Fitch Ratings has released guidelines showing the analysis it uses in considering theimpact of variable-rate debt and interest rate swaps on an issuer's credit rating.
The release comes as the use of swaps to alter interest rates has grown in the municipalmarket and market participants and regulators have begun a dialogue on the products. Italso follows similar releases by Moody's Investors Service, and Standard & Poor's.
"Fitch Ratings recognizes that, when used in the context of comprehensive asset andliability management strategies, variable-rate debt and interest rate hedges can enhancethe finances of some tax-exempt borrowers," said Katherine McManus, Fitch managingdirector.
"However, when used without a coherent strategy or by borrowers with finances that arealready vulnerable, variable-rate debt and interest rate hedges can result in adversecredit consequences," McManus added.
Swaps are contracts done in conjunction with bonds. The most common strategy in themunicipal market is a floating-to-fixed-rate swap, in which the issuers pays a syntheticfixed rate to an investment bank on variable-rate bonds, while receiving a variable-ratepayment from the bank.
While the strategy entails risk, synthetic fixed rates tend to trade lower thanconventional fixed rates. Fitch said that among the things it looks at in rating a dealwith a swap is the netting of payments between the issuer and the bank and the legalopinion underlying the issuer's authority to do the deal.
It said it also looks at issuers selling options to investment banks to do swaps in thefuture, and the use of up-front payments in the so-called swaption.
In October, Moody's published a report called, "Increased Use of Swaps may IntroduceCredit Risks to Municipal Issuers," while last February, Standard & Poor's published,"Credit Impacts of Variable Rate Debt and Swaps in Municipal Finance."
