U.S. states, cities and other issuers in the municipal bond market are increasingly dropping credit back-ups provided by Belgian-French financial group Dexia as the euro zone crisis creeps onto American shores.
Dexia (DEXI.BR), which has been laid low by its heavy exposure to Greek debt and problems accessing wholesale funds, itself is urging U.S. issuers to replace these liquidity facilities as it unwinds its legacy business in munis.
"Our exposure (to the U.S. muni market) has been diminished significantly, and that was a deliberate choice on our part," Guy Cools, general manager of Dexia Credit Local's New York branch, told Reuters on Tuesday.
Liquidity provided by Dexia once supported $54 billion of muni debt, according to Cools, who said that amount has now shrunk to $9.6 billion.
These agreements are akin to insurance for muni bond issuers. But these issuers, facing higher borrowing costs for Dexia-supported debt as a result of Dexia's problems, are replacing these backstops or are letting them expire.
France and Belgium, which are both shareholders in Dexia, said on Tuesday they will bail out Dexia as officials prepare a rescue plan designed to stop the bank's troubles from expanding to other European banks. Dexia's worsening credit profile would have hit muni issuers' interest rate costs.
Moody's Investors Service warned on Monday it could downgrade Dexia's credit ratings, citing concerns over "further deterioration in the liquidity position of the group in light of the worsening funding conditions in the wide market."
Dexia officially stopped backing new U.S. muni debt after 2008 for various reasons, including a lack of enough liquidity in U.S. dollars and stricter capital and other requirements under Basel III, Cools said.
Dexia was the top foreign bank letter-of-credit provider for new muni debt issuance in 2008 when it backed $4.8 billion of debt in 46 issues, according to Thomson Reuters data, through letters of credit, standby bond purchase agreements and other liquidity facilities.
Issuers of variable-rate demand obligations need the facilities to serve as a line of credit if remarketing of the debt, usually on a weekly basis, fails to find new buyers.
The liquidity concerns that necessitated a bailout of Dexia would have caused large increases in borrowing costs for local governments and other issuers.
"People buying (variable-rate debt) were avoiding Dexia so remarketing agents have to raise rates on debt supported by Dexia," said Michael Downing, team leader of Municipal Market Data's short-term desk.
U.S. public finance rating actions in recent months indicated that many issuers have replaced Dexia as a liquidity provider with U.S. and other banks.
Massachusetts in August substituted a standby bond purchase agreement from Wells Fargo Bank for one provided by Dexia on $150 million of debt.
"We had concerns about Dexia's viability, so we acted proactively on the matter," said Jon Carlisle, communications director for Massachusetts Treasurer Steven Grossman.
Last week, the ratings on $100 million of Chicago's O'Hare International Airport third-lien revenue bonds were upgraded after the city replaced a direct pay letter of credit from Dexia Credit Local with one from Barclays Bank. Fitch Ratings upgraded the long-term ratings on the bonds to AA-minus from A-plus, while Moody's raised its rating to Aa1 from Aa2.
Connecticut converted $280 million of general obligation bonds that had a Dexia standby bond purchase agreement into SIFMA Index bonds, according to a Fitch report in July.
Cools estimated that over the last year Dexia facilities supporting about $20 billion of debt have been replaced.
The replacement of Dexia is occurring amid a huge expiration bubble for the liquidity facilities. Nearly half of all the facilities supporting variable-rate muni debt is set to expire by the end of 2012, representing $142 billion of outstanding debt, according to the Municipal Securities Rulemaking Board, which writes the rules for the muni market.
This year alone, facilities supporting $74.5 billion of variable-rate debt will expire.
Jeff Previdi, an analyst at Standard & Poor's Ratings Services, said as providers like Dexia exit the muni market, Japanese banks, which had been big liquidity providers in the late 1980's and early 1990's until their own credit crisis hit, have reemerged.
"So what goes around comes around," he said.
(Reporting by Karen Pierog in Chicago; Additional reporting by Chip Barnett in New York and Lisa Lambert in Washington; Editing by Leslie Adler)