WASHINGTON - Standard & Poor's announced yesterday that it plans to "refine" its credit rating process by routinely asking municipal bond issuers to quantify their exposure to variable-rate debt and interest rate swaps in a standardized manner and to provide documentation of any swaps into which they have entered.
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However, the new policy may not sit well with some issuers because it means that they will have to provide the rating agency with cash flow scenarios that incorporate such risks.
"Some people are not going to be very happy about this," said Peter Block, an associate director at Standard & Poor's in San Francisco. "But this is really the new reality."
The impetus for the new policy is the proliferation of variable-rate issuers and interest rate swaps in the marketplace, according to Block. These instruments provide benefits to issuers, but also certain risks that, to date, have not been thoroughly analyzed.
"We feel like we're doing investors a service by looking at this," Block said. "This should benefit the issuers and the rating agencies, as well as the investors."
Standard & Poor's has tried for years to obtain information from issuers about variable-rate debt and swaps, he said. But issuers have not been consistent in how they quantified the risks associated with these instruments. They also have not always informed the rating agency about swaps and have never seen the need to provide the agency with documentation for swaps.
"We're just trying to provide a more rigorous analysis and some standardization on the part of the issuer," Block said.
Variable-rate debt can provide municipal issuers with lower debt service costs and increased financial flexibility. But it can also expose issuers to increased interest rate risks and certain liquidity risks, Block said.
Issuers can use swaps to hedge their interest rate risk or lower the costs on their fixed-rate debt. But swaps may expose issuers to other risks, such as the chance that the counterparty will fail, the swap will be terminated, or the interest rates or maturities of the swap and bonds fail to match.
"Financial flexibility and access to liquidity resources are very important factors to examine before issuing variable-rate debt or entering into swap contracts," Colleen Woodell, a Standard & Poor's managing director, said in an agency release on this issue. "With some exceptions, issuers that have limited ability to raise taxes or charge higher rates and fees should refrain from taking on significant variable-rate debt exposure or entering into swap contracts."
