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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

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Cross Sector <strong>Criteria</strong>designed to provide assistance and technical supportto their members—that are typically local governments.Examples of such organizations includestate-level chapters of the League of Cities, theAssociation of Counties, and the Rural WaterAssociation. While these programs often have a certainamount of technical expertise, they may alsorely on outside financial consultants to administermost of the financial responsibilities associated withthe pool program. Because these organizations areusually nonprofits with limited liquidity, fundsavailable to be pledged as over-collateralization areusually also limited. While these factors often limitratings on these entities’ pooled loan programs relativeto state revolving funds, they may still attainhigh investment grade ratings if managed effectivelywith sufficient diversity and support.Economic development pool programs differfrom other municipal pool programs in that, whilethe program sponsor and administrator is usually astate or local government agency, pool participantsare often private entities, and the credit quality ofthese participants is generally lower. Accordingly,these programs typically have some percentage ofpledged loans in default at any given time, in contrastto most government-based pools where few ifany defaults occur over the entire life of the program.Although corporate loan defaults are morelikely, this does not pose a real threat to bondrepayment if policies and provisions exist to ensurethat default rates remain manageable given creditsupport under the program. Standard & Poor’sdefault model accounts for the higher risk associatedwith private sector borrowers, resulting in higherrequired over-collateralization levels being requiredfor a given rating level. Nevertheless, this lowerparticipant credit quality, coupled with limited stateor federal equity contributions, often limits the ratingson pool programs designed to promote economicdevelopment through private lending.Lease PoolsStandard & Poor’s rates lease pools typically sponsoredby nongovernmental entities. Assets securingthese transactions are usually equipment ratherthan buildings, therefore the useful life of the equipmentrelative to bond maturity and the likelihoodthat the lessee will otherwise remain current on thelease due to their desire to maintain possession ofthe equipment are of paramount importance.Because of their typically short duration, leasepools rated to date generally enjoy lower requireddefault tolerances than do long-term debt obligations,reflecting the direct relationship betweendefault risk and maturity. <strong>The</strong> risk of nonappropriationwill lead to lower assumptions of credit qualityand recovery, however, somewhat offsetting thebenefit of the short maturity. Unlike SRFs and statebond bank pools, lease pools may also be backedby assets in different states, and the model givescredit for this additional diversification.Standard & Poor’s will discuss with the programsponsor the key criteria used in underwritingcredit risk. Staffing levels, experience of the originator’scredit personnel, and any areas of creditspecialization may also be discussed. A criticalaspect of underwriting is a review of the essentialityof the leased equipment. Standard & Poor’sconsiders the following types of equipment,among others, to be essential:■ Police and fire vehicles■ Communications equipment■ Energy management systems■ Computer hardware and software■ School busesCredit approval policies should be well documented,highlighting internal credit authorities andtransaction approval procedures. Verification ofequipment acceptance, lessee review, documentationrequirements and internal auditing are also componentsof a sound underwriting policy.<strong>The</strong> obligation of the servicer to bill and to collectis critical and can directly affect pool performance.When evaluating the strength of anequipment lease servicing operation, it is necessaryto examine the billing and collecting procedures,when and how delinquent obligors are notified, andif staffing and systems adequately handle thedemands of compliance and reporting.<strong>The</strong> substance of Standard & Poor’s legal analysisdepends on the structure of the transaction presented,but is typically akin to that for a syntheticfloater structure (see <strong>Public</strong> <strong>Finance</strong>—Structuredcriteria for more information).Municipal Collateralized Debt ObligationsCollateralized debt obligations, or CDOs, are structuredvehicles that are similar to leveraged closedend funds. A majority of CDOs are actively managedand invested in different classes. Over the lastseveral years, municipal assets have been used as aportion of the assets securing some CDOs, and afew transactions have contained only municipalsecurities as collateral. At the core of the CDO is abankruptcy-remote, special purpose entity (SPE) thatissues securities to investors in the form of severalclasses that are tranched into differently rated andsome unrated securities. Each class of securities representsa different level of risk and reward associatedwith the asset pool. <strong>The</strong> most senior securitieshave credit ratings higher than the average ratings ofthe collateral pool, with lower tranches being ratedbelow the seniors. <strong>The</strong> first-loss tranche is equity (orpreferred shares) that is typically not rated.48 Standard & Poor’s <strong>Public</strong> <strong>Finance</strong> <strong>Criteria</strong> <strong>2007</strong>

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