Municipal issuers that are more likely to have trouble renewing bank guarantees supporting floating-rate debt face greater scrutiny from Moody’s Investors ­Service, the rating agency said in a report Wednesday.

Moody’s said it plans to monitor ­governments with pending expirations on bank liquidity facilities, particularly issuers with weaker credit ratings, homogenous exposure to one bank, or a heavy concentration of facility expirations in a short span of time.

The contraction in the availability of bank credit to municipalities has surged to the forefront of muni finance.

Almost $80 billion of bank facilities supporting variable-rate municipal debt are scheduled to expire in the next five quarters, according to Moody’s, with an enormous spike in the second quarter of next year.

The reduction of the banking sector’s ability, or in some cases willingness, to extend credit to municipalities has spurred speculation about whether all these facilities can be renewed.

While Moody’s does not expect widespread downgrades because of these expirations, it said it is “placing additional emphasis on monitoring certain borrowers that have expiring bank facilities in the next year.”

Banks play a vital role in the market for variable-rate municipal debt. Many municipalities float a portion of their debt as variable-rate demand obligations, which are long-term bonds that behave like short-term debt because their interest rates reset regularly.

In order to appeal to investors in short-term markets, VRDOs typically feature a put option enabling the investor to sell the debt back to the issuer.

Because few municipalities have the flexibility to repurchase their own debt at the investor’s option, a government issuing a VRDO normally has to pay a bank to agree to purchase the debt from the investor exercising the put, if nobody else will.

The liquidity facilities banks ­offer to provide the service are either ­letters of credit or standby bond purchase ­agreements. VRDO issuance erupted last decade as bank liquidity was plentiful and cheap — reportedly it often cost as little as 15 basis points to secure an LOC or SBPA on a municipal variable-rate ­demand ­obligation.

States and local governments sold nearly $285 billion in puttable variable-rate debt from 2005 to 2008, according to Thomson Reuters, or 17% of municipal borrowing during that time.

An RBC Capital Markets estimate pegged the apex of the VRDO market in 2008 at $525 billion outstanding — a fifth of the overall municipal debt market.

Most bank liquidity facilities expire after an average of three years. VRDOs might expire in 20 or 30 years.

That necessitates a continuing renewal of the facilities. Until last year, that often was done with the same bank. When the supply of bank credit was abundant, expirations of the facilities was a footnote. Not anymore.

The credit crisis depleted banks’ capital and decimated their ratings, disqualifying many of them from writing credible guarantees on municipal debt.

The top five municipal LOC providers last year — JPMorgan, U.S. Bank, Wells Fargo, Bank of America, and SunTrust — controlled two-thirds of the market, according to Thomson Reuters.

Royal Bank of Canada by itself controlled almost 40% of the SBPA market last year.

Renewing bank facilities is now more expensive, and in many cases requires switching banks because the expiring ­provider has left the market. Facing higher costs, many issuers have transitioned out of their variable-rate facilities, often by selling fixed-rate bonds and using the ­proceeds to buy back the variable-rate bonds and terminate the existing facility.

Some issuers have sold Securities ­Industry and Financial Markets Association-based floating-rate notes, which pay a floating interest rate at a spread to the SIFMA swap rate and do not offer a ­liquidity backstop from a bank.

Municipalities this year have sold $4.64 billion of bonds with yields linked to a benchmark rate, such as the London Interbank Offered Rate or the SIFMA swap rate — already a record.

A Municipal Securities Rulemaking Board report earlier this week reported $339 billion of outstanding VRDOs, ­representing substantial contraction from the $525 billion RBC estimate at the 2008 peak.

Against this backdrop, Moody’s is examining the prospects for issuers that have not fixed out of their facilities and face a looming expiration. It is targeting certain municipal borrowers it believes face “above-average renewal risk.”

The agency said a rating of A1 or below is one red flag, because issuers with weaker ratings generally suffer from more restricted access to bank credit or other refinancing options.

Reliance on a bank that is paring down its exposure to municipals or is facing a downgrade itself is another red flag.

“Moody’s expects that renewal and refinancing risk for municipal issuers and not-for-profit organizations will increase through 2011 given the number of bank facility agreements that are scheduled to expire over this period and at a time of greater uncertainty in the banking industry,” the report said. “We do not ­anticipate renewal risk will result in widespread rating changes. However, Moody’s expects to place greater weight on assessing ­borrowers’ ability to renew bank facilities during this upcoming period.”

Failure to renew a facility or figure out a way to convert out of it can be possibly disastrous. Under a typical LOC or SBPA agreement, when a bank steps in to buy a tendered bond, it is able to force the municipality to repay the debt at an accelerated rate.

Moody’s cited an example of a municipal credit it downgraded because of this issue: the Harris County-Houston Sports Authority. In August, Moody’s slashed its senior-lien debt to Ba3 from Baa2 after the issuer failed to obtain a replacement SBPA for its junior-lien bonds. It is now paying off the facility at an accelerated rate to JPMorgan.

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