Moody's Investors Service said yesterday it will relax a rating policy governing variable-rate demand obligations to suit tax-exempt money market managers, the primary investors in such securities.
While interest in tax-exempt money market funds has continued to grow, the supply of new issues in the short-term market has not kept pace, forcing the funds to buy synthetic securities like the variable-rate demand obligation.
Under the new policy, the rating agency will not require a suspension of put rights for insured issues and for securities backed by healthcare or higher-education issuers.
Instead, Moody's analysis will assess the ability of the issuer or insurer to cover possible puts if the liquidity facility is not available.
The previous policy was to require that issuers suspend investor's right to put the obligations if the liquidity facility backing the securities expires or is withdrawn
Variable-rate demand obligations, which are long-term bonds that pay a floating rate of interest, carry a put right allowing the holder to force the issuer to buy back the obligation at any reset date.
Most obligations are backed by a liquidity facility from a bank or other highly rated financial institution to ensure that the issuer will have enough cash on hand to pay off investors exercising their puts.
Neither the new policy nor the old policy effects obligations backed by irrevocable letters of credit. In those cases, the obligations carry the rating of the letter of credit provider.
Federal securities laws limit the types of securities that money market funds may buy. Under Rule 2a7 of the Securities Act of 1940, the funds cannot buy long-dated bonds unless the interest rate on the bond is reset frequently and the fund can put the bonds back to the issuer.
"We had been trying to protect issuers," said Gail Sussman, vice president and assistant director of structured public finance at Moody's. Some otherwise strong credits might face a default if presented with $30 million of bonds tendered on one day, she note.
"But we're not in the business of protecting issuers. Moody's responsibility is to assess the likelihood that payment will be made and that's what we will do under the [new] policy," Sussman said.
Fund managers supported the change, although some said they had bought obligations that already include the put suspension feature.
"We welcome this recognition of reality," one money market fund manager said. "But in most cases, the deal is backed by a bank and not just a liquidity facility."
In a release, Moody's conceded that the previous policy caused problems for some managers. The suspension of put rights "inadvertently caused some money market managers to avoid purchasing issues structured with these tender suspensions under the belief that they did not conform to Rule 2a7 of the 1940 Act," Moody's said.
Standard & Poor's Corp. never required the suspension of put rights, according to an analyst at the agency. But most issuers seek ratings from both Standard & Poor's and Moody's and must, therefore, meet the requirements of both agencies.
The Moody's rating criteria will still require that put rights be suspended in cases where an involuntary bankruptcy proceeding against an issuer of insurer causes the liquidity facility provider to cancel the facility.
Moody's suggested that documentation for liquidity facilities limit suspensions of liquidity under such circumstances to 30 days.
If the situation has not bee resolved, the facility provider could terminate the agreement at that time "without funding a final mandatory tender," Moody's recommended. "However, if the [bankruptcy] petition is dismissed because the issuer is deemed solvent, the bank should resume its obligation to provide liquidity."
