Bond issuers and conduit borrowers, such as hospitals, universities and other nonprofit organizations, with insured bonds should be aware of the following developments, which may require action if a rating downgrade occurs.

Fitch Ratings and Moody's Investors Service have released reports stating that they are monitoring bond insurance companies to make sure the companies have reserves sufficient to support current ratings in light of the reported losses. Some insurers may be exposed to losses because of their insurance of collateralized debt obligations containing high-risk mortgage-backed securities. Fitch and Moody's warned in early November that they may reduce the top-rated credit ratings of some bond insurers. This alert outlines what issuers and borrowers should consider as this process unfolds.

Fitch issued its press release on November 5 and Moody's on November 8. Both agencies stated that within six weeks' time they will reassess the ratings of bond insurance companies. The agencies grouped the bond insurers' risk of being downgraded into four categories as follows:

*Proposed recapitalization announced which Moody's notes "greatly reduces risk" of firm falling below target capital ratios.

What Should You Do?

Issuers and conduit borrowers should analyze their insured tax-exempt bond transactions for the following concerns:

  1. Material Events Notice. A reduction in the rating of a bond insurer will affect the rating of bonds insured by that company. Issuers and conduit borrowers should review any continuing disclosure undertakings they have made with respect to any insured bond issue and be prepared to file a material event notice if a downgrade occurs.
  2. Covenant Review. Issuers and conduit borrowers should check their covenants in the bond documents governing any insured variable-rate bonds to confirm there are no "rating triggered" requirements.
  3. Consider Restructuring. Typically, banks providing liquidity for the purchase of insured variable rate tender bonds have the right to declare an event of default upon the ratings downgrade of the bond insurer. This may trigger a mandatory tender that results in the bonds being held by the bank as "bank bonds" bearing interest at substantially higher, taxable interest rates. If this is the case, obligors may consider restructuring the credit and liquidity support for the bonds with a direct-pay bank letter of credit. Restructuring also may be a consideration in the case of insured auction rate bonds, where the willingness of holders to retain bonds and the ability of the market to complete successful auctions could be affected adversely and result in the application of a much higher "hold rate" to the bonds. This may be avoided if bond documents permit the obligor to buy its own auction rate bonds and it has, or can obtain at lower cost, resources to do so. To read the Fitch release, click here, for the Moody's website, click here.