Bank support agreements to which some municipal issuers are exposed for their short-term debt can weaken an issuer’s long-term credit quality, Moody’s Investors Service said Tuesday.
These agreements include letters of credit, swaps, standby purchase agreements, lines of credit, and loan agreements, Moody’s said in a report.
The key potential risks include rating triggers, renewal or rollover risk, collateral pledges or posting requirements, and financial covenants. In particular, SBPAs associated with insured variable rate demand obligations can pose increased near-term risk,” Moody’s said.
“Downward revisions of financial guarantor ratings over the last several years have increased the possibility that a bank providing liquidity to an insured VRDO transaction could terminate its agreement based on deterioration in the credit quality of the guarantor,” analysts wrote.
Moody’s recently downgraded one of the still active municipal bond insurers, Assured Guaranty Municipal Corp., to A2 from Aa3. Following the financial downturn, many other bond insurers were downgraded to junk ratings.
Analysts said that Moody’s is primarily focused on provisions of these agreements that could potentially cause unexpected liquidity strains for an issuer due to the ultimate results of tender provisions of bond structures or termination and renewal risks of liquidity agreements.
“These provisions in variable rate borrowings can potentially lead to short-term demands on liquidity, causing more rapid credit deterioration for holders of fixed-rated bonds than would otherwise be expected,” analysts wrote.
The report was an update of a special comment on the subject originally published in 2009. The new report includes revisions reflecting Moody’s current view of the risks associated with puttable variable rate debt.
“We will continue to pay close attention to risks to long-term bondholders associated with various kinds of bank agreements, particularly risk that variable rate debt can be accelerated or swap counterparties can demand collateral draining liquidity to the detriment of other investors,” Moody’s said.