While most issuers are coping with the increased interest costs brought on by the current problems in the short-term market, some of the most vulnerable may suffer deteriorating credit quality over a much longer time period, according to a rating agency.

A new report from Moody's Investors Service names a number of potential risks inherent in the current credit crunch. Unless the risks can be mitigated in ways that the rating agency mentions, they could eventually undercut issuers long-term credit quality. In reviews of hundreds of issuers, most have been able to weather the storm.

"Apart from a couple of stress scenarios that have been well publicized, the vast majority of issuers are handling this well," said Matthew Jones, Moody's senior vice president and the lead author of the report.

The analysis comes against a backdrop of a municipal market suffering from the fall in most bond insurer ratings, failing sales of auction-rate securities, and decreased demand from institutional investors. It is the problems in the variable-rate market - both with auction-rates and variable-rate demand obligations - that have most acutely affected issuers. In many cases, debt repayment costs on short-term paper have skyrocketed.

As a result, issuers with a high proportion of variable-rate debt are especially at risk in today's market and for those forced to pay higher costs, long-term credit quality may be affected, Moody's said. Those with weak reserves, limited revenue streams, or narrow debt service coverage could also see their long-term ratings affected. A high exposure to swaps is also a risk, according to the agency.

Recently, Jefferson County, Ala., has suffered from skyrocketing rates on $3.2 billion worth of outstanding sewer debt, the vast majority of which is variable rate debt - $2.2 billion in auction-rates and $847 million of VRDOs. The rates hikes and bond insurer downgrades tied to more than $5.2 billion of swap agreements have plunged the county into financial crisis.

Among others, issuers using a surety policy to meet debt service payments may also be at risk, Moody's said. In most cases, these policies require flawless ratings for the financial guarantors. In cases where the insurer has been downgraded below a threshold, issuers may need to replace the surety policy or use cash to fund the reserve.

In one instance, the Metropolitan Washington Airports Authority put up $13 million to support a surety fund guaranteed by Financial Guaranty Insurance Co., downgraded to Baa3 by Moody's, BB by Standard & Poor's, and BBB by Fitch Ratings.

During the review, Moody's found a number of common elements that served to protect them from the current crisis. Issuers with good access to the capital markets have had an easier time restructuring high-cost variable-rate debt, by restructuring auction-rate securities or removing the tarnished bond insurer from variable rate demand bonds, Moody's said.

"It's just a question of how long it takes to get a new deal together," Jones said.

Issuers with available cash reserves that can be used to cover the increased rate in the short term also have an advantage, as do those with conservative debt servicing ratios, or some other ability to raise funds or cut costs, Moody's said. A combination of these features could work together while issuers with a riskier profile may have more long-term troubles, the rating agency said.

In the meantime, the VRDO market appears to have recovered a bit. In one example last week, a variable-rate restructuring sold by the Sarasota County Public Hospital District fetched a rate of 1.50% with an insurance policy from MBIA Insurance Corp., after having to pay a rate of 7.47% the week before.


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