Bank-Supported Muni Market Faces ‘Headwinds,’ Moody’s Says

The market for bank-supported municipal debt, including variable-rate demand bonds, may face “headwinds” this year because of possible cuts in bank ratings, Moody’s Investors Service said.

Top short-term ratings for both Bank of America Corp. and Citigroup Inc. (C) are under review for a downgrade, according to the credit-rating company. Losing the top grade may cause interest rates on $34.7 billion of municipal bonds to spike as money-market funds redeem the debt and dealers can’t resell it, Moody’s said in an e-mailed statement.

“Issuers whose remarketings fail or who are unable to arrange extensions or replacements for expiring support facilities may face severe cash-flow pressure as they confront higher interest cost and accelerated amortization,” Moody’s said in the report.

During the credit crisis, interest rates on so-called variable-rate demand bonds, often owned by tax-exempt money- market funds, surged after bond insurers and some banks lost their top-credit ratings. The increase in borrowing costs hit already cash-strapped cities, hospitals and schools.

Standby Agreement

Variable-rate demand bonds are long-term securities offering short-term interest rates because investors can demand their money on short notice and turn the bonds in for sale to another buyer. To assure investors there will be money available, governments hire banks to provide standby bond purchase agreements or letters of credit.

The lingering effects of the recession that ended in 2009 and Europe’s sovereign debt crisis have put stress on bank credit ratings.

New regulations intended to strengthen the financial system may also curb banks’ appetite for providing credit support, Moody’s said.

“Weakening credit profiles of some banks may alter their ability or willingness to renew or make new commitments to this market going forward and will make the extension and substitution of expiring support facilities more challenging than it was in 2011,” Moody’s said.

State and local governments didn’t have issues resolving the expiration of 1,800 letters of credit and standby bond purchase agreements on Moody’s rated debt last year, the company said.

To contact the reporters responsible for this story: Martin Z. Braun in New York at mbraun6@bloomberg.net; Greg Chang at gchang1@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

Bloomberg reserves the right to edit or remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.