ty of ‘AAA’ rated monoline bond insurers combined
with the overall stability of municipal ratings indi-
cates that a termination event due to coincidental
rating downgrades is an extremely remote possibili-
ty. In terms of counterparty risk mitigation, swap
insurance can be beneficial to the issuer because
insurers may require swap dealers to post collateral
under credit support annexes, to the extent the
counterparty suffers a credit event.
Risks
The primary risk under swap insurance policies is
the credit risk of the insurer. If the insurer’s credit
deteriorates significantly, the issuer is likely to have
to post collateral in order to maintain the hedge;
otherwise, the swap may be subject to termination.
Some issuers will purchase swap termination poli-
cies to mitigate this risk. However, the monoline
bond insurer industry has had an extraordinary his-
tory of credit stability and presents a very low
probability of an issuer experiencing this risk. A
secondary risk of swap insurance includes the over-
sight and legal restrictions imposed by insurers
under swap policies. Because the insurer is assum-
ing the issuer’s credit risk for the duration of theswap transaction—often 20 years or more—insur-
ers maintain certain control rights under the
insured swap and insert various legal provisions
into an issuer’s bond documents. For example, so
long as the insurer has not suffered a credit event,
insurers reserve the right to allow voluntary termi-
nation of swaps and sometimes place limitations on
additional swaps. These restrictions may become
problematic if the issuer needs to restructure the
swap or enter into additional swaps for economic
reasons. Insurers also typically require that a series
of credit protection provisions be inserted directly
into the schedule to the International Swaps and
Derivatives Association (ISDA) agreement, includ-
ing collateralization by the counterparty. These pro-
tections are typically positive for the issuer’s credit
quality, although they may impact the economics of
the transaction. Also, in some cases the insurer has
the right to direct the issuer to terminate the swap
early if the issuer has experienced an event of
default (as defined under ISDA swap documents).
Standard & Poor’s is not overly concerned about
insurer-directed termination clauses due to an event
of default since these risks are already reflected in
the issuer’s rating.■Cross Sector Criteria38 Standard & Poor’s Public Finance Criteria 2007
S
tandard & Poor’s Ratings Services has revised its
criteria for Debt Derivative Profile (DDP) scor-
ing 18 months after having implemented the
methodology. Standard & Poor’s developed DDP
scoring for U.S. Public Finance in September 2004
to enhance the analysis and transparency of munici-
pal derivative structures and their impact on credit
quality. We believe these revisions will add value to
our derivative analysis, within the context of our
overall credit analysis.
The revisions place more emphasis on near and
intermediate term risks and relatively less emphasis
on longer-term risks that do not add or detract
materially from an issuer’s rating.
We received numerous and varied responses to our
request for comments on the proposed revisions to the
DDP from all sectors of the municipal bond market,
including issuers, dealers, investors, and financial advi-
sors. We considered all comments in making our final
determination of the criteria revisions. This criteria
piece supersedes all prior criteria reports on the DDP.Revisions To Scale And Weightings
Standard & Poor’s is revising the DDP scale to an
“enhanced” four point numerical scale from a five
point numerical scale. The enhancement consists of
eliminating 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 paired
with a risk descriptor that will be consistently used
to characterize the numerical DDP score. The
enhancements provide greater granularity within
the ‘1’ through ‘4’ scale. The revised DDP scores
are as follows:
Additionally, Standard & Poor’s has revised
weightings for component scores and eliminated
several scored factors within the collateral and
termination risk analysis. Details of all the
revised DDP scoring methodology are described
below. The revised criteria results in recalibrated
scores for all issuers (see accompanying article,
“Current List Of DDP Scores”, March 27, 2006,
RatingsDirect).