Some Municipal Borrowers Facing Growing Credit Risk From Expiring Bank Facilities

by: Research Recap

Municipal borrowers rated "A" and below with a significant amount of outstanding variable-rate debt face a growing credit risk from expiring bank facilities in 2011 and 2012, according to Fitch Ratings report.

Bank facility expirations for issuers with variable-rate demand obligations (VRDOs) are a growing credit risk, as large levels of bank facilities expire in 2011 and 2012. This is a by product of the auction-rate securities (ARS)/bond insurance meltdown in 2008 and shift to VRDOs. Fitch Ratings is concerned that bank capacity for renewals will be constrained due to bank consolidation, a contraction of facility providers, and uncertainties regarding Basel III capital/liquidity requirements.

In addition, Fitch expects that available liquidity support capacity will become increasingly expensive:

If issuers are unable to secure replacement facilities to support their VRDOs or are unable to refinance or convert their VRDOs with instruments not requiring such support, the VRDOs would face a mandatory tender. The draw on the liquidity facility in most cases would then have an accelerated principal repayment schedule (generally three to five years) to the bank.

Also, many issuers have fixed payer swaps linked to the VRDOs that would be costly to terminate. However, given historic low long-term interest rates, absorbing the termination cost and fixing out can be a prudent action for many issuers, which many have done to date.

Fitch has always considered in its analysis the ability of municipal issuers to manage their exposure to variable-rate demand debt. However, with the heightened concern regarding the availability of liquidity providers, Fitch believes lower rated credits are more exposed, as they generally have fewer opportunities for obtaining bank liquidity or could face difficulties in refinancing their VRDOs with fixed-rated obligations and terminating swaps. The inability of an issuer to renew expiring facilities, find alternative sources of liquidity, or effectuate a timely refinancing could yield negative rating pressure.

Disclosure: No positions