Credit Crunch Cripples Tax-Exempt Bond Market


Corporate & Finance Alert

October 7, 2008

The financial contagion that is gripping our credit and liquidity markets has finally spread to the tax-exempt bond market. Having claimed as victims some of our most venerable banking, financial, and insurance institutions, the credit crisis effectively shut down the tax-exempt bond market two weeks ago. According to The Bond Buyer, a nationally recognized bond marketing publication, overall new money bond issuances in September 2008 plummeted nearly 40% from a year ago, reflecting in large part the fact that new money bond issuances have effectively ground to a halt since mid-September 2008 with the collapse of Lehman Brothers and the failing of other key market participants. The consequences for issuers of tax-exempt bonds are troublesome and should remain so in the short term until market conditions begin to normalize. The negative impacts are also as multifaceted as the issuers themselves and the particular industries in which they operate. The operations and decisions of educational and healthcare institutions, not-for-profit organizations and redevelopment agencies (“conduit borrowers”) and the multitude of governmental entities, all of which are reliant upon the issuance of tax-exempt bonds in order to finance the undertaking of various public and quasi-public improvements and acquisitions, are all affected by the current credit crisis in their ability to access capital.

Although seemingly counterintuitive, the tax-exempt bond market is experiencing a dearth of buyers and liquidity even as municipal bond yields are now greater than Treasury yields, as investors take flight to the safety of U.S. Treasuries. Municipal bond yields are traditionally lower than Treasury yields due to the tax-exempt character of municipal bond interest. Lack of buyer confidence is exacerbated by the continued demise and merger, and resultant consolidation, of traditional tax-exempt bond underwriters. The foregoing has translated into increased tax-exempt bond yields and thus higher borrowing costs for such issuers and conduit borrowers and in some recent cases, the outright failure to sell one’s bonds in the current market. Against this landscape, it is our view that tax-exempt bond issuers and conduit borrowers will best be served by postponing upcoming bond sales and thus the undertaking of projects contemplated by such tax-exempt bond financings in the short-term until market conditions normalize.

Furthermore, tax-exempt bond issuers and conduit borrowers traditionally relied upon the issuance of municipal bond insurance in connection with their issuances in order to obtain the triple-A credit rating of the municipal bond insurer with respect to their bonds and thus lower their borrowing costs. However, with the downgrading of most triple-A rated bond insurers and the credit ratings of the remaining triple-A rated bond insurers still subject to review and downgrade, greater scrutiny will now be placed on the underlying ratings of bond issuers and conduit borrowers. Accordingly, issuers and conduit borrowers contemplating issuing bonds must ensure their disclosure is comprehensive upon original issuance and that all secondary market disclosure obligations and filings pursuant to Rule 15c2-12 of the Securities Exchange Act are timely satisfied. More than ever, complete transparency of issuer and conduit borrower financial and operating data is of utmost importance to the investing community.