Moody's: Q2 increase in bank support reflects end of decade-long decline in VRDBs

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WASHINGTON – The amount of outstanding variable rate demand bonds rose to $142.4 billion in the second quarter of this year, a gain over $142.2 billion in the first quarter and the end of a decade-long decline, Moody’s Investor Service said in a recent report.

However, the outlook for new VRDB and commercial paper issuance remains uncertain because long-term fixed rates are low and short-term rates are volatile. These headwinds could be offset by reduced competition from direct bank lending in the wake of last year’s tax law changes that lowered the corporate tax rate, the report said.

Banks committed $9.2 billion of credit and liquidity support for Moody’s-rated VRDBs and commercial paper in the second quarter of this year, 33% more than in the previous quarter, according to the rating agency. Moody analysts declined to reveal the amount of VRDBs and CP rated by the credit rating agency.

The dollar volume of bank commitments for new VRDBs and CP rose to $1.36 billion in the second quarter, an 80% increase from $750 million the previous quarter but still less than the $1.84 billion quarterly average in 2017, Moody’s found.

This increase in quarter-over-quarter issuance reflects the weak overall municipal issuance in the first quarter following a surge at the end of 2017 in anticipation of tax law changes and the elimination of advance refundings, the rating agency said.

Banks extended $6.6 billion of their existing liquidity support in the second quarter, 46% more than the $4.5 billion extended in the first quarter and on a par with the quarterly average in 2017.

Substitutions of banks’ existing liquidity support fell to $1.25 billion from $1.68 billion, a 26% decline from the previous quarter and the 2017 quarterly average.

New VRDB issuance and the refinancing of floating-rate bank loans became attractive after the SIFMA rate, the benchmark for VRDBs and an indicator of the interest that municipal issuers pay on their variable rate obligations, fell to 1.05% in May from 1.60% the previous month, Moody’s said.

Bank liquidity support remained widely available in the second quarter as 40 banks issued commitments in the form of direct-pay letters of credit, conforming letters of credit or conditional liquidity facilities (standby bond purchase agreements).

Moody’s found greater diversification among providers of credit and liquidity facilities as leading providers from previous years continued to scale down their activity in the VRDB market.

U.S. banks accounted for 68% of all second quarter commitments, with the leading providers of commitments in 2017 -- JPMorgan Chase Bank, N.A., Wells Fargo Bank, N.S., and Bank of America, N.A. – focusing almost exclusively on extending their existing liquidity support.

State Street Bank and Trust Company led the way in the new issuance and substitutions for the second quarter in a row, with $523 million of new commitments issued.

Foreign banks, which had been less active in the VRDB market of late, increase their participation in the second quarter. Sumitomo Mitsui Banking Corp., Barclays Bank PLC, and Industrial & Commercial Bank of China, Ltd., together issued 46% of new commitments, Moody’s said.

Letters of credit issued, substituted, or extended totaled $6.2 billion of all bank commitments during the quarter, whole standby bond purchase agreements accounted for 32%, according to the report.

About 60% of the aggregate amount of new liquidity support, substitutions, and extensions in the second quarter will expire in the next three years, while the remaining 40% have terms in excess of three years, well above the historical average and an indication that longer commitments are becoming more popular, Moody’s said.

But 19 commitments totaling $113 billion issued by the banks in the second quarter will expire within six months and represent either stop-gap arrangements for borrowers working on substitutions, voluntary alternative financing agreements or alternative financings arranged as a result of the bank’s desire to withdraw support.

Meanwhile, the value of new, Moody’s-rated tender option bond trusts continued to decline, probably because of the relatively high variable rate reset rates during most of the quarter, the report said.

Moody’s said it rated 21 TOB trusts with an aggregate face amount of $323 million in the second quarter, unchanged from the previous quarter but significantly less than the 46 trusts and $1..5 billion average rated in 2017.

“As reset rates stayed mostly high, the profitability of TOBs remained limited,” Moody’s said in the report.

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