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

Cross Sector Criteriaty of ‘AAA’ rated monoline bond insurers combinedwith the overall stability of municipal ratings indicatesthat a termination event due to coincidentalrating downgrades is an extremely remote possibility.In terms of counterparty risk mitigation, swapinsurance can be beneficial to the issuer becauseinsurers may require swap dealers to post collateralunder credit support annexes, to the extent thecounterparty suffers a credit event.RisksThe primary risk under swap insurance policies isthe credit risk of the insurer. If the insurer’s creditdeteriorates significantly, the issuer is likely to haveto post collateral in order to maintain the hedge;otherwise, the swap may be subject to termination.Some issuers will purchase swap termination policiesto mitigate this risk. However, the monolinebond insurer industry has had an extraordinary historyof credit stability and presents a very lowprobability of an issuer experiencing this risk. Asecondary risk of swap insurance includes the oversightand legal restrictions imposed by insurersunder swap policies. Because the insurer is assumingthe issuer’s credit risk for the duration of theswap transaction—often 20 years or more—insurersmaintain certain control rights under theinsured swap and insert various legal provisionsinto an issuer’s bond documents. For example, solong as the insurer has not suffered a credit event,insurers reserve the right to allow voluntary terminationof swaps and sometimes place limitations onadditional swaps. These restrictions may becomeproblematic if the issuer needs to restructure theswap or enter into additional swaps for economicreasons. Insurers also typically require that a seriesof credit protection provisions be inserted directlyinto the schedule to the International Swaps andDerivatives Association (ISDA) agreement, includingcollateralization by the counterparty. These protectionsare typically positive for the issuer’s creditquality, although they may impact the economics ofthe transaction. Also, in some cases the insurer hasthe right to direct the issuer to terminate the swapearly if the issuer has experienced an event ofdefault (as defined under ISDA swap documents).Standard & Poor’s is not overly concerned aboutinsurer-directed termination clauses due to an eventof default since these risks are already reflected inthe issuer’s rating. ■Debt Derivative Profile ScoresStandard & Poor’s Ratings Services has revised itscriteria for Debt Derivative Profile (DDP) scoring18 months after having implemented themethodology. Standard & Poor’s developed DDPscoring for U.S. Public Finance in September 2004to enhance the analysis and transparency of municipalderivative structures and their impact on creditquality. We believe these revisions will add value toour derivative analysis, within the context of ouroverall credit analysis.The revisions place more emphasis on near andintermediate term risks and relatively less emphasison longer-term risks that do not add or detractmaterially from an issuer’s rating.We received numerous and varied responses to ourrequest for comments on the proposed revisions to theDDP from all sectors of the municipal bond market,including issuers, dealers, investors, and financial advisors.We considered all comments in making our finaldetermination of the criteria revisions. This criteriapiece supersedes all prior criteria reports on the DDP.Revisions To Scale And WeightingsStandard & Poor’s is revising the DDP scale to an“enhanced” four point numerical scale from a fivepoint numerical scale. The enhancement consists ofeliminating the score of ‘5’ and adding half points(1.5, 2.5, 3.5) to the 1, 2, and 3 risk categories.Furthermore, all numerical scores will be pairedwith a risk descriptor that will be consistently usedto characterize the numerical DDP score. Theenhancements provide greater granularity withinthe ‘1’ through ‘4’ scale. The revised DDP scoresare as follows:Additionally, Standard & Poor’s has revisedweightings for component scores and eliminatedseveral scored factors within the collateral andtermination risk analysis. Details of all therevised DDP scoring methodology are describedbelow. The revised criteria results in recalibratedscores for all issuers (see accompanying article,“Current List Of DDP Scores”, March 27, 2006,RatingsDirect).38 Standard & Poor’s Public Finance Criteria 2007