Bank regs may jack up muni bond interest rates

State and local governments may be squeezed by rising costs on credit lines needed to support variable-rate bond issues in the wake of new financial regulations, Moody's Investors Service said in a report. Regulators from 27 nations this month set new short-term capital requirements for banks that are set to take effect in 2015. Moody's said uncertainty surrounding the rules, known as Basel III for the Swiss city where world bankers meet, may make banks less willing to purchase the municipal debt, driving up interest rates. “Close attention needs to be paid to the ability of municipal issuers and not-for-profit organizations to renew their sources of liquidity, especially as a high number of bank facilities are scheduled to expire precisely at a time of heightened uncertainty in the banking industry,” Lisa Martin, author of the Moody's report, said in a statement today. Moody's said it doesn't anticipate that renewal risk will prompt widespread rating changes because its rankings incorporate debt-structure analysis. About $200 billion in municipal borrowers' letters of credit are maturing in 2010 and 2011, and $30 billion of that may be difficult to renew, according to the Securities Industry and Financial Markets Association. That may result in more restrictive terms, higher costs and decreased availability for lower-rated issuers, according to Aug. 3 minutes from the Sifma committee that advises the Treasury Department on borrowing. Possible Downgrade “Those at risk may also be relying on banks that face a possible downgrade in their short-term rating, and banks that intend to reduce their credit-support business to certain sectors,” Martin said. Letters of credit, or standby purchase agreements, require banks to buy variable-rate bonds if other investors can't be found at the interest rate set by the issuers' remarketing agent, usually daily or weekly. That promise makes the bonds eligible for purchase by money-market mutual funds, and allows local governments to borrow at lower, short-term interest rates. The rates averaged 0.29 percent in the week ended Sept. 23, according to data compiled by Bloomberg. Variable-rate bonds were frequently paired with interest- rate swaps to guard public officials against the risk that rates would rise, a strategy that backfired after the credit crisis erupted. Facing with rising credit fees, state and local governments have since paid hundreds of millions of dollars to escape from the interest-rate swap deals.