Feb 21 (Reuters) - Moody's Investors Service is sweeping a magnifying glass over thousands of U.S. municipal sector obligations that are linked to 26 banks currently under review for possible credit rating downgrades, it said on Tuesday.
The Wall Street rating agency said it is looking at the ratings of debt sold by states, cities, hospitals and others that are based solely on support provided by banks under review, and also at the short-term ratings of obligations with standby bond purchase agreements and similar facilities from the banks.
At the same time, Moody's said it is considering downgrading the short-term ratings of tender option bonds - where a bondholder can put the bond back to the issuer - and long and short-term ratings based on a joint default analysis.
The last group - when Moody's calculates the default dependence between the bank and issuer - will touch 345 transactions alone.
The news could cause worry in the $3.7 trillion municipal bond market, where issuers have for the most part been successfully extending or replacing letters of credit and other expiring facilities backing their debt.
A bubble in bank letters of credit developed when the auction-rate securities market collapsed and issuers moved their money into variable-rate bonds, which need the facilities to serve as lines of credit during remarketing.
Many facilities provided during the financial crisis of 2007-08 expired last year, affecting approximately $130 billion of variable-rate bonds and issuers began turning to U.S. banks as concerns grew over financial problems in Europe.
When Belgian-French financial group Dexia's credit worsened last fall and issuers faced higher borrowing costs for Dexia-supported debt, they replaced their backstops with support from other banks or let the facilities expire. Dexia, meanwhile, stopped selling support.
Now, though, the creditworthiness of other banks is being called into question. On Thursday, Moody's warned it may cut the credit ratings of 17 global and 114 European financial institutions from the fallout of the euro zone government debt crisis. It said Bank Of America might be downgraded one notch.
In the public finance review it announced on Tuesday, Bank of America figures heavily, mostly because it provides a large share of credit and liquidity facilities.
Moody's is reviewing roughly 500 obligations where the rating was wholly based on support provided by BofA, including a long list of District of Columbia variable-rate bonds and revenue and general obligation bonds sold by New York City and its finance authorities and agencies.
The rating agency said it is also reviewing the ratings of another roughly 500 tender option bonds backed by the bank . These include variable and inverse rate certificates and puttable floating option tax-exempt receipts. Frequently, tender option bonds are deposited into trusts that issue floating rate securities and inverse floater securities.
Moody's said it is also looking at more than 350 obligations where the ratings are based solely on support provided by JPMorgan, with a heavy emphasis on finance authorities and health, housing and educational agencies in Illinois and New York City.
According to Thomson Reuters data, JPMorgan was the second largest provider of domestic letters of credit for new debt in 2011, representing a 20 percent market share. Citibank was the top seller of new letters that year.
Support provided by German banks such as Landesbank Hessen-Thueringen, are also triggering the Moody's reviews for debt.
Meanwhile, the nearly 300 tender option bonds not linked to Bank of America under review are supported by BNP Paribas , Citibank, Deutsche Bank, Morgan Stanley Bank, Rabobank Nederland, and Royal Bank of Canada.