The plan by Berkeley, California, to use blockchain technology to issue microbonds later this year could revolutionize the municipal bond market, said Vice Mayor Ben Bartlett in an interview with Debtwire Municipals.
A microbond or minibond is a smaller issuance of a traditional muni bond – about USD 3m, in Berkeley’s case. The minibond would be marketed to the community, and available for purchase in smaller denominations. Traditional munis allow purchases in denominations of USD 5,000 or USD 10,000, and Berkeley has not yet determined what denominations it will use for its issuance.
Another part of the appeal of the crowdfunded, microbond using blockchain technology for Berkeley is that the cost of issuance will be lower – an anticipated savings of 42% compared to a traditional issuance, Bartlett said. But that provides an opportunity for other issuers as well – Berkeley already has a low cost of issuance as a AA credit, and lower-rated issuers could see the same benefit, he said.
Berkeley would be the first municipality to issue bonds using blockchain technology.
Using blockchain, which is a distributed digital ledger, allows for cost savings in coming to market, and helps increase transparency with regard to use of proceeds, Bartlett said.
“In a time of public financial strain, one way to ease that strain is so communities can fund themselves,” Bartlett said.
“The cost of capital would go down for the other cities, the Detroits of the world (would have better access) and they could be more effective with their opportunities.”
The city will release a request for proposal this fall, seeking a deal team to bring the issuance to market, Bartlett said. That includes an underwriter, bond counsel and financial advisor, he said. The issuance will come to market paired with a larger, “traditional” issuance for other capital projects.
Berkeley has a few ideas for what the minibond could finance, including a new fire truck and new community theater, though the city has not made a final determination as to what the proceeds will be used for or when they will come to market.
“It’s a normal muni bond, the only thing is that because of the (blockchain) technology, it’s going straight to the consumer,” Bartlett said. “There’s real-time transparency with where it’s going and who possesses it.”
Microbonds are appealing to Berkeley as the issuance can be directly marketed to locals, encouraging people to invest in their community, Bartlett said.
Cambridge, Massachusetts and Denver have issued minibonds in recent years, though Berkeley’s intended use of blockchain technology will be the first of its kind. Cambridge used Neighborly Securities LLC as underwriter for both its USD 2m minibond in 2017 and USD 1.8m 2018 issuances, but Denver’s 2014 USD 12m issuance did not have an underwriter. Cambridge’s sales were completed in a week, but the Denver microbonds sold out in an hour.
“One of the advantages is that they’re issued in tiny denominations, which makes them (accessible) for anyone,” said Kevin Dayton, president of the California-based Labor Issues Solutions. “It’s reverting back to a time in history where regular people would buy bonds.”
But the revolution is not a certainty, given the nature of the municipal market itself.
The municipal market is already resistant to change, and the volatility, uncertainty, and lack of understanding of blockchain technology and cryptocurrency all factor into the skepticism among market participants, an industry analyst said.
“While this in theory is great, you could have a new audience investing in bonds that weren’t before,” said Eric Kazatsky, portfolio manager at Clark Capital Management Group. “I think it definitely could be a disruptive technology if it’s game-changing in the municipals space.”
In addition, the demographics of municipal bond investors trend toward older and higher-wealth individuals, Kazatsky said.
“It’s nice in theory, but who are they trying to target that aren’t already purchasing bonds?” Kazatsky said.
Direct marketing to retail investors sounds easy in principle, but in execution, removing broker dealers from the process to lower the cost of issuance is unwise, said Vikram Rai, head of municipal strategy at Citigroup. The cost of issuance is going up because of fiscal mismanagement, not broker dealer fees, he said.
“Broker dealers, whose fees have shrunk dramatically over the last few years, are a value proposition because they provide scale, market access, valuation expertize and a resources for handling complicated credit situations,” Rai said. “The vilification of banks and broker dealers seems to have populist appeal.”
If the blockchain and minibond trend catches on, it could make the market more accessible to smaller issuers bringing small deals forward, the analyst said. In addition, it’s possible more regulation will come to fruition to minimize any potential market disruption. It’s also possible the grassroots nature of the financing could be risky for some investors who have not fully explored the issuer’s credit quality.
“I don’t see blockchain and microbonds as practical mechanisms for debt financing and these are unlikely to transform the municipal market in anyway,” Rai said.
Berkeley is rated Aa2/stable by Moody’s Investors Service and AA+/stable by S&P Global Ratings.
A USD 2m tranche of 1.6% Series 2017A Cambridge minibonds due 2022 last traded in odd lots at 99.826 to yield 1.786% on 12 July.
A USD 2.8m tranche of 5.5% Series 2015 Berkeley general obligation refunding bonds due 2020 last traded in round lots at 107.318 to yield 1.75% on 11 September.
by Maria Amante