BLX Municipal Market Report | May 2009
by Eric Chu, Managing Director
and Amy Kron, Investment Officer

The Impact of the Economic Crisis on Guaranteed Investment Contracts

For many years municipal issuers and borrowers have invested their bond or related proceeds (e.g.,. Reserve, Project, Capitalized Interest Funds, etc.) in Guaranteed Investment Contracts* ("GICs"). GICs offered the prerequisite safety and liquidity at attractive yields, and for all practical purposes continue to be the only investment option that can effectively provide a long-term asset-liability match (e.g., fixed rate of return for the life of a fixed rate bond issue). GICs are typically procured from financial entities ("GIC Providers") rated in the top two or three rating categories by Moody's and Standard & Poor's and often contain downgrade remedies (collateral posting, assignment, or termination) if the providers ratings fall below certain pre-determined levels. The combination of initial counterparty financial strength and the downgrade provisions result in very high credit quality (i.e. safety of principal). GIC's provide for withdrawals at par whenever a valid expenditure is required thereby providing sufficient liquidity. This combination of features and benefits often make GICs the investment of choice for bond proceeds.

However, the GIC market has not escaped the effects of the current economic crisis. Many of the GIC Providers have experienced ratings downgrades, which have affected both existing GICs as well as the overall number of GIC Providers that meet typical minimum ratings requirements. Issuers currently invested in GICs where the GIC Provider has been downgraded should determine whether the downgrade gives rise to any rights or options, and importantly whether any action is required by the issuer (or its Trustee if applicable) to exercise such rights. For example, it is not uncommon for the GIC to specify that if the long-term debt rating of the GIC Provider falls below either AA- by S&P or Aa3 by Moody's then the GIC Provider 1) shall notify the trustee and/or issuer of the downgrade and 2) will have the option to either (i) collateralize the GIC (pursuant to specific collateral requirements); (ii) assign the agreement to another counterparty rated at least AA- by S&P and Aa3 by Moody's; or (iii) provide a guaranty (or replacement guaranty) from an entity rated at least AA- by S&P and Aa3 by Moody's. However, if the GIC Provider fails to remedy with (i), (ii) or (iii) above then the issuer will often have the right to terminate the agreement (most likely at par, but possibly at the then market value of the GIC. In addition, most GIC's also contain a second downgrade trigger whereby if the long-term debt rating of the GIC Provider falls below either A- by S&P or A3 by Moody's, the GIC Provider must notify the trustee and/or issuer of the downgrade at which point the issuer will have the option to terminate the agreement. As mentioned, it is important to know that in some cases, the issuer must make a formal request, sometimes within a specified period of time, for the GIC Provider to remedy the downgrade or to otherwise exercise its rights.

May 2009 Standard & Poor's and Moody's Provider Ratings


GIC's have been issued by many different counterparties and each GIC may have different provisions, including those in connection with ratings downgrades. While the differences in language may be very subtle they could have a large impact on the direction of actions after a downgrade occurs. While this article contains some general information about downgrades it is always prudent to review your particular GIC's specific downgrade language. Should you wish a consultation, the Structured Products group at BLX would be happy to assist. Please contact either Eric Chu (213) 612-2136 or Amy Kron (201) 963-6663 or your BLX representative.


*For purposes of this article GIC's will include Investment Agreements, Repurchase Agreements, Collateralized Investment Agreements.


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BLX Municipal Credit Comment | May 2009
by Joanne Thorndike, Managing Director
First Quarter of 2009

Quarterly statistics for the municipal long term bond market through March 30, 2009 reveal significant changes from the first quarter of 2008. Year over year total volume was down slightly from $85.4 billion in 2008 to $83.8 billion in 2009, a 1.9% decline. More significantly, the dollar volume of traditional fixed rate bond issues in 2009 accounted for 90% of issuance compared to 73% in 2008. Variable rate transactions declined 65% over the period, accounting for about 9% of total issuance in 2009.

Credit enhancement products, both bond insurance and letters of credit, also experienced declines. Insured deals encompassed 27% of the market in 2008 compared to 13% in 2009. The dollar volume of letter of credit supported deals declined by 31% in the period, from 9% of total volume to 7% in 2009.

These statistics would imply that the tax-exempt market is reorienting itself to a predominately traditional fixed rate market as a result of the scarcity of high quality bank letters of credit and unease with the variable rate structure. Borrowers with higher grade underlying credit quality ("A" or above) are issuing fixed rate debt to avoid the risks of variable rate bonds, including letter of credit renewal, deteriorating bank credit quality and failed remarketings. The use of interest rate swaps to hedge variable rate interest risk has also caused headaches for borrowers as negative mark to market values and collateral posting requirements have adversely impacted balance sheets and liquidity. It is likely this trend will continue for the remainder of 2009, as borrowers remain risk averse in the current credit environment.

Bond Insurance Companies

Assured Guaranty captured 86% of the insured tax-exempt new issues during the first quarter of 2009. Financial Security Assurance, which is in the process of being acquired by Assured Guaranty, was a distant second at 11% of the market.

Downward rating changes impacted two bond insurers in April, Berkshire Hathaway and AMBAC. On April 8th, Moody's downgraded the only Aaa rated insurer, Berkshire Hathaway Assurance Corporation to Aa1 with a stable outlook. The primary reason for the downgrade was the impact of investment losses from the falling equity markets and the resultant decline in its capital cushion. On April 13th, AMBAC's rating from Moody's was dropped to junk status with a downgrade from Baa1 to Ba3 with a developing outlook.

With Assured Guaranty and FSA combining forces, Berkshire Hathaway approaching the market very cautiously and MBIA and AMBAC struggling to come back from dramatic rating declines, it is currently a very limited and non-competitive market for bond insurance.

Credit Agency Comments

Both Moody's and Standard & Poor's are actively monitoring the impact of the recession and credit squeeze on tax-exempt borrowers' credit quality. Although the ratio of upgrades to downgrades for the entire public finance sector is still favorable, the ratio has weakened during the first quarter of 2009. The higher education and health care sectors experienced more downgrades than upgrades in the first quarter and that trend is anticipated to continue.

Moody's announced in April that it will begin publishing a new set of liquidity metrics for non-profit borrowers to measure the liquidity of their assets, in particular, their investment portfolios. These metrics will be measured over a variety of time frames, weekly, monthly, quarterly and annually. Moody's also continues to express concern over the general credit quality of the health care sector with their heavy reliance on variable rate debt, weaker consumer demand, investment losses and capital market access problems.

Standard & Poor's published a ratings update on April 28th which articulated their concerns regarding not-for-profit health care credits as the current recession is hurting operating margins and balance sheets. In the higher education sector, the predominant use of variable rate debt and reliance on bank letters of credit is a major point of credit stress. The possibility of failed remarketings of variable rate bonds and the possibility of higher interest costs and accelerated amortizations from "bank bonds" puts extreme pressure on an institution's liquidity. The rating agency remains concerned about the still to be felt impact of investment and home equity losses on parents' ability to pay for college education in the future. Cutting costs and operating with fewer investment dollars from endowment is the new financial reality for the non-profit sector.

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