NEW YORK--(Business Wire)--
Fitch Ratings has received numerous investor inquiries about the
Tender Option Bond (TOB) and insured variable-rated demand obligation
(VRDO) markets in response to recent rating actions on a number of
financial guarantors. Fitch is preparing a report in light of these
developments, which will be released later this week. The report will
provide an interpretation of Fitch's long and short-term ratings on
TOBs and insured VRDOS. Given current market interest in this topic,
Fitch is providing this brief commentary in advance of the report.
Recently, in response to rating actions on several financial
guarantors, a number of the TOB programs have amended their
documentation to consider the credit quality of both the underlying
bond, as well as the bond insurer, in their tender option termination
events (TOTE) language (previously tied solely to the insurer rating).
For higher quality municipal bonds that carry an underlying rating,
the amendments have the advantage of making the TOTE language
effectively based on the higher of the bond rating and that of the
financial guarantor. Fitch views these revisions as prudent and more
reflective of the credit quality of the underlying security.
Market Overview
In TOB and VRDO structures, both a long and short-term rating is
assigned. The long term component of the rating represents the
likelihood of payment of scheduled principal and interest. The
short-term rating is a reflection of both the ability of the liquidity
provider to provide timely payment of purchase price upon an optional
or mandatory put in the event of a failed remarketing of the VRDOs or
TOBs, and the likelihood of an immediate termination of the obligation
to provide liquidity. Accordingly, as the risk of such termination
increases, the short-term rating is adjusted downward to reflect this,
even if the liquidity provider's own short-term rating remains higher.
The liquidity facilities in these structures provide money market
funds with the ability to 'tender' the instrument at par on any
business day with appropriate notice, meeting the unique needs of
money market investors. These facilities commit the liquidity provider
to fund timely payment of purchase price upon an optional or mandatory
put in the event of a failed remarketing of the TOBs or VRDOs,
provided the issuer or in the case of those that carry a financial
guaranty, the guarantor, is rated investment-grade ('BBB-' or higher).
A long-term rating below investment-grade, however, causes investors
to lose the right to tender their bonds.
New Criteria
TOBs: Fitch will base its long-term rating on the higher of the
underlying bond rating, if Fitch rates it, and the financial
guarantor's Insured Financial Strength (IFS) rating. With respect to
the short-term rating, where amendments have been incorporated in the
TOB structure, Fitch will look to the higher of the bond rating or the
insurer rating when assigning its short-term rating.
For underlying bond ratings, Fitch will continue to apply our
traditional long and short-term rating correlations to determine the
short-term rating on the TOB, as outlined in our published 'Rating
Municipal Short-Term Debt' Report dated October 18, 2007.
For bonds with insured ratings, Fitch will utilize the following
amended scale (see below), to determine the short-term rating on the
TOB. This more compressed scale for insured TOB ratings reflects where
necessary the potentially greater rating transition risk of financial
guarantors.
Importantly, for all financial guarantor Insurer Financial
Strength (IFS) long-term ratings on Negative Outlook or Watch, a lower
short-term rating than those indicated in the table below may be
assigned.
FINANCIAL GUARANTORS IFS
--'AAA' 'F1+'
--'AA+' 'F1+'
--'AA' 'F1+'
--'AA-' 'F1'
--'A+' 'F1'
--'A' 'F2'
--'A-' 'F2'
--'BBB+' 'F3'
--'BBB' 'F3'
--'BBB-' 'F3'
VRDOs: Fitch has not yet seen such amendments in the context of
insured VRDO structures where there is a public underlying rating on
the insured bond. Should the parties to these transactions choose to
adopt this methodology, we see no reason at this time why the approach
outlined for TOBs could not be applied as well.
Specifically, for short-term ratings on insured VRDOs that are
amended, as described above Fitch will look to the higher of the bond
rating and the insurer rating when applying its scale, capped at the
liquidity provider's short-term rating level. In insured VRDO
structures where the liquidity termination events are tied solely to
the insurer, the above Financial Guarantors IFS ratings scale will
determine the short-term rating, again capped at the liquidity
provider's short-term rating level.
Fitch's rating definitions and the terms of use of such ratings
are available on the agency's public site, www.fitchratings.com.
Published ratings, criteria and methodologies are available from this
site, at all times. Fitch's code of conduct, confidentiality,
conflicts of interest, affiliate firewall, compliance and other
relevant policies and procedures are also available from the 'Code of
Conduct' section of this site.
Fitch Ratings, New York
Trudy Zibit, 212-908-0689
Joseph Staffa, 212-908-0829
Mary Jane Ziga, 212-908-0529
or
Media Relations:
Cindy Stoller, 212-908-0526
Copyright Business Wire 2008
