Moody's Investors Service has released a report entitled Frequently Asked Questions on Rating Bonds Backed by Bank-Issued Standby Letters of Credit.

The report explains that unlike guarantees, which are direct obligations of a bank to cover the timely payment of related bonds, standby L/C transactions require trustees of the bonds to provide demand notices to the banks in case issuers fail to make bond payments.

Transaction analysis

Consequently, Moody's reckons that standby L/C transactions require more analysis of whether the language of the credit and the transaction mechanisms support timely payment to bondholders should issuers default.

The report deals with how credit substitution is applied tostandby L/C transactions and whether the credit quality of issuers affects the ratings of bonds.

Default on obligations

Other issues addressed include whether support provided by a bank on a bond through a standby L/C is stronger or weaker than other types of bank support, such as guarantees.

Moody's also addresses what rights standby L/C-backed bondholders have in cases where issuers or the L/C-providing bank default on their obligations.

Location

The report maintains that the location of the branch office from which a bank provides a standby L/C can make a difference to the rating of a bond backed by the L/C.

The ratings agency says that if an A1-rated bank issues a standby L/C through its branch in a jurisdiction with an A2 ceiling, the bonds would likely be rated below A1.

The report is available to Moody's subscribers at https://www.moodys.com/research/Frequently-Asked-Questions-on-Rating-Bonds-Backed-by-Bank-Issued--PBC_156574.

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