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Global Credit Research - 06 Jan 2011
Reduced demand and higher interest rates may impact certain issuers
New York, January 06, 2011 -- Most US municipal debt issuers could weather a period of diminished or
more costly capital market access because they can control long-term
debt requirements in ways that corporate and sovereign issuers cannot
and relatively few rely on the markets to fund short-term operating
needs, Moody's Investors Service concludes in a new report.
Municipal issuers that would face the greatest credit stress if market
conditions become more hostile are those that finance deficits through
bond issuance, rely on short-term notes to finance seasonal
cash flow needs, issue bond anticipation notes, or need to
convert variable rate to fixed rate debt. These include some of
the highest profile municipal issuers, such as the states of Illinois,
California and Arizona.
The Moody's report also addresses the related issues of recent record
outflows from tax-exempt mutual funds, forecasts for lower
municipal debt issuance in 2011, and the potential impact of diminished
market access on municipal credit.
"Despite reports of a loss of investor confidence in municipal bonds,
credit risk is only one of several factors driving investor decisions
about holding municipal bonds," said Moody's Managing
Director Naomi Richman.
Other important drivers are the impact of the expiration of the federal
Build America Bond (BAB) program, extension of the 'Bush tax
cuts,' and increasing relative attractiveness of the corporate
equity markets and other investments.
Many municipal debt issuers are indeed undergoing an unprecedented level
of credit stress, and Moody's has maintained a negative outlook
for all major municipal market sectors since 2008.
Should negative market commentary about municipal credit risk continue,
said Richman, "diminished investor demand for municipal bonds
could persist or even accelerate in the coming year."
Moody's expects that no state government and only a few local governments
will default on Moody's-rated debt in 2011. There
were no defaults by Moody's-rated state or local governments
in 2010, although one tax-exempt healthcare borrower did
default on its debt.
Most municipal borrowers are also structurally well-equipped to
weather a period of diminished market access, according to Moody's.
Unlike most corporate or sovereign debt, almost all state and local
government debt is fully amortizing, with both interest and principal
payments included in operating budgets. As a result, issuers
generally do not rely on the markets to roll over principal maturities.
"Most municipal debt is used to finance capital projects,
and governments have the ability to defer projects if they cannot finance
them at rates that make sense," said Richman. "Even
many issuers of short-term cash flow notes could draw down their
available cash reserves, if necessary, to handle seasonal
cash flow imbalances."
Debt service is also a relatively small portion of most governments'
budgets. Yields could increase quite a bit and still remain relatively
affordable by historical standards.
Exceptions to this rule are the small portion of state and local governments
that issue long-term debt to fund current operations.
"Reliance on deficit financing is one of the reasons that California,
Illinois and Arizona are the three lowest-rated states,"
There could also be pressure from diminished market access on issuers
who have no alternative to short-term notes to finance seasonal
cash flow needs, and for issuers of bond anticipation notes for
interim construction financing. It could also be a hardship for
an issuer seeking to convert outstanding variable rate demand bonds to
a fixed-rate mode.
"Even for those issuers most exposed to market risk, we anticipate
that they will still find ways of meeting their funding needs, and
that defaults will remain rare," said Richman.
The report, "Municipal Market Investor Confidence: Linkages
to Credit Quality," is available at www.moodys.com.
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Senior Vice President - Team Leader
Public Finance Group
Moody's Investors Service
MD - US Public Finance
Public Finance Group
Moody's Investors Service
Moody's Investors Service
Moody's: Most US munis could weather more difficult market conditions in 2011
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