09:54 *S&P: Some LIBOR-Based Swaps May Strain Credit Quality
NEW YORK (Standard & Poor's) Feb. 20, 2003 -- The use of LIBOR-based interest
rate swaps at below-market rates may strain U.S. municipal credit quality over
the near to intermediate term, Standard & Poor's Ratings Services said today.
Many issuers that have entered into LIBOR-based, floating-to-fixed rate
interest rate swaps are experiencing cash flow shortfalls due to a significant
and gradual tightening of the BMA and LIBOR indices.
"Many variable-rate bond issuers are experiencing basis exposure under
their hedging programs," said credit analyst Peter Block. "At this time of
already pressured credit, we may see additional credit problems due to the
under-hedging of variable rate debt."
The unprecedented low level of short-term interest rates, fueled by a
stagnating economy and uncertainty over an impending war, could lead to
further credit pressure for under-hedged tax-exempt bond issuers already
experiencing credit stress. Issuers have made significant use of unhedged
variable rate debt over the years and most have successfully managed interest
rate risk.
Many issuers thought that interest rate risks had been successfully
hedged, but are realizing now that there is more risk than originally
anticipated.
The BMA-to-LIBOR relationship has significantly and gradually tightened
over the last year, averaging 78%, with weekly ratios in excess of 100%.
During this period, many tax-exempt bond issuers have entered into long-dated
(20 to 30 year) LIBOR-based floating-to-fixed interest rate swaps in the
60%-70% of LIBOR range. The mismatch in the variable rate paid under the swap
against the actual rate owed on the variable rate bonds continues to diverge,
leading to cash flow shortfalls.
"Standard & Poor's does not expect the additional debt service to
severely impact most issuers at this time," said credit analyst Colleen
Woodell. "However, thinly capitalized or revenue-constrained issuers may
experience credit quality erosion to the extent trends continue."
Standard & Poor's will continue to monitor various legal and economic
indicators to determine the severity of the under-hedging problem.
"We're keeping our eye on whether the Bush administration is successful
in accelerating income tax reductions, or eliminating the double taxation of
dividends," added Block. "These factors, coupled with the state of the economy
and interest rates will determine the ultimate severity of the exposure."
Standard & Poor's is looking to issuers to develop and implement concrete
variable rate debt and swap management plans with emphasis on basis risk
mitigation plans in place for existing transactions as well as to structure
new swaps with higher levels of floating receiver rates.
"The real question is what steps issuers are now taking to cover basis
risk, and what level of floating rates will they use on future transactions,"
added Woodell. "We expect that issuers with solid risk management plans will
be able to avoid credit erosion due to basis risk." |
