Municipalities in the US that issue letter of credit (L/C) backed variable-rate demand obligations (VRDOs) may lose the benefits provided by the L/C if they buy their own bonds according to S&P Global Ratings.

As a result of market uncertainty triggered by the coronavirus pandemic, VRDO reset rates have surged to 5 per cent or higher versus less than 2 per cent in the first half of March, and the higher rate makes it more expensive for municipalities to finance their operations.

Market uncertainty

S&P says it has recently received inquiries from municipal VRDO issuers that have contemplated buying their own bonds and holding them until market conditions improve.

But by doing so, S&P says issuers risk losing the benefits of the L/C or standby bond purchase agreement (SBPA) backing they customarily use to back issues.

Not eligible

The ratings agency says that without L/C or SBPA backing, municipal issues would no longer be viewed as "eligible bonds" under the transaction documents.

S&P currently maintains ratings on approximately 2,300 primary market bank-enhanced VRDOs, totalling US$144.9 billion in debt, of which 52 per cent are backed by L/Cs and 48 per cent are backed by SBPAs.