PubFinCriteria_2006_part1_final1.qxp

Additional Factorsbelow). A high overall DDP

score, component scores, high net variable exposure

ratio, or a speculative transaction can be partially

or fully mitigated as negative rating factors to the

extent an issuer has sufficient liquidity reserves or a

robust cash flow stream to offset the worst-case

financial risk. On the other hand, if financial expo-

sure is not offset at the issuer’s current rating level,

this is a cause for concern and could be a reason

for a negative rating action.

Debt Derivative Profile Scoring Criteria

The DDP is a weighted average of four factors,

each of which is scored on a scale from 1 (minimal

risk) to 4 (high risk). The four factors that comprise

the DDP are:

■Issuer collateral posting and termination risk

(35% weight);

■Counterparty termination credit risk (15%

weight);

■Economic viability of the swap structure (15%

weight); and

■Quality of swap and debt management policies

and procedures (35% weight).

Standard & Poor’s has determined that more

weight should be placed on management and the

risk of termination and collateral posting due to

the near and intermediate term risks inherent in

these factors. Furthermore, counterparty credit risk

and the economics and cash flow strength of an

individual trade (economic viability), while impor-

tant over the long-term, are both relatively less

important from a near to intermediate term credit

risk perspective.

We perform the DDP analysis using documenta-

tion and representations provided by the issuer

(swap management policies, business plans) and the

swap dealer combined with proprietary statistical

models. Due to the single agreement concept, scores

for issuer collateral posting and termination risk

and counterparty termination credit risk are derived

by evaluating the International Swap Dealers

Association Inc. (ISDA) document, since the legal

terms and conditions are consistent for an unlimit-

ed amount of related transactions.

Termination and collateral posting risk

Termination and collateral posting risk is scored on

a 1 through 4 scale based on the risk that the issuer

will be required to post collateral or terminate a

swap on an involuntary or voluntary basis. The

weighting for termination and collateral posting

risk is 35% due to the potential impact on an

issuer’s liquidity reserve position.

Analytically, collateral posting in favor of a swap

dealer is equivalent to payment of a termination fee

due to the restricted nature of collateral on an

issuer’s balance sheet. To determine a final termina-

tion and collateral posting risk score to be used in

the DDP, Standard & Poor’s will score and weight

three factors that could lead to a collateral posting

or early swap termination. The three scored termi-

nation and collateral posting risk factors include:

■The likelihood of an involuntary event of default

or termination or collateral posting due to ratings

downgrades, or a likelihood of voluntary termi-

nation under unfavorable market conditions

(50% weight);

■The issuer’s historical ratings volatility (number

of downward rating or negative

outlooks/CreditWatch listings in last three years;

30% weight); and

■Average swap durations applicable to the ISDA

document (less than 10 years, 10-15 years, 15-20

years, greater than 20 years; 20% weight).

We will assign the lowest termination and collat-

eral posting risk scores for swaps with a relatively

wide ratings trigger spread, low ratings volatility,

and overall short swap durations (reduced likeli-

hood of a rating transition). There may be mitigat-

ing factors that would warrant a termination and

collateral posting risk score of either 1 or 4 for

specific transactions. In these cases, these transac-

tions will be separated apart from the other trans-

actions applicable to the ISDA document for

scoring purposes.

Factors that warrant a termination and collateral

posting risk score of 1, include:

■No material events of default or termination;

and/or

■Issuer has an option to terminate the swap at any

time, for any reason, at little or no cost.

Factors that warrant a termination and collateral

posting risk score of 4, include:

■Events of default or termination, other than rat-

ings triggers, that are considered likely to occur

over the life of the transaction; and/or

■Speculative transactions where there is a distinct

possibility of early, voluntary termination by the

issuer (if such an option exists) under adverse

market conditions, and/or

■Unfavorable swap options (swaptions), where the

dealer owns the option to impose an unfavorable

or speculative transaction on an issuer.

Cross Sector Criteria

40 Standard & Poor’s Public Finance Criteria 2007

‘AAA’ ‘AA+’, ‘AA’, or ‘AA-’ 1

‘A+’ 2

‘A’ and ‘A-’ 3

‘BBB+’ and lower 4

Counterparty Rating Counterparty Risk Score