SEC report says real-time muni pricing would help

NEW YORK, Feb 11 (Reuters) - The lack of real-time price reporting has cost retail investors dearly in the U.S. municipal bond market, according to a study by the Securities and Exchange Commission released on Wednesday.

"Municipal bonds are expensive for retail investors to trade," said the study, co-authored by the SEC's chief economist, Lawrence Harris. "We attribute these results to the general lack of price transparency in the bond market."

Retail investors, who directly own more than a third of the $1.9 trillion of outstanding munis, would have the most to gain from real-time price reporting, the study said.

The 59-page study of liquidity in the muni market came the same day that the Municipal Securities Rulemaking Board began a meeting expected to discuss how quickly and how extensively real-time price disclosure will take effect next year in the tax-exempt bond market.

The roughly 2,700 muni dealers in the United States will be required to report all trades within 15 minutes beginning in January, 2005. Decisions about how that data will be made public have yet to be made.

Retail investors pay an average markup, or spread, of about 2 percent of the dollar value of their bonds. That is half the average 1 percent spread that institutions pay, the report said.

There are no stated commissions in the muni market. Rather, dealers buy at one price and hope to sell at a higher price.

Munis are usually issued in $5,000 denominations. That means retail investors pay $100 per bond on average, compared with $50 paid by institutional investors.

"This is the equivalent of almost four months of total annual return for a bond with a 6 percent yield-to-maturity," the study said.

Munis are issued with various features, such as early optional call dates, sinking funds and other credit enhancements. More complex bonds tend to trade with wider spreads, the study said.

What's more, dealers are apparently steering retail investors toward more complex bonds as a way to boost their trading profits, the study said.

Institutional investors seem to be aware of these higher trading costs, it said. "Alternatively, dealers may direct uninformed retail investors toward complex bonds because dealers can earn more trading them," it said.

Selling simpler bonds would likely help reduce costs to both issuers and investors, the study said.

Trading costs tend to be lower on higher-quality bonds, a widely held view among market participants.

Market players also tend to believe larger bond issues trade at lower spreads. But the study said this is unlikely.

"Actively traded bonds are as expensive to trade, and sometimes more so, than infrequently traded bonds," it said.

The study noted that most munis trade infrequently. The most actively traded bonds in the study tended to trade less than six times per day, it said.

The study used pricing data from November 1999 through October 2000.

Price transparency has improved in phases since then. Currently, all prices are available to the public on a next-day basis.