Sell Side

Insurance Against Insurers

For every problem, there is at least one solution. And for issuers looking to navigate the many pitfalls of unsettled markets, the Connecticut Housing Finance Authority has the latest solution.

The CHFA, working with financial adviser Lamont Financial Services Corp., restructured its variable-rate demand obligations so that the liquidity facility is independent of the bond insurer attached to the deal.

The authority reached an agreement with Depfa Bank PLC, the bank that provides the standby bond purchase agreement on $407 million of VRDBs, to amend the termination events for the liquidity facility. The change will make the trigger contingent on the rating of the issuer, rather than the insurer, falling below investment grade. Ambac Assurance Corp. insures more than $900 million of the CHFA's variable-rate demand bonds. Fitch Ratings last month dropped Ambac's rating to AA from AAA.

A termination event allows the liquidity bank out of its obligation to buy back VRDBs from investors, in what is called a put. It is this put that makes variable-rate bonds different than auction rates, and it is an assurance of liquidity for investors if they ever want to sell the bonds back to the remarketing agent. It is a feature required to make the bonds eligible investments for money market funds subject to the Securities and Exchange Commission's Rule 2a7.

Under most standby bond purchase agreements, the termination event is tied to the rating of the bond insurer. And as the bond insurers have seen their capital cushions eroded and their ratings under pressure, investors have begun to worry about the liquidity tied to these uncertain ratings. This reluctance from investors drove up rates on the variable rate debt for the CHFA and others, and led issuers to seek ways to insulate themselves.

"We had conversations several weeks ago with a number of different investors and also talked to people about the feedback they were getting from investors," said John Craford, executive vice president for finance and administration at the CHFA. "What was consistently expressed [in conversations with investors] was these triggers in the agreements: what would allow the liquidity provider to walk?"

In response, the CHFA approached Depfa, and the other two liquidity providers, the Federal Home Loan Bank and Helaba Bank, that guarantee liquidity on the whole of the CHFA's variable-rate demand program. The authority proposed amending the agreement so that the liquidity was tied to the stable, triple-A rating of the issuer, and Depfa was the first to agree.

"As market players, [Depfa is] in touch with the market and realized they were in danger of getting a lot of puts," Craford said. "And though they could handle that - they have the capacity - that wasn't in their business plan. They have been very receptive and cooperative."

Depfa did not return calls seeking comment.

The FHLB has also been responsive and is in communication with Craford on "an hourly basis," he said.

The rating agencies agreed with the credit strength of the structure, and recently released updated ratings opinions. Standard & Poor's Monday affirmed the underlying AAA long-term rating for the CHFA bonds, and the A-1 short-term rating, after reviewing the amendments, and Moody's Investors Service also affirmed the Aaa long-term rating, and VMIG-1 short-term rating, yesterday.

Monday, Moody's released a report Monday entitled "Issuers Can Strengthen Liquidity Agreements to Secure Top Short-Term Ratings," which sought to communicate Moody's views on what would need to change to bring an insured VRDB floater either back to VMIG-1, from speculative grade, or to prevent a future downgrade if another bond insurer was downgraded, said Joann Hempel, vice president and senior credit officer at Moody's.

"Higher rated municipal issuers with public underlying ratings may be able to restore the highest short-term ratings or avoid negative rating actions should other financial guarantors be downgraded in the future," wrote Nick Samuels, the author of the report and an assistant vice president at Moody's. "Issuers can amend the [standby bond purchase agreements] associated with their insured variable rate debt to link automatic termination events to their own credit quality in addition to or instead of the financial guarantor's."

The thinking behind the Moody's report is much the same as the CHFA's. Hempel said the rating agency first heard from issuers after it downgraded Financial Guaranty Insurance Co. and XL Capital Assurance Inc. to A3. When that happened, the short-term ratings on about 60 issues of insured floaters fell to speculative grade, and the calls started coming in.

"We were obviously representing the likelihood that you could lose your liquidity facility based on the downgrade to the bond insurer," Hempel said. "[Issuers] wanted to amend their standby bond purchase agreements in order to eliminate that link of the short term rating being linked only to the financial guarantors' long term rating."

Hempel said less than half of the issuers that called Moody's over the past few weeks have submitted final documentation. One reason may be that issuers have not gotten the approval from their liquidity banks to amend the documentation. Liquidity providers must be comfortable and willing to risk exposure to the underlying credit of the issuer, said Renee Boicourt, managing director at Lamont.

"You have to convince the liquidity bank that they would want to face the underlying credit," Boicourt said. "CHFA is an underlying triple-A, which makes them particularly well suited for this. A double-A credit could do this as well."

Any doubts about the underlying credit, much like doubts about the insurers, would cause investors to put bonds back to the liquidity provider. And as Craford said, this is not something the liquidity banks want to happen.

The infancy of the structure makes it too early to tell whether it is ultimately successful.

"We have a reset coming up, this Wednesday to Thursday," Craford said. "Hopefully it will reflect this [structure] and calm people's fears. Our [uninsured] bonds without Ambac have been trading as well as ever so this should bring these back in line with those."


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