Monday, May 9, 2011

So Much For the Municipal Bond Collapse

At the end of last year and beginning of this year, the municipal bond market was dropping. The typical Cassandra's of Doom were arguing this was the coming of the End of Times. As is typical, these calls for collapse were wrong.

The municipal-bond market appears to be surmounting one of its most urgent challenges of the year as banks renew billions of dollars worth of expiring credit agreements with state and local governments, avoiding a costly scramble to refinance.

Early this year, with municipal-bond prices tumbling amid worries of defaults, analysts raised fears over tens of billions of dollars worth of bonds that would need to be refinanced if banks didn't renew letters of credit issued during the financial crisis. Those fears haven't yet been realized, according to a new report from Moody's Investors Service, another sign the $2.9 trillion muni-bond market is steadying itself after months of turmoil.

Of the $13.5 billion of letters of credit and other backstops tracked by Moody's that expired in the first quarter, 85% were either renewed or replaced by another bank, and the costs of many of the letters actually declined, the ratings firm said.

A bigger test comes in the second and third quarters, when $50 billion worth of letters of credit expire.

"We are cautiously optimistic that it all continues to work," said Thomas Jacobs, a senior credit officer in Moody's public finance team. "We are not through the end of this quarter, but we are not seeing problems with extensions." The borrowers typically use these letters of credit to backstop variable-rate demand bonds, which are long-term bonds with interest rates that reset periodically.

Let's take a look at the chart:

The fall at the end of last year was caused by the then-approaching expiration of the BAB program, where the federal government provided support for the muni-market. There was also concern about municipal finances. However, although finances are still tight, there are more and more signs of improvement. In addition, the renewal of the Letters of Credit adds further support to the market.