CHICAGO — Last year’s dire predictions that a coming record wave of expiring bank credit facilities would tax the municipal market did not come to fruition in the first quarter, according to a new report from Moody’s Investors Service.
Letters of credit and standby bond purchase agreements that support $130 billion of floating-rate debt are set to expire in 2011, an amount equal to more than one-third of the $380 billion VRDO market, according to data from the Securities Industry and Financial Markets Association cited by Moody’s.
Another $94 billion of credit support will come up for renewal in 2012.
Moody’s reviewed the outcome of 277 expirations that occurred involving its rated transactions in the first quarter and discovered that most issuers found manageable solutions even as many faced persistent credit challenges and banks faced tougher regulations, according to a special report being released today.
The report was previewed at a The Bond Buyer’s Midwest Public Finance conference last week.
“Although issuers with weaker credit may have fewer options, the first quarter’s track record indicates that the orderly resolution of bank facility expirations is likely to continue through the expiration bubble over the balance of the year,” Moody’s concluded in its report, “So Far So Good: Market Absorbing High Volume of U.S. Public Finance Sector Bank Facility Expirations.”
Of the 277 transactions, 72% were extended and 13% were replaced with substitute facilities. Issuers redeemed their bonds using their own liquidity, converted the debt to a fixed rate or some other product, or obtained direct bank loans on the remaining 15%.
Only two issuers’ bank facilities expired without an alternative solution. In such an event, the bank typically holds the bonds and the issuers face an accelerated repayment schedule.
The report’s authors found the results somewhat unexpected.
“We thought that, in general, people would successfully either extend their facilities or find substitutes or other solutions,” said Thomas Jacobs, vice president and senior credit officer at Moody’s. “We’re a little bit surprised that it was as consistent as it was. The degree of success was encouraging for issuers with upcoming expirations.”
The lion’s share of credit facilities, however, are set to expire over the next two quarters and so the potential for rapid credit deterioration remains a risk for issuers that are unable to renew or substitute their facilities.
Risks remain for municipalities concerning the heavy volume of bank-facility expirations still coming due in 2011. Less than $15 billion of transactions rated by Moody’s expired in the first quarter. About $70 billion will expire in the remaining three quarters.
In general, Moody’s remains cautiously optimistic that the first quarter’s successes will continue, especially for those higher-rated issuers that are in a better position to negotiate more favorable terms. Factors that pose some risk to the municipal market’s ability to absorb the expirations include the departure of one of the key bank players that provide credit enhancement.
Five banks account for roughly 70% of the par amount of facilities substituted or extended in the first quarter: Bank of America NA, JPMorgan Chase Bank NA, Barclays Bank Plc, Wells Fargo Bank NA and U.S. Bank NA. If one or more should exit, that could lessen competition and drive up pricing.
Saturation also could become an issue, according to the report. If money market funds — the largest buyers of bank-supported VRDOs — begin to lose their appetite for securities supported by certain banks, interest costs could rise during remarketing cycles. Headline and regulatory risks also could impact the market’s absorption of expirations.
For its report, Moody’s analyzed roughly 1,800 municipal transactions it rates that represent $83 billion of debt supported by facilities due to expire in 2011. New or extended facilities in the first quarter averaged just less than 21 months, according to the report. So in another two years the cycle will repeat itself and governments could find themselves scrambling again.
Moody’s found a positive correlation between the credit rating of the underlying borrower and the length of the renewal. Issuers with the lowest ratings face the most difficulty extending or substituting their facilities and negotiating longer terms.
Factors that have helped renewals include a move by some banks to directly buy an issuer’s debt as part of an investment strategy, while the entrance of Japanese banks into the LOC and liquidity facility market has helped ease prices and other terms.
Large amounts of variable-rate demand obligations were issued in late 2007 and 2008 after the collapse of the auction0rate securities market left borrowers with stiff interest penalties and sent them scrambling for a solution.
That resulted in an aversion to floating-rate risk that remains for some issuers — especially more conservative ones — who now favor fixed-rate structures. That has lessened the percentage of new-money issuance in need of credit support that traditionally has represented about 25% to 30% of the market, according to a panel discussion on the floating-rate market at last week’s Bond Buyer conference.
Direct purchases by banks are growing in popularity as, unlike with LOCs and SBPAs, they are not subject to the growing restrictions imposed by a web of federal regulations and capital requirements.
With the short end of the yield curve offering the most favorable rates, the smoothness with which the first quarter expirations were managed could help make the case for hesitant issuers to include some floating-rate structures in their debt portfolio, panelists said.
“There’s still a lot of fear out there,” Nat Singer, a managing director at Swap Financial and panel member, said of ongoing issuer aversion to floating-rate debt. He added that the first-quarter results suggest “maybe variable-rate isn’t such a bad thing.”