In the News: Recent Developments

Published April 28 2005, 2:00am EDT

Letters of Credit: Landesbanks to Remain in LOC Market Despite Downgrades

Despite lower ratings assigned to German landesbanks earlier this week, at least three of the four landesbanks that have been significant participants in the municipal letter of credit market expect to continue offering LOCs and plan to pursue business as their ratings will allow after they lose their state guarantees in July.

On Tuesday, Moody’s Investors Service assigned non-guaranteed ratings for the German public sector banks. Samuel S. Theodore, managing director of the financial institutions group in Moody’s London office, said yesterday that the international market Hmay see a winding down of the business of the landesbanks” as some of the 12 face Hpressure from the savings banks that partially owns them to be more active in their home markets.”

The landesbanks with a strong presence in the municipal market, however, indicate that they expect to remain.

Landesbank Baden-Wurttemberg, which ranked 14th among LOC providers in the municipal market in 2004, saw its rating fall to Aa1 from triple-A. Landesbank Baden-Wurttemberg served as enhancer on $607.9 million in bonds through two issues last year.

Ronald Bertolini, general manager of the New York branch of the bonk, said, “LBBW will continue to be active in the letter of credit and the liquidity markets based on the strong Aa1 by Moody’s.”

Bertolini said LBBW will fully participate and expand its presence in the market based on the long-term strategy it embarked upon two years ago. The bank “will expand its presence in the municipal market by expanding in the higher education, housing and the better-rated health care sector.” he added.

Bertolini said the bank would pursue business with issuers on deals rated A and above. As part of its global strategy, the bank “sees public finance as an important business segment,” he added. Bertolini said he does not view the ratings downgrade as “a detriment because of our good reputation in the U.S. public finance market.” The bank has an A-plus rating from Standard & Poor’s and is still awaiting a rating from Fitch Ratings, he added.

Another bank, Bayerische Landesbank, which has also held a triple-A rating, received a new rating of Aa2 on Tuesday. In 2004, Bayerische Landesbank ranked 18th among letter of credit providers in the U.S. as it provided enhancement on $352.8 million through two issues.

Joseph Campagna, senior vice president at Bayerische Landesbank, said, “We will continue to play in the market as long as our ratings will allow us.” He noted the bank is still under review from Standard & Poor’s and Fitch.

Meanwhile, Moody’s in February changed the ratings on Landesbank Hessen-Thuringen, or Helaba, and WestLB after the banks issued debt with maturity past 2015. Helaba, formerly triple-A, was rated Aa2. It ranked 13th among LOC providers in the U.S. in 2004 as it backed $756.7 million through nine issues.

Patricia South, senior vice president and manager of the financial institutions and public finance group at Helaba, said yesterday that so far this year, the bank has provided $347.76 million in LOCs through three issues. She said the bank plans to stay involved in the public finance sector in a variety of ways.

“We are cautiously optimistic that we can participate in some of the areas that we have historically participated in.” she said, adding that the firm will be providing liquidity in sectors including health care, higher education, transportation, water and sewer, public power, pension obligations, and on various revenue deals.

South said the bank will take a broader look at revenue-based transactions that may be lower rated than what it had looked at in the past. The bank will also be looking for opportunities that are less rating sensitive. To that end, Helaba will offer liquidity lines and other credit enhancement opportunities that are not tied to specific bond transactions. The bank is rated A by Standard & Poor’s and A-plus from Fitch.

At the same time, Moody’s rated WestLB A1, down from its previous rating of Aa2. Last year, WestLB ranked 23rdas it served as letter of credit provider on $244.8 million through four issues. Despite the slide to the single-A category, spokeswoman Connie Kain said: “We don’t see any change in our business. We’re not exiting. We’re staying in the business.”

She declined to comment further. The firm is rated A-minus by Standard & Poor’s and Fitch Ratings.

The German landesbanks were downgraded ahead of the planned elimination of the state guarantee in July. In 2001, the European Commission and the German authorities agreed to begin phasing out existing state guarantees for German public-sector financial institutions.

The legislation came about as competitors around the European Union expressed concern about the leverage that the landesbanks had in issuing debt using triple-A ratings they inherited from the state. The ratings were higher than many of their competitors, allowing the landesbanks to issue debt at a lower cost of funds and boost their earnings.

With the recent rating changes, the landesbanks that were ranked triple-A will now lose their competitive advantage and have to compete on an equal footing with other providers in the double-A category. Top LOC providers with at least one double-A rating from a major ratings agency include Citibank, Dexia Bank, and J.P. Morgan Chase & Co. The most recent addition to the double-A ranks was Wachovia Bank, which was upgraded April 8 by Standard & Poor’s to AA-minus, from A-plus. With WestLB’s drop to the single-A category, Wachovia has been added to the class of banks that could provide a viable alternative for issuers.

Jeffrey Previdi, director at Standard & Poor’s, said Wachovia’s move into the double-A category will give issuers more choices in light of the contraction that has occurred in the market. The upgrade is a benefit for the LOC market, which has, in recent years, seen downgrades, consolidation among providers, and the exit of certain players.

Alex Wallace, managing director and head of public finance at Wachovia, said the bank’s upgrade may create additional business opportunities as many issuers have counterparty requirements in the double-A category. Although the bank previously had an A-plus rating, its LOCs have been trading in the double-A category, Wallace added.

For the first three months of this year, Wachovia Bank, which combined its letter of credit business with SouthTrust Bank after the two banks merged in November, has backed about $500 million in bonds, according to Thomson Financial.

In 2004, the bank ranked 10th as it provided letters of credit on about $831.1 million in bonds, according to Thomson data. Wallace noted that the downgrade of the landesbanks doesn’t change Wachovia’s strategy, although the value placed by issuers on the lineup of LOC providers in the primary credit markets may change. Wallace noted that there is “the potential for a stronger secondary market” and he expects “the landesbanks will continue to be active in syndicates.”

Joseph Fichera, chief executive officer at Saber Partners, said there may be more demand for letters of credit if issuers sell less auction-rate debt or if people think of converting auction rates to LOC-backed variable-rate debt in light of increased regulatory scrutiny and other changes in the auction rate sector. Generally issuers have a conversion feature or option to change into a variable-rate-type debt, he said.

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