NEW YORK - The credit quality of the U.S. municipal sector as a whole has been largely unaffected by the European sovereign debt and banking crisis, but potential direct and indirect credit risks do remain for some public finance issuers, says Moody's Investors Service in a report.
"The U.S. municipal market's most direct links to the credit challenges faced by European governments and banks is through the issuers' exposure to material counterparty risk," said Moody's Managing Director Tim Blake, an author of the report. "These exposures are low in the aggregate but are material for a small number of issuers and such risks are already incorporated in our municipal ratings."
Of the $3.7 trillion of municipal debt outstanding, 1.2% or approximately $44 billion is variable rate demand debt and commercial paper supported by letters of credit or standby bond purchase agreements provided by European bank counterparties. Municipal issuers have additional European bank counterparty exposure through guaranteed investment contracts (GICs) and interest rate swaps totaling $28 billion.
"The unprecedented challenges facing the European Union and its banking institutions have potential implications for the global economy and for most, if not all, global sectors including the U.S. municipal market," said Blake. "Avenues do exist through which the economic instability in the EU could spill over to the U.S., adding downward pressure to credit conditions in the U.S. municipal market."
Still, absent a dramatic intensification of the debt crisis and contagion to the U.S. economy and U.S. banks, Moody's contends that the direct risks associated with support facilities, GICs and derivatives provided by European banks are manageable and credit stress on municipal issuers will be episodic rather than systemic.
By dollar amount, 84% of European bank support facilities enhancing U.S. municipal debt are provided by banks domiciled in France, Germany and the United Kingdom, three of the strongest European economies. Counterparties based in Ireland, Italy, Portugal, and Spain support less than less than 6% of debt enhanced by European banks. Moody's-rated U.S. municipal credits have no direct exposure to Greek banks.
"European bank exposures in most cases are small proportions of an individual municipal issuer's total debt and total revenues for Moody's rated issuers," said Blake. "In a limited number of cases there is exposure amounting to more than 25% of the issuer's debt outstanding, presenting a potentially material refinancing or swap-related risk for the issuer."