April 4 (Bloomberg) -- 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. 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.
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.
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