As liquidity for municipal issuers remains scarce in the short-term market, a regional broker-dealer group and an organization representing nonprofit student loan lenders are urging the Treasury Department to provide standby liquidity facilities for issuers still trying to convert from auction-rate securities to variable-rate demand obligations.
In a five-page letter sent to the Treasury yesterday, the Regional Bond Dealers Association and the Education Finance Council said the department should consider providing a liquidity backstop for VRDOs under the new authority to purchase or commit to purchase "troubled assets" that Congress gave it in the recently enacted bailout legislation. Alternatively, it could use authority in the legislation allowing it to guarantee troubled assets issued prior to March 14, the letter said.
"Safe, stable variable-rate securities supported by a Treasury-provided liquidity facility would appeal to a broad range of investors," said the letter, which was signed by RBDA's co-chief executive officer Michael Decker and EFC president Kathleen Smith. "It is unlikely that the facility provided by Treasury would be drawn on to a significant extent, because its mere existence would likely provide confidence to investors and restore normalcy to the market for the affected products."
Though the auction-rate market collapsed in February and many issuers have been trying to convert them to VRDOs, liquidity has dried up to the extent that there are essentially no banks willing to provide issuers with letters of credit or standby bond purchase facilities. VRDOs have long-term maturities and short-term interest rates like ARS, but feature a put option that allows the issuer to sell them to a bank if they cannot be remarketed. ARS typically have been backed by bond insurance and have not included put options.
The letter noted that of the roughly $330 billion of outstanding ARS prior to the market's collapse in February, some $200 billion of the troubled securities remain outstanding. That figure includes some $80 billion of ARS sold by municipal issuers, according to statistics compiled recently this month from Bloomberg LP, the bulk of it from failed auctions.
The dearth of liquidity has become so widespread that even triple-A rated counties have been unable to find it. In a hearing this morning before the House Ways and Means Committee, Tim Firestine, the chief administrative officer for gilt-edged Montgomery County, Md., plans to testify that his county received no response to a request for proposals issued earlier this month for an $80 million to $90 million liquidity facility. It sought the facility for a bond transaction to finance intersection improvement projects and a "smart growth initiative" to relocate a 150-acre county service center near a Metro stop and convert the land to housing.
After putting the transaction on hold, Firestine said the county ultimately decided to issue the debt as fixed rate , which will carry higher interest rates than VRDOs.
Were the Treasury to step in with a standby liquidity facility, "an orderly market would emerge" for the billions of dollars of assets frozen on the balance sheets of banks, broker-dealers, and investors, the RBDA and EFC letter said.
Issuers would also be freed from high penalty and maximum rates on their "failed" securities. Though the assets are technically "troubled," the groups noted that the bonds themselves are creditworthy and "soundly performing" assets that would not expose Treasury to undue credit risk. In the case of student loan-backed securities, which are already 97% federally guaranteed, "providing a liquidity backstop for these issues would entail no new credit risk at all for the government," the groups said.
"The program would preserve the integrity of the municipal finance and student loan systems and would free up resources for student lenders to make new loans and states and localities to pursue projects that create jobs and enhance services," they said.
A Treasury spokeswoman could not be reached yesterday for comment.