Moody's Downgrades Hit Muni Market After Banks' Cut
06/22/2012| 05:37pm US/Eastern
By Mike Cherney and Kelly Nolan
Moody's Investors Service (>> Moody's Corporation) Friday lowered ratings on 1,675 public-finance obligations supported by one or more of the 15 banks it downgraded the previous day. Roughly $45 billion in debt is affected.
The agency also said Friday it expected few ratings changes for U.S. municipal-bond issuers that rely on the banks to support variable-rate securities, whose interest rates are reset periodically. However, Moody's said the long-term ratings of less than 5% of the approximately 500 issuers could be affected.
Bank support for the obligations being downgraded include letters of credit, standby bond purchase agreements and other liquidity facilities, Moody's said. Banks downgraded by Moody's on Thursday include Bank of America Corp. (>> Bank of America Corp), Barclays PLC (BCS, BARC.LN), Citigroup Inc.(>> Citigroup Inc.), Credit Suisse Group (CS, CXGN.VX), Goldman Sachs Group (>> Goldman Sachs Group, Inc.), J.P. Morgan Chase & Co. (>> JPMorgan Chase & Co.) and Morgan Stanley (MS).
The ratings firm said the bank downgrades could lead variable-rate bondholders to exercise their option to tender the bonds back to the issuer. If the tendered bonds aren't resold to other investors, the bonds are purchased by the supporting banks. This exposes issuers to higher interest rates, and they are often required to pay the debt back faster, Moody's said.
Usually, issuers would then seek to replace their bank-support facilities, or refinance the variable-rate debt with fixed-rate bonds or privately placed direct bank loans.
"The bank downgrades have exacerbated the remarketing risk associated" with the variable-rate bonds, Moody's said in a statement. "Issuers likely to be the most pressured are those that have significant variable-rate exposure within their debt portfolios, coupled with low liquidity."
Immediate market reaction to the downgrades has been muted. Rates on many bonds in the $300 billion variable-rate muni market have already been set for the week, and won't reset until around mid- to late next week, market participants said. Investors had since February--when Moody's first said it was reviewing the banks--to prepare. Some investors selectively sold debt that could be affected ahead of the downgrade, while issuers sought additional ratings for their bonds or got backing from banks that weren't being targeted by Moody's.
Bank of America and Citibank, both of which had their short-term ratings cut to P-2, backed roughly $35 billion of muni bonds as of February, according to Moody's.
"There's not going to be any 'oh my gosh' moment here because this was so well telegraphed," said Craig Mauermann, who manages the $850 million BMO Tax-Free Money Market Fund.
Stephen Simcic, acting co-executive director at the Pittsburgh Water and Sewer Authority, said he wasn't expecting a change in interest rates on roughly $73 million in variable-rate bonds that are backed by Bank of America. That is because the authority got an additional rating from Fitch Ratings on the debt, which it sold in 2008.
That gave the authority a third rating, along with Standard & Poor's and Moody's. The extra rating means the bonds now have at least two top short-term grades, offsetting any impact from the Moody's downgrade. Money-market funds, which are big buyers of variable-rate munis, are tightly regulated in what they can own; in general, they can only hold very highly rated securities.
"The third rating is acting as a buffer, as we had hoped," Mr. Simcic said.
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