(PDF: Full Report)
XBRL COULD UNDERMINE MARKET EFFICIENCY: Proposals to require municipal bond issuers to create and post financial reports in XBRL format—which allows easier electronic extraction of selected data points—appear to have at least limited purchase among Federal and market regulators.
Last week’s first annual SEC conference on municipal disclosure spent considerable time discussing XBRL versus the current PDF standard. And how, hypothetically, a move to XBRL could engender faster and more scalable municipal credit research: an apparent balm amid worsening asset manager fee pressure. However, XBRL lacks meaningful constituency among actual municipal investors and issuers, the related costs to be borne by the latter would represent a significant drag on current market efficiency, and the tangible, incremental credit value of issuer created XBRL financials to municipal analysts is questionable. So, while this is likely to be a major topic of discussion in Washington in 2019, a transition is highly unlikely absent a multi-billion-dollar Congressional appropriation to pay for its costs. Which is also unlikely.
Questionable Value To Issuers: The burden will be on regulators to demonstrate how XBRL would be a net benefit to the issuers paying for its implementation. In the corporate bond and equity markets, issuers’ use of the protocol has broadened sell-side analyst coverage, earnings and stock price modeling, and investor acceptance. By contrast, municipal issuer access to capital is already pervasive; even the tiniest governments are consistently able to borrow at aggressive rates and spreads. If anything, the status quo is too aggressive, creating more risk of governments overborrowing than the opposite. And looking ahead, the rapid, secular change in municipal demand (that favors aggregated institutional management over smaller retail-directed accounts), not to mention persistent long-term net supply concerns, suggest that things will remain borrower-friendly vis-à-vis historical standards in the foreseeable future.
Limited Monetizable Investor Interest: Electronic versions of many (most, if measured by par) issuer financial reports are already widely available via private sector products like CreditScope and Bloomberg, both of which integrate detailed financial and economic data into wellused portfolio management and trading platforms. The rating agencies already provide curated and standardized ratio analyses of borrowers, covering ~90% of all municipal bond par outstanding. And the biggest institutional investors—who represent a growing share of aggregate lender interest—all employ sizeable research staffs that will maintain internal analytic resources regardless of how the data are provided. So while XBRL data would surely be used by a wide variety of investors, it remains questionable that the effect would be material additional investor demand sufficient to warrant issuers’ cost.
Issuer “Cost” Is Not Just Auditor Fees: Here is the paragraph on the municipal market’s uniquely bespoke nature and its state-based accounting and definitional challenges. While the GASB does provide a national accounting standard, a transition to XBRL would demand much stricter adherence than current practice. An ideally-scalable version needs buyin from all 50 states, meaning the most reasonable political outcome would be a very limited implementation, perhaps involving only a few top-line financial numbers and/or a select group of larger borrowers. Obviously, the more limits created (and borrower exceptions allowed), the less of a hypothetical scaling benefit for hypothetical investors.
Issuer-Coded XBRL Data Feed Would Be A Garbage Tornado: Assume instead a pervasive XBRL mandate involving all public municipal debt issuers, and then look to current issuer data-coding performance on EMMA: “CAFR” is spelled a half dozen ways; “Non-payment Related Default” is used to disclose at least five different kinds of impairments; and borrowers regularly categorize anything remotely interesting as “Other.” Even leaving aside issuers’ ability to create customized tags for their own data, XBRL downloads would be rife with problems. XBRL US, in a report on the thousands of errors and bad tags among corporate data, notes how uneven quality makes it harder, “to extract and analyze ... financial fundamentals.” Exactly. For the municipal sector, XBRL data validation, correction, and calibration would be an essential user task, reasonably consuming the majority of time and cost involved. The alignment of similarlynamed but definitionally-distinct entities across states is alone an existential concern for this concept. Whether the total effort here outweighs the current system of purchasing scrubbed data from a third-party provider or keypunching data directly is not nearly as clear as advocates hope.
Municipal Defaults Not Well Correlated To Financials: Financial analysis alone cannot consistently identify likely defaulters, in particular among governmental borrowers. While it is reasonable to assume that, for example, an entity’s low cash or reserves heightens its bonds’ default risk, there are thousands of governments with barely positive cash that will never default. Further, the most recent government to default—Platte County MO—has AA-category finances but walked away from an appropriation- backed debt payment out of spite. A better example is Harvey IL, which defaulted on its GO bonds in 2015 but stopped posting financials 30 months prior. Non-disclosure of financials can often be a better predictor of payment default than the things disclosed in financials.
XBRL Is Helpful But Could Muffle Non-Financial Data: Which is not to say that financials lack value, noting in particular how ratings and thus rated bond prices are tightly correlated with audited results. Here, an XBRL standard could be at least theoretically useful to the average investor. Yet again with a caveat: things could go too far, in particular if post-transition investors begin to lose focus on the (non-automated) non-financial data that can be more important to credit quality in the long term. These include an understanding of the state’s relationship with its local governments, extremely local economic and political developments, and the kinds of one-off developments disclosed only in audited financials’ notes sections, issuer websites, and third-party news feeds. In other words, financial data, presented as comparable, may not be, inviting credit selection errors to the detriment of long-term discipline and performance.
XBRL May Already Be Outdated: The use of machine learning and other tools to scrape financial data from existing PDFs represents a more state of the art (albeit still developing) technology than the decade-old XBRL regime. But the cost burden of PDF scraping falls much less heavily on issuers, meaning: 1) state and local taxpayers would not be tied to a single, aging technology; and 2) the digitization strategy itself would only move forward if it held substantial and monetizable investor interest. Admittedly, issuer practice with respect to creating and submitting PDFs to EMMA would have to improve (e.g., blurry or sideways scans no longer allowed), but the related net issuer expense would be much lower than that involved in a comprehensive, issuer-paid XBRL rollout.