Swap liabilities make downgrades possible for some not-for-profits

PRESS RELEASE
New York, February 11, 2009 -- Growth in mark-to-market liabilities for interest rate swaps poses credit risks that could result in credit stress and downgrades for some not-for-profit hospitals, higher education institutions, and other non-profit borrowers, says Moody's Investors Service in a new report.

"Some borrowers have seen the fair value of their swap agreements decline significantly over the last few months, in certain cases resulting in large collateral posting requirements," said Moody's Associate Analyst Daniel Steingart, author of the report.

He said large mark-to-market swap liabilities and swap collateral posting requirements mean that "rating downgrades are possible, especially for lower-rated borrowers, who have additional balance sheet or operating stress at the time that they are required to post collateral under their swap agreements."

Additionally, he said, swap liabilities or collateral posting may cause a borrower to violate financial covenants under related documents, and expose the borrower to the risk of bond acceleration and a liquidity crunch. He said current conditions are a marked contrast from the relatively narrow band of fluctuations in the fair value of most swap agreements over the past decade when the vast majority of borrowers met collateral calls with little difficulty.

"Combined with poor investment returns over the past year and deteriorated operating results for some rated borrowers, many not-for-profit organizations find themselves ill prepared for the sudden drain on liquidity that swap liabilities can cause," Steingart said.

In addition to assessing the rating implications of large mark-to-market swap liabilities and swap collateral posting requirements, the report provides examples of rating actions taken over the last several months.

"The report does not address the impact of this risk on governmental, housing and public infrastructure issuers as collateral posting is either uncommon or structured with different terms than for not-for-profit hospitals, colleges and universities, and other not-for-profit borrowers," said Steingart.

The report, "Interest Rate Swaps Cause New Liquidity Stress for Some Healthcare, Higher Education and other Not-for-Profit Borrowers Rating Implications Will Depend on Borrowers' Other Credit Attributes," is available at moodys.com.