Eleven of the market's largest tender option bond programs have approached Moody's Investors Service with plans to update the documents defining their programs so the underlying ratings of insured bonds are taken into account.
The banks that have provided amendments to Moody's are Bank of America NA, Bear, Stearns & Co., BB&T Capital Markets, Eclipse Funding LLC, Citi, JPMorgan, LaSalle Bank Corp., Lehman Brothers, Merrill Lynch & Co., Morgan Stanley, and State Street Global Markets.
While the amendments have multiple provisions, the primary change is one where both an issuer and an insurer must meet the bankruptcy or insolvency provision to trigger a tender option termination event. The triggering of such an event would compromise an investor's ability to sell the floaters back to the remarketing agent, in what is called a put.
"The [tender option termination event] overrides the put," Eric Vandercar, executive director and TOB program manager at Morgan Stanley, said at the Municipal Analysts Group of New York luncheon Friday. But, an investor is "very, very likely to be able to put that paper back to the liquidity provider before the TOTE occurs."
In light of these amendments, Moody's last month published a special comment addendum to its publication "Rating of Transactions Wrapped by Financial Guarantors: Frequently Asked Questions." The comment states that its rating methodology for TOB floaters encompasses both the short term rating of the issuer and the financial guarantor. In these cases, Moody's will apply the higher of the two short-term demand obligation ratings to the TOB.
"We'd look at the rating of the financial guarantor and the rating of the issuer and then choose the higher one," said Lisa Washburn, managing director for the municipal structured products and housing team at Moody's, at the same luncheon.
The transition to lower short-term ratings begin farther down the rating scale for muni issuers than for financial guarantors because of the increased stability of investment grade municipal ratings compared to investment grade corporate ratings, Moody's said in a comment accompanying the policy.
The TOB programs have made the amendments to their paperwork to address the concerns of money market funds, who are big buyers of TOB floaters. However, the funds have strict regulations, often referred to by the 2a-7 rule, for the credit quality of the securities they buy and the maintenance of the liquidity function, which allows the funds to sell the floaters back to the remarketing agents if they choose.
As bond insurers are downgraded, and others are threatened with similar actions, money market funds have begun to worry that they would lose their liquidity function. For many programs before the recent changes, documents accompanying the TOB floaters had looked solely at the rating of the insurer when calculating the possibility of losing the liquidity facility through a termination event.
This is still true for many variable rate programs not associated with the TOB programs, Washburn said.
"The problem that exists on insured variable rate debt is that for most liquidity facilities the automatic termination events are limited to the credit quality of the monolines," said Michael Loughlin, vice president and senior analyst at Moody's, who was also at the luncheon. "As Lisa said, until those begin to be changed, the VRDO market is subject to the monolines' credit."