S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Short-Term DebtCash Flow Note PoolsMultiple-issuer TRAN pools are most often structuredas several obligations of various participants—meaning that each participant is responsible foronly its own debt service payments. Standard &Poor’s bases a TRAN pool rating on either an overcollateralizationor weak-link approach. Under theweak-link approach, the TRAN pool rating isequivalent to the creditworthiness of the weakestissuer in the pool—the so-called “weak link.”Under the overcollateralization approach, theTRAN pool rating is assigned according to a blendedapproach of individual issuer quality and commondebt service reserve provisions that overcollateralizethe total borrowing. In addition, note pool ratingsinclude analysis of a pool’s structural and legalstrengths, and liquidity facilities, such as state andcounty guarantees and intercepts that provide forrepayment of note debt service. TRAN pool ratingsalso may be enhanced through liquidity facilities—such as irrevocable bank letters of credit—andbond insurance that unconditionally transfers thecredit risk to a higher-rated entity.Weak-link approachThe weak-link approach assesses each participant’sability to repay its share of the TRAN pool financing.Each participant is evaluated and assigned aTRAN rating as if it were issuing TRANs on astand-alone basis and not as a member of a pooledfinancing. Because full and timely debt servicerepayment is reflected in the rating, this approachresults in TRAN pool ratings that are only asstrong as the creditworthiness of the weakest participantregardless of the relative size of that issuer’sparticipation in the financing. Where all participantsare strong enough to be rated at least ‘SP-1’individually, the pool rating assigned is ‘SP-1’. Inanother example, where one pool participant israted ‘SP-1’, and the rest of the participants arerated ‘SP-1+’, the rating assigned to the pool wouldbe ‘SP-1’. The ‘SP-1’ rating based on the creditworthinessof the weakest issuer would be assignedregardless of the magnitude of borrowing by theweakest participant.Overcollateralization approachThe overcollateralization approach allows issuers toachieve strong TRAN pool ratings even if a widedisparity of credit quality exists among the participants,including, in some cases, noninvestment-gradeissuers. This approach also allows TRAN poolscomprising very small issuers to achieve higherratings through structural enhancement.A common debt service reserve that overcollateralizesthe total borrowing results in higher ratingswithout issuer reliance on a third party to guarantee100% of principal and interest payments. Cashreserves, a surety bond, or other forms of financialguarantee provide the extra security reflected in thehigher rating. While each participant’s obligation torepay only its share of the total borrowing remainsunchanged, all reserves must be available for notepayment on shortfalls from any participant.Standard & Poor’s determines the common debtservice reserve level necessary to address the principalportion of a pool that would be rated lower thanthe desired pool rating. The establishment of thereserve level begins with analysis of the pool’sunderlying credit quality. The pool participants aresegregated into four credit quality categories correlatingto ‘SP-1+’, ‘SP-1’, ‘SP-2’, and ‘SP-3’. Theavailability of statutory protections, intergovernmentalaid distributions, and institutionalized financialpractices will determine the depth of analysis on theindividual pool participants. Many pools require afull cash flow analysis of each participant.Standard & Poor’s identifies those pool participantsrated lower the desired rating on the entirepool. Please refer to Standard & Poor’s criteria forExample: Reserve Pool LevelsTo illustrate the basic approach to establishing a pool’s reserve level (see table 3), consider a $100 million pool. The desired rating is‘SP-1+’, and total principal due comprises 65% ‘SP-1+’, 25% ‘SP-1’, 7% ‘SP-2’, and 3% ‘SP-3’. Reserves are necessary only for 35% ofprincipal, or that portion of the pool below ‘SP-1+’. The level of reserves for each portion of principal below ‘SP-1+’ is calculatedaccording to the ratios displayed in the table. Reserves to raise the ‘SP-1’ portion to ‘SP-1+’ are set at 20% of the ‘SP-1’ principal, or5% of the total pool (20% of 25%). Reserves for the ‘SP-2’ portion are set at 25% of the ‘SP-2’ principal, or 1.75% of the total pool (25%of 7%). Reserves for the ‘SP-3’ portion are set at 35% of the ‘SP-3’ principal, or 1.05% of the total pool (35% of 3%). As a result, totalreserves necessary to achieve an ‘SP-1+’ rating for the pool financing are 8% of $100 million, or $8 million. This reserve level isdetermined by adding the total of 5% + 1.75% + 1.05%.Alternatively, consider a $100 million pool comprising 10% ‘SP-1+’, 40% ‘SP-1’, 35% ‘SP-2’, and 15% ‘SP-3’. The rating desired is‘SP-1’. Reserves are needed to cover only the portion of the pool below ‘SP-1’ or 50% of the par amount. Using the ratios shown inthe table will yield reserve levels of 20% for the ‘SP-2’ portion, or 7% of total principal (20% of 35%); plus 30% of the ‘SP-3’ portion,or 4.5% of total principal (30% of 15%). Total reserves required to achieve the desired ‘SP-1’ rating are 12% or $12 million, the sum of7% + 4.5%.www.standardandpoors.com15