Agency issuers

A primary distinguishing feature of a bond is its issuer. The nature of the issuer will affect the way the bond is viewed in the market. There are four issuers of bonds sovereign governments and their agencies, local government authorities, supranational bodies such as the World Bank, and corporations. Within the corporate bond market there is a wide... 

There are two main types of credit risk that a bond portfolio or position is exposed to. They are credit default risk and credit spread risk. Credit default risk is defined as the risk that the issuer will be unable to make timely payments of interest and principal. Typically, investors rely on the ratings agencies—Fitch Ratings, Moody s Investors Service, Inc., and Standard 8c Poor s Corporation—who publish their opinions in the form of ratings. 

Since the establishment of European Monetary Union on 1 January 1999, the word Eurobond has taken on an additional meaning— that of a euro-denominated security. In this chapter we generally use Eurobond both for issues that are in Eurobond format, and that are euro-denominated. There are, of course, markets for noneuro denominated corporate issues, chiefly in dollars and sterling. Noncorporate borrowers, such as sovereigns, supranationals, and agencies, are also big issuers of Eurobonds in all the major currencies. 

With regard to credit rating, the Jumbo market has developed considerably from its inception in 1995. In that year, only three of the issuers were formally rated. During 2003 all issuers were rated by one or more of the public rating agencies. 

This distinction between the two translated, until recently, into very little in practice. However, as the mortgage banks, in common with all German banks in the latter half of 2002, experienced significant credit deterioration these different approaches have become far more apparent. Pfandbrief paper from the same issuer is now rated differently by the two main rating agencies for example, Moody s now rates AHBR s mortgage-backed bonds A1 whereas S P still maintains a triple-A outlook. 

The amount of credit enhancement for a transaction is determined by the rating agencies and varies by issuer depending primarily on the performance of the underlying collateral. Exhibit 13.9 shows total enhancement levels for three recent transactions completed by different issuers. 

Recovery rates for individual obligors differ by issuer and industry classification. Rating agencies publish data on the average prices of all defaulted bonds, and generally analysts will construct a database of recovery rates by industry and credit rating for use in modelling the expected recovery rates of assets in the collateral portfolio. 

After the termination of the Ramp-Up Period, the Reinvestment Period will start. This period has traditionally lasted around five years, but nowadays, we are seeing longer Reinvestment Periods. In this deal, the Reinvestment Period will last seven years from the Final Closing Date. During the Reinvestment Period, any proceeds received by the issuer upon redemption of any Collateral Debt Securities will be reinvested in further Collateral Debt Securities subject to compliance with any rating agency requirements. 

FIGURE 13. mrmsoTc Issuer j nypoinericai imiv Mortgage agency... 

To assess credit risk, individual investors are made aware of the issuer s creditworthiness by agencies such as Standard Poor s, Moody s, Fitch, and other bond-rating firms. Often, to make an issue more attractive, an issuer— usually a company or a municipality—will seek the stellar reputation of an underwriter (Salomon Smith Barney, Merrill Lynch, etc.) and now, as additional strength, will include a layer of insurance in the deal—all to reassure investors that credit risk is minimal. 

Yes, it s true. Municipal-bond holders used to expect virtual immunity from the IRS, but now that has been significantly challenged. The agency can now revoke the bonds tax-exempt status and tax muni investors when it finds that the bonds don t comply with tax laws and it can t reach a settlement with the issuer. The IRS can do this when it learns that the proceeds of a municipal bond offering have been misappropriated. Also, when a local government fails or refuses to pay certain taxes, the IRS will go no only after the municipality, but also the bondholders. 

Because of these uncertainties, the three ratings agencies— Moody s, Standard Poor s, and Fitch— while all giving relatively high marks to the issuer are all divided on the issuer s outlook. 

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