Fitch Ratings yesterday announced the creation of its new "AAApre" rating designation for prerefunded municipal bonds. The new rating is designed to help clarify the basis of a triple-A rating.
"The 'AAApre' tells investors instantly that the rating is based on the escrow arrangement," said David T. Litvack, managing director at Fitch. "We have received a lot of interest from investors who want to be able to know immediately what the AAA rating is based on, especially if it's an escrowed-to-maturity bond, because the risks for those types of securities are much different from those posed by a natural or insured AAA."
Litvack said the new rating is not intended to designate relevant strength between a credit that is triple-A rated and one that is rated AAApre. The new rating is to be used strictly for investor convenience.
When interest rates fall, many issuers will seek to take advantage of lower rates by refunding existing debt. To do this, an issuer will typically issue new debt, called a refunding bond, and escrow the proceeds from the sale in order to have them available to pay principal and interest on the original bonds when they mature or become callable. Once the funds for payment of the original bonds are escrowed, they are considered prerefunded.
To date, refunding issuance remains on pace for its second strongest year on record with $116 billion having been brought to market, up 44% from last year, according to Thomson Financial. "The change seems particularly timely given the strong refunding activity this year," Litvack said.
According to Fitch, in order to receive the 'AAApre' rating, the rating agency must be able to "determine that escrowed funds will be adequate and available, under all foreseeable circumstances and at all times, to make all required payments on the refunded bonds until maturity or earlier scheduled redemption." Fitch is not changing its methodology for examining the escrow.
Currently, Moody's Investors Service assigns either a Aaa rating or a #Aaa rating, with a preceding hatchmark, for prerefunded debt, but the distinction between the two relates to how the bond's escrow is funded. Moody's does not differentiate between a triple-A rated bond and a prerefunded triple-A rated bond.
"A hatchmark triple-A implies direct obligations of U.S. Treasuries that are noncallable and non-prepayable," said Greg Lipitz, a vice president in the municipal structured products group at Moody's. "A triple-A implies certain other obligations that we permit to be deposited in the escrow other than direct obligations of the U.S. government, like agency debt or certain other triple-A rated securities."
Standard & Poor's does not differentiate between an triple-A rated credit and a triple-A prerefunded credit and has no plans to do so in the near future, according to spokesman David Wargin. (c) 2005 The Bond Buyer and SourceMedia, Inc. All rights reserved. http://www.bondbuyer.com http://www.sourcemedia.com
