As large domestic banks feel the pinch of the credit crunch, regional and international banks are stepping into the void. In few places is this more evident than in the municipal market, where these banks have moved to provide liquidity and credit enhancement to issuers feeling left out in the cold.
The issue got more visible last week, when State Street Bank withdrew a letter of credit promised to the Massachusetts Turnpike Authority. The bank told MTA officials that it had withdrawn the LOC based on market volatility and credit constraints.
State Street's actions are by no means unique. As many domestic banks have had losses related to subprime mortgages, they have been more reluctant to take on risk and put capital to work.
In a municipal market reeling from the turbulence of auction-rate securities failures and other dislocations, liquidity needed for converting ARS to variable-rate debt has been in high demand. With banks less willing to take on risk and issuers needing more capacity than ever, it has become a serious challenge for the market.
"There is a huge deficiency because demand is far outstripping supply," said S. Kurtz Barkley3d, the first vice president for KBC Bank NV, at yesterday's Bond Buyer conference on the credit crunch, speaking about both letters of credit and standby bond purchase agreements.
To be sure, some large domestic banks are still involved. Bank of America NA and JPMorgan, number one and number two in providing letters of credit last year, have continued to keep up that pace this year. Through March 24, Bank of America was still first, providing the LOC on 18 deals for a total par value of $889.5 million, according to Thomson Financial. JPMorgan remained in second place, providing the LOC for 15 issues for total par value of $596 million.
Bank of New York Mellon, the sixth-most active bank last year, moved into third place through March 24, providing LOCs on seven issues for total par volume of $371.8 million, according to Thomson.
However, other large banks have scaled back their involvement. Wachovia Bank NA, ranked third last year, is 10th so far this year. Citibank NA and Comerica Bank NA, 11th and 17th last year, respectively, have not written a single letter of credit this year, according to Thomson data. KeyBanc Capital Markets and LaSalle Bank have also dropped out of the top 10, where they were last year.
"Many banks are using their capital to deal with their internal situations," said one banker at a prominent broker-dealer. "I think there are some banks that could be reevaluating their commitment to the market."
In their place, a number of international banks have filled in. The second largest bank in Spain, Banco Bilbao Vizcaya Argentaria SA, has moved into fifth place by par volume, providing LOCs through its Grupo Banco Bilbao Vizcaya unit on two issues for a total of $267.2 million, according to Thomson Financial.
Last week, it was announced that BBVA would provide a portion of the one-year standby bond purchase agreement for $530.8 million in variable-rate bonds issued by the Oklahoma Turnpike Authority, which was looking to replace the XL Capital Assurance Inc. insurance attached to the bonds.
Also, the Bank of Scotland - a member of one of the U.K.'s largest banks, HBOS PLC - KBC Bank, Bank of Nova Scotia, Allied Irish Bank PLC and Harris NA, owned by parent company Bank of Montreal, are all either foreign banks or those with foreign parents that have moved into the top 13 in terms of liquidity providers this year. Every one of them ranked much lower last year.
"Allied Irish has been providing letter of credit enhancement for 22 years," said a spokesman for the bank. "The disruption in the auction rate-security market [where the bank does not participate] is providing numerous opportunities to write quality business."
And even as existing international banks that have previously been involved in the market have increased their participation, others that may have left the market are getting back in. For example, two of the top twelve providers of liquidity this year, the Bank of Nova Scotia and BBVA were not active last year at all, according to Thomson.
HSBC BankUSA, owned by one of the largest banks in the U.K., has also looked to get more involved in the market, said Dominique de La Chappelle, partner at Nixon Peabody LLP, in an interview at yesterday's conference.
The banks are responding to better pricing conditions in the market. Over the last few years, prices for LOCs have come down, driving many of the marginal players out of the market. However, in the last few months, as increased demand for liquidity has placed a premium on the supply, spreads have widened out and prices have increased.
"The pricing for credit facilities has begun to widen out dramatically," said Brian McGough, managing director at Fifth Third Securities Inc.
Letters of credit costing 10 basis points by double-A rated issuers before the credit crunch are now going for 30 to 40 basis points, while lower-rated issuers may be paying even more. According to KBC's Barkley, a three-year LOC nine months ago would have gone for 15 to 25 basis points for an A underlying credit. Today that is more like 30 to 45 basis points.
"From a bank's credit committee point of view, it's easy money," said Ed Merrigan, director of research at B.C. Ziegler & Co.
In addition to foreign banks, regional banks are also taking advantage of the opportunity. BB&T Corp., with headquarters in Winston-Salem, N.C., has moved into the top 10 in providing letters of credit. Ranked 26th last year, BB&T is fourth so far this year, providing an LOC on seven deals worth a combined value of $312.3 million.
"Market circumstances have put us in a good position," BB&T spokeswoman A.C. McGraw said.
US Bank NA, in the top 10 last year, has started getting involved in some of the bigger deals that previously might have only involved JPMorgan or Bank of America, de La Chappelle said.
Regions Bank, parent of investment bank Morgan Keegan & Co., and SunTrust Bank, fourth and fifth last year, have remained in the top ten without losing much ground. Regions Bank is ranked sixth in 2008, through March 24, providing an LOC on six deals worth $230.1 million, while Sun Trust is ranked ninth so far this year, with LOCs on six deals worth $130.5 million.
Other domestic banks with clean balance sheets have looked to leverage the need for liquidity as a tool for bringing more business to other areas of the bank.
Fifth ThirdBancorp, the regional bank headquartered in Cincinnati which runs broker-dealer Fifth Third Securities, has long provided credit facilities for muni issuers. In the current market, Fifth Third has been able to take advantage of its relatively clean balance sheet and robust capacity.
In doing so, Fifth Third has continued to provide liquidity for certain deals, while also steering clients to other services including investment banking and financial advising.
"We have a big bank that has all of the tools to service the tax-exempt sector," said McGough, who oversees the health care investment banking business for Fifth Third.
Others are trying a different approach. Dexia Credit Local, a unit of the large European-owned bank Dexia Group, has started to expand its direct lending program.
"In this market, we are doing a lot of letters of credit, liquidity, and direct lending," said Stephen DeGroat, senior vice president at Dexia Credit Local. "We have a lot of capacity, most of it is standby bond purchase agreements."
Dexia Group is first in providing standby bond purchase agreements this year, backing 14 issues to date for total of $2.1 billion. JPMorgan, Depfa Bank, Lloyds TSB Group PLC - one of the U.K.'s five largest banks - and BNP Paribas SA round out the top five in that category.
Pricing on SBPAs has also widened out, with a 364-day SBPA for a double-A, or A-plus underlying credit costing 20 basis points, up from 10, Barkley said.
DeGroat said that under Dexia's direct lending program, his bank will buy and hold entire issues. At this point he is looking at large and small deals, and hopes to use more than a billion dollars in capacity this year. Most of that will be with general obligation and sales-tax backed issues, DeGroat said.
In January, Dexia Credit Local provided the liquidity for the Illinois State Toll Highway Authority's $760 million of advance refunding bonds, and DeGroat said Dexia is working with the Chicago schools on another large deal.
In this market, even banks with available capital are having to choose wisely. Many are having to decide between old clients and new clients, and more often than not responding to the needs of "friends and family" first, one trader said.
"The fact is we're cherrypicking, as is every other bank," Barkley said.
Market sources tell stories about bankers' desks piled high with requests for proposals, and more than one has reported a temporary "moratorium" on the award of further liquidity facilities. At KBC Bank, between 10 and 20 request for proposals were submitted every day in January and February, compared to 10 to 20 each month before the failures began in the auction-rate market, Barkley said.
The liquidity crunch is apparent in Thomson's data as well. It shows that of the 109 current refundings in February, not a single letter of credit or standby bond purchase agreement was written. Current refundings are one of the structures used by issuers looking to retire ARS and by paying them off with proceeds of a new issue bonds of a different type, in some cases those could be VRDBs that need liquidity facilities.
The absence of bank liquidity last month was a drop from the six such refunding issues that had an LOC or SBPA in December, representing 27.4% of all current refunding issuance, and four issues in January, for 11.9% of all deals, according to Thomson. In March so far, already 13 current refundings, or 26.3%, have had credit enhancement in the form of LOCs or standby bond purchase agreements.
The liquidity crunch has led others in the market to seek alternatives. At least one law firm is working to structure synthetic LOCs - a technique that has enjoyed success in the taxable market - with leveraged buy-outs. If successful, the solution has the potential to take some of the pressure off liquidity banks.