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

Municipal Swapsoccurrence of the automatic termination eventwithin the specified period. The termination bythe SBPA provider can happen no earlier thanupon the occurrence of the permitted automatictermination event.Other Concerns Regarding InsuredLiquidity TransactionsIn insured liquidity transactions, all payment eventsfor bondholders should be covered either by thebond insurance policy or the SBPA. Careful attentionis paid to the optional redemption, purchase in lieuof redemption, and tender provisions of the trustagreement. If obligor funds can be used to paybondholders (a common example is optionalredemptions which are not covered by the bondinsurance policy or SBPA), the source of such fundsshould be limited to those sources deemed preferenceproof by Standard & Poor’s (see the “LOC-BackedMunicipal Debt” criteria).Another payment event is acceleration of thedebt. Unless specifically noted in the bond insurancepolicy, insurers will not fund accelerated debt unlessthe acceleration happens with their prior writtenconsent. Therefore, it should be clearly stated in thetrust agreement that acceleration can only occurwith the bond insurer’s prior written consent.Another possible payment event is a specialmandatory redemption of bonds held by the SBPAprovider. Unless specifically covered under the bondinsurance policy, insurers will not fund this specialmandatory redemption. Therefore, Standard &Poor’s will review the endorsement or rider to thebond insurance policy that evidences coverage ofthis redemption. ■Municipal SwapsInterest-rate swaps are being used in conjunctionwith bond issues to save interest costs, increasefinancial flexibility, synthetically refund bondissues, and access various investor markets.However, swaps expose issuers to counterpartycredit risk, termination risk, basis risk, rolloverrisk, and for many housing bond issuers, amortizationrisk. If used to speculate on the direction ofinterest rates, or if they are not structured properly,swaps can reduce an issuer’s ability to pay debtservice on time, thereby affecting its credit quality.Standard & Poor’s Ratings Services assigns DebtDerivative Profiles (DDP) to all U.S. municipalbond issuers that have engaged in swap or otherderivative transactions. The DDP scoring methodologycodifies the following Swap Criteria and is discussedin an accompanying section.Swap StructuresThe most common types of swaps in the municipalmarket are floating-to-fixed-rate swaps and fixed-tofloatingrate swaps. The floating-to-fixed rateswaps are typically used to create synthetic fixedratedebt while the fixed-to-floating rate swaps aretypically used to create synthetic variable rate debt.Other common swap structures are also describedbelow, including forward starting swaps, rate locks,basis swaps, and swaptions.Floating-to-fixed swapsSynthetic fixed rate debt is created through use offixed payer, or floating-to-fixed-rate swaps. Thisstructure provides a low cost alternative to issuingconventional fixed-rate debt, by allowing the issuerto access the short-term debt market. The issuerissues variable rate debt and hedges its floating-rateexposure with floating-to-fixed-rate swaps. Underfloating-to-fixed swaps the variable rate indexreceived by the issuer from the counterparty matchesor closely approximates the variable rate on thedebt, leaving the issuer with a fixed-rate exposurefor the term of the swap and, in most cases, termof the bonds.Fixed-to-floating swapsSynthetic variable rate debt is created through useof floating payer, or fixed-to-floating-rate swaps.The synthetic floating-rate debt structure provides alow cost alternative to issuing variable-rate debt. Itcreates nonputable variable rate debt and allowsthe issuer to avoid variable-rate program costs,such as credit, liquidity, and remarketing or auctionagent fees. This structure is used to convert existingfixed-rate debt to a variable rate or as part of anew issuance. Some issuers take advantage of thisstructure to hedge negative arbitrage on large cashand short-term asset positions.www.standardandpoors.com29