S&P - Public Finance Criteria (2007). - The Global Clearinghouse
S&P - Public Finance Criteria (2007). - The Global Clearinghouse
S&P - Public Finance Criteria (2007). - The Global Clearinghouse
You also want an ePaper? Increase the reach of your titles
YUMPU automatically turns print PDFs into web optimized ePapers that Google loves.
Municipal Swapscharges. An issuer that has limited liquidityresources should include provisions in the swapagreement that allows the issuer to pay the terminationvalue over a period of time. A stress test of anissuer’s income and cash flow statements is done todetermine the amount of cushion that is availableto pay additional unexpected cash settlement. <strong>The</strong>worst-case termination value would be used indetermining the amount and term of the paymentstructure. For example, repayment terms could be afive-year term with an annual maximum paymentof $10 million.<strong>The</strong> issuer can also reduce termination risk by:■ Entering into a swap with a strong counterparty;■ Limiting the termination triggers and eventsof default;■ Reducing the term of the swap; orDeveloping contingency plans for making thetermination payment.ManagementOne of the most important aspects of the analysisof the use of swaps is the evaluation of the understandingand expertise that management contributes.Managing derivatives like interest rateswaps requires an ongoing commitment from theissuing entity’s senior executives. All senior management—notjust the chief financial officer—shouldbecome familiar with the risks and rewards of thederivatives being considered. Because of the complexitiesinvolved, some small issuers may not be ina position to develop the necessary expertise andsystems to adequately manage some derivatives. Infact, smaller issuers’ capital needs generally are notlarge enough to justify the sizable fixed costsassociated with putting together these types oftransactions. <strong>The</strong>refore, Standard & Poor’swill request a discussion of the issuer’s SwapManagement Plan and Policies as part of theDDP process.Swap Management Policies Versus Swap PlansIt is important to distinguish between a swap managementpolicy and a swap management plan. Aswap policy is a formally approved written documentintended to guide management decisions over time,whereas a swap plan is similar to a plan of finance,intended to rationalize or explain specific transactionsdone within the swap policy’s parameters.Because of this distinction, the two serve differentpurposes and are viewed differently in the DDPscoring process. A formally adopted swap policydetails operating parameters for entering into andexecuting swaps, outlines exactly what types oftransactions can and cannot be entered into, laysout credit decision matrices and levels of maximumrisk exposure, and is part of institutionalizedmanagement and financial policies.Swap Management PolicyIssuers can adopt formal swap management policiesand procedures that simultaneously minimize therisks and maximize the rewards from swaps. Ameaningful and effective swap policy includes thefollowing components:■ Purpose■ Authorization■ Controls■ Oversight■ Disclosure■ StrategyPurposeA swap policy should include a purpose statementthat indicates the reasons for entering into interestrate derivative transactions. Answering the question,“why does using swaps and other debt derivativesmake sense?” will allow the issuer to outline thegoals and expectations of hedging fixed or variablerate exposure with swaps in relation to its portfolioof debt instruments. Issuers should state underwhat scenarios and opportunities derivatives mightbe used to hedge interest rate risks. With thesegoals, the issuer provides an important measureof transparency regarding the use of swaps inthe broader context of the municipal entity’sfinancial operations.AuthorizationIt is important that the issuer have the appropriatelegal power to enter into swap contracts. Anissuer’s swap policy should clearly cite the legalreference or statute that provides authorization.Also, the issuer should outline any formal authorizationprocess for entering into interest rateswap agreements.Risk controlsManagement should outline policies designed tominimize the liquidity and cash flow risks associatedwith swaps. <strong>The</strong> revenue source for making netswap payments should be identified and budgetedfor once the swap structure is stressed against differentinterest rate scenarios and payments can beestimated. <strong>The</strong> source of termination paymentsshould also be identified with an attendant “liquidityat-risk”policy, outlining the maximum amount ofliquidity reserves, which could be placed at riskshould a collateral posting or terminationevent occur.Risk mitigation strategies could include thefollowing parameters:www.standardandpoors.com35