Moody’s Investors Service called the second-quarter a “critical test” for liquidity facilities supporting the variable-rate demand market. So kudos all around, for the market passed with “near-universal success.”
“Almost all public finance issuers successfully resolved their expiring bank facilities in the first half of 2011, with many issuers having multiple options available to them,” Moody’s said in a report to be published Monday.
A record $130 billion of liquidity facilities supporting VRDNs is set to expire in 2011. The second quarter was expected to be by far the busiest time as 567 facilities worth $40 billion expired, and that raised the prospect of renewal risk for borrowers across the country.
For an issuer that can’t find a renewal, the threat can be “severe and rapid credit deterioration,” the Moody’s report says.
Issuers are typically forced to sell penalty-rate bonds to a bank facility provider that would amortize more quickly than planned, causing distress for issuers lacking the resources to cover the debt.
The wave of expirations caused deep concern last year just as mass default predictions dominated the headlines. But as the default predictions came to naught, so too have fears about renewal risk.
Nearly four-fifths of expiring liquidity facilities were renewed or replaced in the first half of 2011, though the renewal-replacement rate fell to 78% in the second-quarter from 85%.
In the remaining 22% of cases, debt was refunded by issuing bonds in public offerings, or through private placements and direct loans — two alternatives which have been growing.
Some participants have said a lack of issuance in 2011 helped banks to focus on expiring facilities as a way to keep business up. Just $4.95 billion of new VRDNs were issued from January to June, compared with $8.34 billion in the first half of 2010 and $16.8 billion in the first half of 2009, according to Thomson Reuters.
But Thomas Jacobs, senior credit officer at Moody’s, said making sure renewals and replacements run smoothly goes deeper than that.
“The market had to focus on these expirations — it’s not optional,” Jacobs said Friday. “These are transactions that have to be taken care of and maintained.”
Expiring liquidity facilities include letters of credit, lines of credit, and standby purchase agreements.
Since the financial crisis, the landscape of supporter providers has been dominated by a small number of U.S. banks, namely JPMorgan, Wells Fargo, and Bank of America Merrill Lynch. Some newcomers to the top-10 list of LOC providers include RBC Capital Markets, U.S. Bank, and Northern Trust.
Moody’s senior analyst Robert Azrin said a liquidity facility cost as little as 10 basis points before the financial crisis, whereas in 2011 “we’ve been seeing 50, 60, 70 basis points, and for lower-rated issuers it’s higher.”
The smooth transition in the second-quarter should set the tone for the coming years, but a number of challenges still lie ahead, Moody’s said. These include the potential for a large municipal default, a shift in expectations for default rates, or sovereign-credit troubles in developed nations that could discourage banks from providing credit or liquidity.
Problems with the renewal and replacement process could also develop if the small number of banks that provide these services change their tune.
Basel III, the Dodd-Frank Wall Street Reform Act, and the Consumer Protection Act, could also prove problematic in causing uncertainty in the coming years.
“Key components of the Basel III accords such as the 'liquidity coverage ratio’ for banks would not affect the municipal market in the near term,” Moody’s said. “However, it remains to be seen whether other elements of Basel III and the Dodd-Frank legislation could cause banks to reevaluate their commitment to the municipal market.”