WASHINGTON May 1 Private bank loans are riding
a wave of popularity among cities, counties and other U.S. local
governments, leaving the $3.7 trillion municipal bond market
racing to assess and contain any risks they may pose, a white
paper said on Wednesday.
"Bank loans provide issuers with access to capital, supply
needed cash flow...and can be easier and less costly to obtain
for an issuer than a public debt issuance," a task force that
included members of nine major banking, investing, trading, and
bond organizations said in the white paper.
But a loan could "introduce potential risks that may impact
a bondholder's willingness to continue to hold the issuer's
bonds, affect bond ratings or impact pricing in the secondary
The climb in borrowing, either by selling bonds to banks or
through direct loans, has been swift and steep. U.S. banks held
a record high level of municipal bonds and loans in the final
quarter of 2012, $363.1 billion, according to the Federal
Reserve, one of the few sources of data on the loans.
The public is often in the dark about the details of the
borrowing, with investors and regulators sometimes having to
wait for annual statements to learn loans even exist.
"I think it's great that there's again another opportunity,
another tool for state and local governments to tap, but I do
think we do need to be vigilant about some of the pitfalls in
that private funding market," Municipal Securities Rulemaking
Board (MSRB) Executive Director Lynnette Kelly said last month.
"What are the terms of those bank loans and do state and
local governments really understand the risks involved with bank
loans? Are those loans being disclosed? Is there a refinancing
risk in five years, seven years, 10 years - whenever these great
loans come due?" she added in a speech to a meeting of state
The MSRB is a self-regulatory organization that writes the
rules for the market that the Securities and Exchange Commission
enforces. In a statement on Wednesday, Kelly commended the task
force for assisting issuers by laying out possible ways to
disclose the loans.
Issuers do not have to provide offering documents when they
take out the loans, and they do not have to tell traders in the
secondary market about them. Last year, though, the MSRB began
pushing for voluntary disclosure.
The task force, which included representatives from the
American Bankers Association and the Securities Industry and
Financial Markets Association, suggested disclosing bank
documents such as the financing agreements or providing
summaries that cover the loan's terms. It emphasized that
issuers should promptly post the information.
Banks have long made tax-exempt and taxable bank loans to
issuers, but since 2009, they have been more willing "to make an
increasing amount of tax-exempt bank loans to issuers as an
alternative to publicly offered tax-exempt bond issues,"
according to the white paper.
The 2009 federal stimulus plan raised the amounts of
"bank-qualified obligations" that banks could hold, as part of a
grander scheme to thaw a municipal credit freeze. In 2009 and
2010, issuance of the obligations doubled.
Essentially, the obligations are exceptions to part of the
tax code that prevents banks from deducting the carrying cost of
municipal bonds from their taxes. By doing so, the tax code
eliminates the appeal of most tax-exempt debt for banks.
When the stimulus plan expired issuance of the qualified
obligations slowed, but the public sector continued relying on
banks in general, the task force found.
"Contrary to the expectations of many participants in the
municipal market, however, banks have continued to make a
substantial amount of bank loans on a non-bank-qualified basis
since Jan. 1, 2011," according to the white paper.
Many loans are being used as substitutes for the liquidity
facilities and letters of credit that banks provide to back
variable-rate demand bonds, according to Thomas Jacobs, who
tracks products related to municipal bonds as a vice president
for Moody's Investors Service.
Direct borrowing is less expensive for both issuers and
banks than selling variable-rate bonds with support facilities,
according to the rating agency.