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

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

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Municipal Swapsmeasures the potential risk to an issuer’s revenuestream and reserve levels resulting from rising variablerates. <strong>The</strong> ratio is calculated on a current and proforma basis to gauge prospective levels of variableexposure, given either proposed derivatives oradditional bonds.<strong>The</strong> net variable interest exposure ratio primarilyfocuses on debt and debt derivatives. Variable rateand short-term debt includes commercial paper,unhedged variable rate bonds, and synthetic variablerate debt. Unhedged variable rate bonds includethose bonds, which are not hedged through floating-to-fixed interest rate swaps or variable rateinvestment assets. Synthetic variable rate bondsconsist of traditional fixed rate bonds, which areconverted to variable rate bonds through fixed-tofloatingrate swaps. Any variable rate bonds thatare converted to fixed rate debt through a swap canbe netted from variable rate liabilities.In addition, if the issuer can demonstrate historicalsufficiency of offsetting principal and interestcoverage from short-term and variable rate investmentassets held in unrestricted, non-operatingaccounts, these assets may be netted from variablerate liabilities. Earnings on short-term or variablerate investments are typically well correlated tovariable interest owed on bonds. We consider nonoperatingaccounts, those accounts, which theissuer holds as unrestricted funds for true surplusreserve or hedging purposes only. Investments inthose accounts should be highly liquid and investedin short-term securities with maturities of one yearor less. Assets held in operating, capital, or debtservice purposes are not considered available on anongoing basis due to the variability of balancesover time. Qualifying investment securities mayinclude short-term Treasury notes, commercialpaper, repurchase agreements, and guaranteedinvestment contracts with low volatility of mark-tomarket.Revolving lines of credit and other forms of“soft capital” are typically not counted as shortterminvestments due to the fact that issuers arerequired to reimburse the provider for any drawsmade under the facilities.Swap InsuranceSwap insurance polices are similar to bond financialguarantees in that policies guarantee payments to abeneficiary, in this case a swap dealer, for failure topay by the insured, in this case the issuer. Also similarto bond insurance, issuers are required to reimburseinsurers for any payments made tobeneficiaries under swap policies and must live withinsurer legal restrictions. Under regular swap insurancepolicies, the insurer will make regularly scheduledswap interest payments if the issuer fails to doso. <strong>The</strong> majority of policies issued by insurers todate have been regular swap insurance policies, asthey present immaterial, incremental risk to insurers,since in most cases the insurer is also insuringregularly scheduled payments on the issuer’s bonds.Swap and bond payments are typically on paritywith one another. In addition to regular swap paymentinsurance, some issuers have purchased swaptermination coverage through a policy endorsementfor an additional premium. Termination coveragetends to become expensive, as this coverage doespresent incremental risk for the insurer over scheduledpayments on bonds and swaps. Swap terminationinsurance provides further, although notcomplete, protection against termination exposuredue to issuer and insurer credit events (ratingdowngrades). Under swap termination policies,insurers will make swap termination payments, upto a specified amount, to the extent that a terminationevent under the swap is triggered and theissuer has failed to make the termination payment,or in lieu of termination, failed to post collateral orsecure a third-party enhancer.Benefits<strong>The</strong> benefits of swap insurance to an issuer arenumerous, including significant, although not complete,mitigation of counterparty, collateral posting,and termination risks. Standard & Poor’s DDPscores to date indicate that if not for regular swapinsurance, many issuers—notably lower-ratedhealth care issuers—would have been exposed tomuch greater levels of these risks. Of the approximate210 issuers that have received a DDP score todate, about 15% have benefited from swap insurancethrough a lower overall DDP score as a resultof scoring lower in the termination and collateralposting risk section of the DDP. <strong>The</strong> significance ofswap insurance in the health care and transportationsectors is greater, with about 25% of issuershaving benefited from insurance through lowerDDP scores.Regular swap insurance mitigates terminationand collateral posting risk in several ways. In termsof collateral posting risk, the issuer is spared fromhaving to post collateral under a credit supportannex, due to the joint obligation of swap paymentsby both the issuer and the insurer. If theinsurer has suffered significant ratings downgrades,collateral postings by the issuer are typicallyrequired, however. Furthermore, involuntary terminationrisk becomes more remote with regular swapinsurance despite the fact that policies do not covertermination payments. This is because underinsured swaps, the issuer’s rating trigger for earlytermination becomes applicable only to the extentthat the insurer has also suffered a significant ratingsdowngrade. <strong>The</strong> extremely low ratings volatili-www.standardandpoors.com37

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