Finance partner Les Jacobowitz was quoted by Turnarounds & Workouts for an article focused on Moody’s credit ratings cut in the summer of 2012. In the article, Mr. Jacobowitz offers several reasons why municipal issuers could be affected. “The downgrades potentially means that people who three weeks ago would have no problems owning this paper may now be forced to sell the paper or, more likely, consider selling the paper, which will negatively impact the pricing of that paper,” said Mr. Jacobowitz. He predicted that “rates may go up, but not nearly to the extent they did in 2009 because these downgrades had been anticipated for several months. It’s a warning shot, and it’s possible the other rating agencies are going to follow suit with their own downgrades in the next several months. If that happens, I see interest rates on letter of credit-backed debt going up.” 

Mr. Jacobowitz added “[p]erhaps the biggest concern of all is the issue of swap exposure. From the perspective of borrowers and issuers, the fact that rates have been falling the last few years means that existing swaps probably have a substantial termination payment associated with them. The bottom line is that existing derivatives could result in expensive early terminations and added borrowing costs. Most issuers were hopefully prudent with all their issuances of variable-rate paper. The issuers of variable-rate paper could have had their rate synthetically fixed through a swap or interest rate cap. The problem is what happens when the banks fail (e.g. Lehman) or the debt needs to be repaid early.”

Mr. Jacobowitz agreed that municipalities must get their financial house in order. He added “[m]unicipal defaults will most likely be caused by expensive pension and health benefit obligations. More than a few states and localities are significantly underwater on funding these obligations, and their situation will be further impacted by new rules being promulgated by accounting bodies as how to disclose those liabilities. In the end, there will be many more municipal issuers that are going to have to pay higher interest rates when they borrow.”

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