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

Cross Sector Criteriaty of principal because of the large debt serviceexposure that occurs at maturity of the notes; forthese reasons, the guidelines presented here forinvesting operating funds take on more importancefor such issuers, and investment practices that veerfrom them could be cause for rating concern.Nonoperating funds, such as endowments and pensionfunds, can be invested long-term while ensuringthat assets and liabilities are maturity matched.The following guidelines are suggested for investinggeneral operating funds. Operating funds, as definedby Standard & Poor’s, are those needed to pay recurringexpenses, such as payroll, maintenance, debtservice, and other expenses needed to provide normalessential services during the fiscal year. Issuers thatdeviate from these guidelines will be examined individuallyto determine the effect, if any, their investmentpractices have on their credit ratings.‘Prudent Practice’Standard & Poor’s general operating fund investmentguidelines are based on what it considers “normal,prudent” investment practices with regard tomaturity and liquidity, leverage, and credit quality.Average maturity and liquidityThe weighted average maturity of the operatingfund, as well as the maturity of individual securitiesin the fund, should be limited to one year, or asneeded for the issuer’s normal disbursement patterns.Operating funds should be invested in liquidsecurities to meet withdrawals related to operatingexpenses, debt service, note payments, and so forth.Principal protection and liquidity are typically theprimary goals of an operating fund and investmentreturn a secondary goal. If the operating funds areinvested in county or state investment pools, theweighted average maturity of the county or statepool should typically be one year or less.LeverageBorrowing through reverse repurchase agreementsand other types of leveraged investments is typicallylimited and reflective of the risk profile of theissuer. If reverse repos are used for enhancing yieldon the portfolio, the money borrowed should beinvested in securities of a high credit quality andmatch the term of the reverse repos. Issuers that usereverse repos need to have the sophistication andskills in place to hedge collateral call and interestrate risks associated with reverse repos.Credit qualityAn entity’s operating fund investments should meetthe minimum credit quality standards permitted bystatute, or its own investment policy. Investmentscan include deposits in local financial institutionsthat are FDIC-insured, commercial paper issued byinvestment-grade corporations and financial institutions,bankers’ acceptances, and treasury or governmentagency securities.DerivativesFor the purposes of these guidelines, derivativeinvestments can be described as those whose yield ormarket value does not follow the normal swings ofinterest rates. They include, but are not limited to,such items as structured notes issued by agencies andcorporations, “inverse floaters,” leveraged variableratedebt, and interest-only or principal-only CMOs.These securities are volatile and can result indramatically different market values if liquidatedbefore maturity. Significant investment positions inrisky derivatives could be viewed negatively,depending on the proportion of derivatives tototal investments and the liquidity needs of theissuer. These derivatives are extremely sensitive tointerest rate changes and are highly susceptible toliquidity risks.Pools And Mutual FundsThe same guidelines regarding average maturity andliquidity, leverage, credit quality, and derivativesshould be adopted for operating fund investments inexternally managed investment pools. Exceptions canbe made depending on the amount of nonoperatingand surplus funds invested in the pool. In addition toreviewing the pool investments, the historical andprojected cash flows of the pool will be examined.While we do not require investment funds to berated by Standard & Poor’s in order to evaluate anissuer’s credit quality, a public rating on the investmentfund provides transparency as well as the initialand ongoing information that is asked for aspart of an investment review.Review And OversightIssuers should be aware of statutory investmentrequirements and may want to supplement statutoryguidelines with a written investment policy tailoredto that entity’s situation. The policies shouldaddress credit quality, maturity, market valuationfrequency, leverage, and derivative-type investments.Officials should be aware of such policies,and periodic reporting of compliance and performanceshould be in place. As part of Standard &Poor’s analysis, we may request a discussion of theinvestment practices and how they follow writtenor otherwise adopted policies.In general, the longer the maturity or duration ofpermitted investments—and the less liquid the securities—themore frequent the need for “mark tomarket” valuations of operating fund investments.50 Standard & Poor’s Public Finance Criteria 2007