European and North American banks continued to strengthen their grip on the letter of credit market in the first nine months of the year, but overall issuance fell dramatically.
Through the end of September, $5.4 billion of issues were sold with letter of credit backing, according to preliminary figures from Securities Data Co., representing a 53.4% drop from $11.6 billion in the first nine months of 1993. Through September, overall tax-exempt volume was off 44%.
In the third quarter, only $884.1 million of issues were backed by letters of credit, according to Moody's Investors Service, a 60% drop from $2.2 billion in the third quarter last year.
With interest rates rising, market participants and analysts expected letter of credit volume to be up this year, at least relative to overall issuance. In a rising interest-rate environment, municipalities generally favor short-term borrowings that employ letters of credit.
That, coupled with a desire by issuers to balance their portfolios with short-term variable-rate debt after two years of heavy long-term refunding and borrowing at fixed rates, had some bankers expecting solid demand this year for their credit enhancement.
Two factors have conspired to spoil the party, according to market participants and rating agency analysts: a downturn in short-term borrowing by state issuers and the growing use of alternative forms of credit enhancement.
State issuance of bond anticipation notes, tax and revenue anticipation notes, commercial paper, and other short-term cash borrowings historically have been the mainstay of many banks' public finance activity. But many state issuers who have traditionally accessed the short-term market have forgone or scaled back their annual borrowings this year, notably Michigan, New York, Iowa, Pennsylvania, Massachusetts, and New Jersey.
In the first nine months of the year, state government note programs totaled $10 billion, down 30.4% from $14.4 billion in the same period last year, according to Securities Data.
"The volume of BANs and TRANs and those kind of financings are down because of the fiscal situation of some of the traditional entrants into the marketplace," said Alan Jaffe, vice president and manager of public finance at Societe Generale. "They simply don't need to access the short-term market."
However, Jaffe noted that the volume from smaller or non-traditional issuers has been solid throughout the year and that overall activity is starting to pick up.
Patricia Countryman, a senior manager at Credit Suisse, agreed with Jaffe's assessment.
The third quarter was a "transition period," Countryman said, with "uncertainty about the direction of interest rates" keeping the lid on variable-rate offerings. Like Jaffe, she expects to see more short-term variable-rate issuance in the fourth quarter and the earlier part of 1995.
Thus far in 1994, however, banks have had to contend with fewer state deals. In addition, they are also increasingly facing inroads from alternative credit enhancement vehicles, including insured floaters, and liquidity-supported and unenhanced variable-rate demand notes.
"We've [rated] more variable-rate demand notes supported by internal liquidity as interest rates stabilized and then crept up," said Gail Sussman, vice president and assistant director at Moody's. "There's also been a pretty significant increase .in the use of liquidity facilities versus a total wrap from a letter of credit."
The use of liquidity facilities is rising because domestic banks do not have to set aside reserves against the lines if they are less than one year in duration, as they do with letters of credit, Sussman said. As a result, the lines of credit are less expensive than traditional letters of credit.
In cases where issuers used bank letters of credit, they continued a trend in recent years of employing U.S., Canadian, and European providers much more frequently than Japanese firms, which once dominated the market.
Market participants and analysts also noted increased participation from regional U.S. banks like PNC Bank NA. The regionals' credit quality is on the rise, making them more attractive as enhancement providers.
Union Bank of Switzerland led the pack for the first nine months of the year, backing $561.5 million of notes and bonds for a 10.4% share of the letter of credit market, according to Securities Data.
Canadian Imperial Bank of Commerce and Societe Generate took second and third place, with market shares of 7% and 6.9%, respectively.
Rounding out the top five were Credit Suisse and Morgan Guaranty Trust Co.
Dai-Ichi Kangyo International Ltd. scored best among the once-dominant Japanese banks, ranking ninth with a 3.6% market share.
Securities Data's rankings are based on all municipal notes and bonds sold with letter of credit backing. Private placements and taxable debt sold by private nonprofit organizations are excluded. For issues that have multiple LOC providers, each bank involved gets credit for the full par value of that issue.
For that reason, some bankers point out that the rankings do not reflect the level of each bank's participation. In addition, some bankers noted that the numbers may not fully account for refunding activity and may underestimate the activity of the larger Japanese banks because each branch files separately.
