Commonwealth of Massachusetts Disclosure Enhancements Monday, August 13, 2012 Enhancing Transparency...

Commonwealth of Massachusetts Disclosure Enhancements

Monday, August 13, 2012 Enhancing Transparency and Disclosure in the

States

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Overview of the Presentation

NASACT 1

I. Why Enhanced Disclosure Matters for State Issuers of Municipal Bonds

II. One State’s Example: Massachusetts’ Historical Disclosure Practices

III. Massachusetts’ New Enhanced Disclosure Program

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I. Why Enhanced Disclosure Matters for State Issuers of Municipal Bonds

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Why Enhanced Disclosure Matters – Theoretical Perspective

NASACT 3

Adequate disclosure is critical to the efficient functioning of the bond market , or any market for that matter

Academic research* has generally shown that better disclosure leads to lower borrowing costs for issuers

More disclosure and more frequent disclosure improves price volatility in the secondary market

Completely intuitive that more frequent disclosures by a credit will make trades of the credit’s bonds at more homogenous prices than the same types of bonds of credits who only make minimal disclosures

Higher efficiency = lower transaction costs, promotes fairness, and improved transparency

But enhanced disclosure – more voluntary interim disclosures – does require additional resources

Every issuer wants to know: what’s the enhanced disclosure worth in terms of reduced costs of borrowing?

It’s hard for any issuer to allocate additional resources to enhancing disclosure beyond their basic obligations without understanding the value of the benefit

Its difficult to point to specific examples of an issuer lowering its borrowing costs through better disclosure, however, there are instances where inadequate disclosure has clearly impacted an issuer’s borrowing costs

* Li (2007), Reck and Wilson (2006), Fairchild (2000 & 1998), and Fairchild and Kock (1998).

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NASACT 4

Number of instances where an issuer’s poor disclosure practices – late audits, financial re-statements, etc. – have led to higher borrowing costs

Poor disclosure practices can lead to reduced access to the market, decreased investor demand, poor pricing execution, additional risk premium, and rating downgrades

If information about a bond or credit is not robust, investors will demand additional return to compensate them for the additional information risks they are bearing

Most municipal bonds are fixed rate with long durations, don’t have ‘put’ features

Thus it increases the cost of capital for issuers when they go to borrow

Poor disclosure also impacts how bonds price and trade in the secondary market

It reduces market efficiency by making bonds less liquid, leading to higher transaction costs when trades do occur

It discourages information sharing amongst investors, which increases price volatility

Price volatility – caused by the liquidity – will also impact bond prices/yields in the primary market for issuers

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NASACT 5

Recently released research paper* showed that 53% of all municipalities had to book some sort of financial restatement over a 36 month period

One example: In 2002, the City of San Diego announced a restatement of $640 million, or almost 10% of total net assets

Larger than the restatement of $580 million restatement reported by Enron

The analysis also showed that borrowing costs for these municipalities increased on average by 35 basis points following their restatement

The paper also found that restatements are less likely, and the increase in borrowing costs were lower, in the states where state auditor oversight was strong

* Accounting Restatements, Governnance, and Municipal Debt Financing by Baber, Gore, Rich and Zhang).

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Why Enhanced Disclosure Matters – Practical: Investors’ Perspective

NASACT 6

Issuer disclosure remains an extremely timely topic with investors

Investor demand for municipal disclosure that is accurate, detailed, and more timely has greatly increased since the financial crisis

Credit have generally weakened due to the effects of the recession, and

The loss of municipal bond insurance

Investor demand for better disclosure has increased as investors work to determine how best to position their investment capital among different asset classes, especially during this low-yield, market environment investors continue to face

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NASACT 7

Why is this the case?

Investors are now undertaking credit reviews/opinions in-house, instead of relying on rating agency reports/ratings and bond insurance

New-issue credit analysis is labor intensive, performed on daily basis

Many big investors have to quickly review 30+ municipal credits per week Requires Reliable Access to Quality Information about Issuer.

New-issue analysis requires an intensive review of POS, particularly the issuer’s most recent audit and other financial data.

Analysis includes review of legal security, economic/demographic profile, tax position, etc.

Analysis may also require review of issuer websites, EMMA postings, and communication with issuer/underwriter/banker/financial advisor and other analytics

Active participation in secondary trading market requires real-time credit analysis

Issuer disclosures and EMMA major part of credit surveillance methodology

Investment in a municipality is absolutely contingent on the timeliness, accuracy and submission of disclosure

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NASACT 8

Retail and institutional investors buy municipal bonds – lend money to state & local governments typically over long periods – as opposed to other asset classes for principally three reasons:

1. Because of the unique attributes of municipal bonds, such as favorable tax treatment,

2. Because they provide support for public projects in local communities/ states, and

3. Because of the risk-return profile of muni bonds: historically positive investment returns relative to credit risk

• Does the current environment of low yields amidst a general growing concern over state and local credit impact this risk-return proposition for investors?

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II. Massachusetts’ Experience: Historical Disclosure Practices

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Massachusetts Historical Disclosure Practices

NASACT 10

Massachusetts’ disclosure practices were/are considered very strong

Massachusetts is one of the largest issuers in the municipal bond market, issuing roughly $2 billion in bonds per year

As of June 30, 2012, more than $20 billion in debt outstanding

More than 70 series outstanding, with roughly different 900 CUSIPs, under five different bond programs

Bond programs include the state’s General Obligation (GO) Bond program secured by the state’s full faith and credit pledge, as well as the state’s Special Obligation Bond programs secured by a specific revenue source

All of the borrowings are managed by the State Treasurer’s Office

GO Bonds is by far the largest bond program ($18.8 bn outstanding) for Massachusetts, and is the focus of the state’s disclosure efforts

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NASACT 11

The Commonwealth’s disclosure practices have always been comprehensive and timely

The Commonwealth was one of the first states to provide extensive disclosure to its bond investors, starting in the mid-1970’s.

Preparation of investor disclosure is an integral function of state government, spread across numerous agencies and departments

Detailed Information Statements and a website with more than 10,000 pages of documents for investors

MuniNet Guide ranked the debt website the 4th best issuer website in the market in 2010

The Commonwealth Information Statement contains all information pertinent to an investor in GO bonds, including:

Government organization, budget and financial management controls, revenues and expenditures, financial data, current and recent fiscal year information, long-term liabilities, capital investment plans, state workforce, and pending legal matters

The Information Statement was updated annually in February or March

Information Statement Supplements are prepared periodically throughout the year in connection with particular financings

Each Supplement supersedes all previous Supplements, so at any given time investors need only consult the Information Statement and the most recent Supplement

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NASACT 12

The Information Statement and each Supplement was signed by the State Treasurer and the Secretary of Administration and Finance, and those officials also deliver to the underwriters of Commonwealth general obligation bonds a “10b-5” certificate to the effect that the documents do not contain any material misstatements or omissions

Two sets of Commonwealth financial statements are prepared by the State Comptroller included by reference:

The Statutory Basis Financial Report is typically released in late October after the end of the fiscal year on June 30th

The Comprehensive Annual Financial Report (CAFR), prepared in accordance with generally accepted accounting principles, is typically released in late December

All disclosure documents (financial statements, annual continuing disclosure filings, official statements and information statements and supplements) were filed promptly with the Municipal Securities Rulemaking Board, through its Electronic Municipal Market Access (EMMA) system

So we are starting from a very good baseline…

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NASACT 13

Knowing that the municipal market has shifted from a rates-driven market to a credit driven market, with increased emphasis on disclosure from rating agencies, regulators, and most importantly issuers, the STO working with the Executive Office for Administration & Finance determined to focus more resources into enhancing the state’s disclosures and investors communications

Perceived benefits of enhanced disclosure:

Achieve and maintain good ratings and support from rating agencies

Increase credibility with investors, facilitate long-term investor relations, and broaden investor base

Differentiate Massachusetts from other state issuers in the competitive municipal marketplace

Which leads to:

Demonstrating proactive financial administration and management standards and practices to taxpayers

Demonstrating adherence to disclosure best practices (GFOA, NFMA, NABL, etc)

Attaining lower borrowing costs and improving the liquidity of Massachusetts paper

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III. Disclosure Enhancements: Devoting Resources to Be a Market Leader

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Massachusetts’ Investor Disclosure Enhancements

NASACT 15

• Investor Disclosure• Continue to re-write and overall information statements and

supplements, enhancing sections based on investor or regulatory feedback and focusing on plain English.

• Enhanced pension liability / asset sections in 2010 and 2011

• Working to incorporate economic narrative

• Developing formal schedule of disclosure releases to make disclosure more predictable

• More voluntary filings on EMMA

• Continuing to seek investor feedback

• Investor Communication & Outreach• Annual investor conference

• Targeting investors in Boston and outside region for one-on-one meetings away from financings

• First state to implement quarterly investor conference calls

• Revenue, budget, debt updates, as well as

• Access to senior leadership of the state

• Investor surveys

• New Consolidated Investor Website• Website dedicated to investor needs, data consolidated across the

Commonwealth

• Debt reports, bond authorizations

• Cash flow reports

• Forward financing calendar

• Monthly revenue reports

• Operating & capital budgets

• CAFRs, pension and OPEB actuarial reports

• Disclosure and O.S. archives, rating information

• Goals• The Commonwealth’s goal is to have the best investor

disclosure and investor outreach program in the municipal market place

• Better disclosure documents, better investor website and more predictability in disclosure publications

• Focusing on investor outreach efforts

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Enhancements to Information Statements

NASACT 16

The foundation of Massachusetts’ enhanced disclosure program is the emphasis on improving the state’s written disclosure document

Like other states, Massachusetts is always striving to meet or exceed the best practice recommendations of such groups as the NFMA, GFOA and NABL for its disclosure documents

But we’ve also focused on investor feedback – through formal and informal surveys – for re-writes or enhancements of specific sections

For example, we rewrote our pension liability / asset sections in 2010, 2011 & 2012 based on feedback from investors

By the time NABL had finalized their recommendations to issuers in May 2012, Massachusetts pension disclosure had met nearly all recommendations (projections by end of 2012)

We are currently working to include an economic narrative into our information statements for the first time, to be a resource to investors in addition to the quarterly economic statistical section that we currently provide

Incorporated recommendations from “A Plain English Handbook: How to Create Clear SEC Disclosure Documents” (1998)

Tried to make the document more readable, with more logical flow, defined page breaks, consistent use of data, more tables, etc.

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Enhancements to Information Statements

NASACT 17

In 2012, we introduced two big changes in terms of the process around the release of the Information Statement

First, starting in 2012, the Commonwealth moved away from Information Statement Supplements

Full re-write of the information statement – roughly 100 page document – each time disclosure is updated

Second, developed formal schedule of disclosure releases six times per year to make disclosure more predictable, again based on investor recommendations

The Information Statement is released on or about the fifth business day of every other month

The scheduled of disclosure releases has been published to the market

Disclosure updates every January, March, May, July, September, November

10b-5 letters, modeled after Sarbanes-Oxley

Whether the state is selling bonds or not it has committed to following this schedule

Investors know when to expect disclosure data – should give investors more confidence knowing they will have reliable information in the future to make informed buy or sell decisions

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More Voluntary Filings to EMMA

NASACT 18

Our goal is to have many more voluntary filings on EMMA, including:

Cash flow statements

Rating agency presentations

Investor presentations

Revenue reports and forecasts

Investor questions and answers

Transcripts of investor conference calls

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Investor Communication

NASACT 19

• The second phase of Massachusetts’ enhanced disclosure program is more direct investor outreach

• Massachusetts is the first state to implement regular investor conference calls

• Live calls, modeled on corporate earnings calls

• Scheduled for roughly 7 days after disclosure is updated, six planned per year

• Access to senior leadership of the state, whether or not state is selling bonds

• Regular updates on the economy, revenues, budgets, capital updates, as well as one “big topic” per call

Commonwealth of Massachusetts 2012/2013 Investor Disclosure & Conference Call Schedule

Disclosure Update

Targeted Investor

Conference Call "Big Topic" Participants

9-May-12 21-May-12 Disclosure Enhancements Treasury

23-J ul-12 30-J ul-12 FY12 Revenue Review Dept of Revenue

10-Sep-12 17-Sep-12 Review of Major Spending Categories Admin & Finance

7-Nov-12 14-Nov-12 Review of 2012 Pension Actuarial Report State Actuary, PERAC

7-J an-13 14-J an-13 State Financial Controls & Financial Statements State Comptroller

7-Mar-13 14-Mar-13 Review of Updated 5-Year Capital Plan Admin & Finance

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Investor Communication

NASACT 20

• Massachusetts held its inaugural annual investor conference December 2011

• The 2012 conference targeted for early November 2012

• More than 200 investors attended, most from Boston region but some from New York, Chicago, and San Francisco

• Besides the Commonwealth, ten other state agencies/authorities presented to investors

• Ongoing targeting of investors in Boston and outside region for one-on-one meetings away from financings (New York, Chicago, San Francisco)

• Focus on existing large holders of Massachusetts bonds and large investors who don’t hold a lot of Massachusetts bonds

• Continue to seek investor feedback on disclosure and liquidity via third party surveys

• Investor email subscriber list

• Twitter feed for investors: @BuyMassBonds

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New Investor Website

NASACT 21

The third phase of Massachusetts’s enhanced disclosure program – and perhaps the most important, is a new consolidated website dedicated to investors

There are three issues around improving continuing disclosure in the municipal market:

1. Timeliness

2. Format, and

3. Frequency

Massachusetts’ goal is to address these issues for investors through a new website

Use of new website to efficiently provide more information to investors and more information more frequently to investors

Recently released SEC report on muni disclosure said the increased use of issuer websites would be useful

Also follows GFOA Best Practices: Using a Website for Disclosure (2002 and 2010); Using Websites to Improve Access to Budget Documents and Financial Reports (2003); and Website Presentation of Official Financial Documents (2009)

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NASACT 22

The Treasury’s existing debt management website will have its content re-purposed for debt material that may be pertinent for investors

The new investor website will consolidate all of the information currently available to investors on different websites

Target to go live mid-September

Approximately 20,000 pages of downloadable information, including:

Debt schedules, bond authorizations, variable rate summaries, swap summaries

Cash flow and short-term investment reports

Monthly revenue reports

Operating & capital budgets, including supp budgets

CAFRs, pension and OPEB actuarial reports

Forward consolidated issuer financing calendar

Disclosure and Official Statement archives

Live links to MSRB secondary market trading activity by CUSIP numbers

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NASACT 23

Timeliness, format and frequency…

In developing our new website, we’ve tried to address those areas by asking a couple of simple questions

State financial data changes continuously, while state financing-related disclosures may be quarterly or less often – in Massachusetts case, six times per year

Even with six disclosure per year, relevant state economic indicators change continuously

Also, some state economy indicators are available from state agencies before being released by the Federal government (e.g., Employment data from state labor and workforce development agencies who feed the BLS)

The gap between when an economic or financial data point changes and when its formally disclosed by a state in its bond disclosure represents a cost and an opportunity

These information gaps will always translate into “uncertainty discounts” being imposed by investors on state borrowings

A successful closing of those gaps would reduce the “uncertainty discount” imposed by investors

So, how could we close the gaps?

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NASACT 24

Using a enhanced investor website, the Internet presents a pathway for collapsing the disclosure cycle from quarterly or less often, to potentially real time

What would this require?

Continuous information flows from state reporting units to a central disclosure platform – in Massachusetts case, a dedicated page or pages on its new investor website

Dedicated pages would feature all or nearly all of the data points and tables current presented in the state’s Information Statements and its Quarterly Economic Statistical Report

And ultimately, continuous information flows from the investor website to the desktops of credit analysts and portfolio managers at major investment firms

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NASACT 25

What would this look like?

Continuously updating disclosure data on the Commonwealth’s investor website

As an example, a monthly tax revenue table from the state’s Information Statement

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NASACT 26

• Each line on the table would be interactive, with one click on a data point leading an investor to the data source (website of the source of the original data) or to a pop-up window showing some kind of trend analysis

• Transforms the table of data into one that provides instant trend analysis or historical perspective

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• Working with our website programmers, we would like to allow investor to select from the hundreds of different tables and data points to highlight the ones that are most important to their analysis

• Drag and drop the selected data to their own desktop

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• This feature would allow an investor to receive continuous data updates in real time being delivered right to their desk top

• We think features like this, with a dedicated website, closes the information gaps and addresses the timeliness, format and frequency objectives

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Conclusions

NASACT 29

Important for all issuers to realize that the market has changed since 2008 as it has moved from a rates-driven market to a credit driven market

With the loss of muni bond insurance the subordination of rating agency views, investors are undertaking more and more credit analysis in-house, and thus the demand from bond buyers on better disclosure continues to increase

Will investors respond to Massachusetts’ enhanced disclosure efforts?

We think the answer is a resounding ‘yes’

Some evidence that we are pricing more like a ‘AAA’ than a ‘AA+’ state

One of only two states to be upgraded by S&P since they downgraded the US’ rating

We believe enhanced disclosure is our way of differentiating Massachusetts from every other state, via better documents, more direct investor communication, and a better website

Disclosure responsibilities may be going up for issuers anyway

We know in this low-rate environment investors are making choices, and we think better disclosure – whether the news is good or bad – will lower our borrowings costs over the long run

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Questions & Contact Information

NASACT 30

Colin MacNaught

Assistant State Treasurer for Debt Management

[email protected]

617-367-9333 x226

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