obligor on the MSRB’s EMMA site. Other private companies, in the meantime have created obligor-based search systems to fill that gap.
“It takes a lot to figure out where your credit exposure is and where that debt service is being paid for,” Nguyen said.
The MSRB said being able to easily find information on EMMA by obligor is a challenge they want to take on now that all of its market transparency systems are operating in the cloud as of a few months ago.
“One of our top strategic priorities at the MSRB is to deliver greater value to the market through data,” said Brian Anthony, MSRB chief data officer. “With the benefit of insights from our Market Transparency Advisory Group and other stakeholders, we have a clear understanding of the pain points for investors and others seeking to understand and analyze the municipal market.”
Finding the correct obligor more easily would help investors aggregate risks in their portfolios with sectors that move together, Nguyen said.
“In a sector, you want to have all of the credits that are driven by the same economic factors — that’s the whole point of having sector assignments,” Nguyen said.
During the pandemic, investors more than ever want to know what their credit exposure is in their portfolios. A uniform classification system would allow market participants to identify the nature of credit risk in their holdings and to aggregate that risk into meaningful sectors that share common risk drivers, Nguyen said.
“Truth be told, the municipal industry has been a notorious laggard when it comes to the adoption of technological innovations,” Nguyen said in a November report. “Still, the current pandemic environment offers a unique opportunity to address a gaping hole in our reference data set. The uncertain fiscal environment facing most state and local issuers calls for increased credit vigilance on the part of all market participants, from the institutional investor to the individual financial advisor.”
As an analyst, it’s difficult to compare securities without doing a deep dive analysis, said Lisa Washburn, managing director for Municipal Market Analytics.
Private companies use different sector classifications and have varied ways for assigning them to securities.
“I have long thought that to improve market transparency it would be beneficial for an organization like the MSRB to either develop this type of methodology or spearhead an industry-wide working group that would agree on a comprehensive list of municipal sectors and come up with a rules-based methodology for assigning a sector to each transaction,” Washburn said.
A working sector classification system would allow analysts to make comparisons, Washburn said.
“We just don’t have that in a uniform way in our marketplace,” she said.
For example, it’s difficult to classify issuers into a sector since they may issue on behalf of a number of parties. The security pledge should dictate what sector something belongs in, not the use of proceeds or who the borrower is, Washburn said.
“If you’re presented with a bond … without knowing what sector that falls into, it is more difficult to make a judgment quickly on pricing or determine whether or not you’re comfortable with the security based on the rating because bonds in different sectors have different credit drivers and levels of volatility,” Washburn said.
Being able to have consistent sector assignments would help analysts more easily understand how the bonds are being paid such as knowing whether a security is backed by hotel taxes, development-based growth or a general obligation pledge.
“My view on those credits may be very different, even if the obligor is the same,” Washburn said.
Both issues — categorizing sectors and finding obligors — are somewhat linked.
“You have to know who the obligor is in order to be able to find what the security pledge is in order to figure out the sector,” Washburn said.
DPC DATA is rolling out a new obligor and sector classification database which would allow investors and analysts to accurately identify and aggregate their credit risk exposure. It would be a paid service and available initially as a data feed that can be imported into existing portfolio management and credit research systems. Later, the goal is to build out a user interface.
Diver by Lumesis, a municipal market software and data company, has an obligor database.
Finding the obligor has been a long-standing issue, long before the pandemic, said Gregg Bienstock, CEO and co-founder of Diver by Lumesis.
“From a credit perspective, from an understanding of who is responsible for debt obligations and who is responsible for continuing disclosure obligations, understanding and knowing who the obligated party is critical,” Bienstock said.