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

Cross Sector CriteriaRequired Documentation ForVariable Rate Debt And Swaps(1) Cash flow projections as discussed under “Cash Flows.”(2) Dbt Management Plan(3) Swap Management Plan(4) Swap legal documents:■ Bond Trust Indenture■ ISDA Master Agreement■ Schedule with Confirmation■ Acceptable additional termination events, includingmaximum rating triggers;■ Use of insurance or collateral to protectcounterparties, and if so, what are theminimum thresholds;■ Cross default provisions;■ Termination payment terms (subordinate and/orpayout as lump sum or amortized over time); and■ Counterparty rating minimums and other creditprotection provisions, such as collateral requirementsor third-party guarantees.OversightManaging derivatives, such as interest rate swaps,requires an ongoing commitment from the issuingentity’s senior executives and governing body. Allsenior management and officials—not just the chieffinancial officer—should become familiar with therisks and rewards of the derivatives. As part of aswap policy, an issuer should delineate whatprocess it will follow to consider entering intoswaps and which positions have direct and indirectoversight of the real-time management of swaps. Interms of ongoing oversight, issuers should routinelymonitor swaps under current and forecasted interestrate environments, in order to gauge potential cashflow gains and losses as well as market opportunitiesfor voluntary terminations and restructurings.Market valuations of derivatives should also beroutinely calculated.DisclosureIssuers should commit to continually disclose allaspects of derivatives position in accordance withGASB guidelines, or FASB, as applicable. Currently,GASB’s 2003 Technical Bulletin (“2003-01-DisclosureRequirements for Derivatives Not Reported at FairValue”) provides guidelines for adequate disclosureof pertinent information related to derivatives. Inaddition, at the time of a rating review, managementshould be prepared to discuss the details of theswap plan and plan of finance and state the currentand future economic viability of the swaps in additionto the likelihood of voluntary or involuntarytermination during the course of the current andupcoming fiscal year.StrategyThe issuer should outline the different types ofswaps or derivatives that would be included withina swap plan; that is the types of structures thatcould be considered when presenting an opportunityfor risk management (e.g., in which interest rateenvironments) and how they should be used (e.g.natural hedges, basis swaps or synthetic refundings,rate locks, synthetic fixed and variable, etc.) in thebroader context of the capital financing plan. Thedesirable capital structure of variable to fixed-ratedebt should also be determined as a percentage oftotal debt outstanding (net variable exposure).Management Check ListAddressing the following issues will strengthen theswap management policy:■ Formal approval of written documents by theissuer’s governing body;■ Swap risks identified and discussed in the contextof the issuer’s financing plans;■ Annual management review and discussion ofhedging strategies;■ Commitment to complete and comprehensivedisclosure of swaps in audited financial statementsabove and beyond required GASB orFASB parameters;■ Monitoring of swaps with semi-annual valuationby a third party■ Policies on legal provisions, including optionalswap terminations, collateral, or swap insurance;■ Counterparty diversification or a minimumratings policy for counterparties; and■ A net variable rate exposure policy.Net Variable Rate Debt CalculationStandard & Poor’s believes that quantification ofboth balance sheet and cash flow risks associatedwith variable rate debt is necessary to properlyevaluate an issuer’s financial flexibility resourceswhen entering into swaps. The quantificationprocess includes determining net variable rate andshort-term debt. Once quantified, the overall creditimpact of variable rate debt and swaps can be factoredinto an issuer’s rating. This evaluation processwill be made on a case-by-case basis.Net variable rate and short-termdebt exposure ratioStandard & Poor’s monitors an issuer’s use of variablerate debt as part of the ratings process through anet variable interest rate exposure ratio, which36 Standard & Poor’s Public Finance Criteria 2007