Leveraged Closed-

Closed-End
Fund Ratings
Hot Topics Seminar
Thursday, June 21, 2007

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Copyright (c) 2006 Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.
 Standard & Poor’s
Leveraged Closed
Closed-End
End
Fund Ratings

David Tesher
Managing Director/Product Manager

Francesca Neilson
Director

Jean-Baptiste Carelus
Director

Eric Hudson
Associate Director

Gwen Fink
Associate
Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.
2.
 Seminar Topics
I. Overview of Collateral and Structural Analysis
– Manager meeting
– What determines the OC Level
– Asset Valuation
– What is an S&P Hedging Transaction
II
II. S&P L
Legall A
Analysis
l i for
f IIssuance T
Types
– Preferred Shares
– Commercial Paper
– Notes
III. Surveillance
– Basic Maintenance Amount (BMA)
– Minimum Asset Coverage
IV. New developments
– D i v. Kentucky
Davis K t k
– Accounting for Tender Option Bonds
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3.
 R ti
Rating process

Management meeting/review
- What is the investment policy?
- Who makes investment decisions?
- How is risk managed?

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4.
 Ratings Process
P f li /C di A
Portfolio/Credit Analysis
l i

Collateral eligibility
– Established secondary market
– Can the securities be priced?
p

Collateral levels – How are they determined?

– Historical analysis of price movement
– Adjustments made for excess portfolio concentration

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5.
 Ratings
g Process
Portfolio/Credit Analysis

Security Level Approach

- Primary
P i focus
f on iindividual
di id l assets
- Bottom up analysis.
- Current portfolio holdings analyzed
- 36-months
h off monthly
hl returns required
d
- Index OC applied*

Portfolio Level Approach

Primary focus on the portfolio – single OC level*

*10 percentage points added to OC level for issuer above 5%

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6.
 Ratings
g Process
Portfolio/Credit Analysis

Valuation of assets
– Pricing

S&P Exposure Period Determines the OC Level

– Frequency of valuation
– Cure period
– Redemption time frame

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7.
 Ratings Process
P tf li /C dit Analysis
Portfolio/Credit A l i

What is S&P Exposure Period?

- MAC Test Coverage Calculated Weekly (Valuation)

- Vp (passed coverage)
- Vf (failed coverage)

- Cure Period (CP) of One Week

- Two Weeks To Redeem In The Event Of A Failure to Cure

within Cure Period (RP)
Vp Vf CP RP
|-------------|-------------|-----------------------|
5 10 20
Business Days
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8.
 Ratings Process
Structural Considerations

Di id d /I t
Dividends/Interest
tEExpense C
Calculations
l l ti
Sum of:
– Current Dividend/Interest
– Projected Dividend/Interest

C
Current
t=C
Currentt R
Rate
t x days
d remaining
i i in
i currentt period
i d
Projected = Adjusted rate x days remaining in the exposure period
Adjusted
djusted rate
ate = Market
a et Index
de x Maximum
a u Rate
ate x Volatility
o at ty
Factor*

* Volatility
V l tilit FFactor
t iis 2
2x LIBOR if th
the reference
f rate
t is d.
i LIBOR based
b

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9.
 Ratings Process
St
Structural
t l Considerations
C id ti

Determining Dividend Exposure Period

Dividend exposure variables
- Valuation date: weekly, each Friday
- Cure period: 5 business days (following)
- Redemption period: 10 business days

Vp Vf Cp Rp
|
|----------------- |------|-----------
| |------------|-----------------------|
| |
Fri hol. Mon. F. hol. Tues
10 cal. Days + 8 cal. days + 15 cal. days = 33 cal. days

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10.
 Ratings Process
St ct al Considerations
Structural Conside ations

Rating Agency Restrictions I:

Restrictions on Borrowings/Lending or giving a Guaranty

– Borrow money, except for clearing transactions; on a short term
basis; limited to 5%
– Issue
I additional
dditi l shares
h or debt
d bt
– Merge or consolidate
– Change pricing service

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11.
 Ratings Process
S
Structural
lCConsiderations
id i
Rating Agency Restrictions II:
Hedging Transactions
– Sell or purchase futures or options, unless covered or assets are segregated for obligations
due
– Reverse repos, Repo, Dollar rolls, unless covered or assets are segregated for obligations
due
– Interest Rate Swaps/Locks/Caps/Floors, counterparty A-/A-1 or better; MTM weekly,
notional not greater than preferred liquidation, Terminate swap on two consecutive failed
valuations, segregate assets equal to net excess of the fund’s obligation
– Lend securities, counterparty rated same as deal, MTM daily, all transactions matched on
both sides, repayment obligation is liability under MAC test, limited to 25% with term of 30
days
– Engage in short sales unless against the box/covered or assets are segregate for funds
obligations

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12.
 Ratings Process
L
Legal
lAAnalysis
l i

Documents Reviewed
- Articles of Incorporation
- By-laws
- Articles Supplementary/Statement of Preferences
- Prospectus’ (common and preferred shares)
- Disclosure
sc osu e requirements
equ e e ts

Legal Opinions
- Local (state) Law Opinion - addresses compliance with local
laws
- 40 Act Opinion - addresses compliance with 40-Act

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13.
 Ratings Process
Legal Analysis

CP, Loans, Notes, Bonds (Debt)

– Timeliness (optional & mandatory redemption)
– Ranking of the rated debt
– Priority of payments
– Non-petition covenants
– Commercial paper
– Accounts
A t
– Investments
– Performance of the other parties
Preferred Stock (Equity)
– Shareholder’s voting rights
– Common stock restrictions

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14.
 Ratings Process
Legal Analysis
• Business Development Companies v. Regulated Investment Companies
– Purposes
ƒ BDC’s – To make capital more available to small, developing and financially troubled
companies
ƒ RIC – To act as a partial conduit of income to shareholders

– Differences
ƒ BDC’s tend to be have more concentrated pools, able to directly finance companies
ƒ RIC’s no corporate level taxation

– Requirements
ƒ BDC’s – 70% Eligible Investment concentration, 200% asset to senior security ratio
ƒ RIC’s – Distribution Requirements

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15.
 Ratings
g Process
Surveillance - Basic Maintenance Amount (BMA)

Liquidation Preference & Other

Liabilities
– Liquidation
Li id ti Preference
P f
– Redemption premium
– Dividend/Interest
/ Expense
p
– 90-days expenses
– Maximum gross-up amount (if applicable)
– Liabilities senior to the preferred shares

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16.
 Ratings Process
Surveillance

Minimum Asset Coverage test

– Determine market value
– Calculate discounted value
– Sum discounted value
– Calculate liabilities
– Calculate dividend coverage amount
– Deduct liabilities and dividends (BMA)
– If discounted value g
greater than liquidation
q preference
p
coverage is met

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17.
 Ratings Process
S
Surveillance
ill - Minimum
Mi i A
Assett Coverage
C (MAC)

Discounted Eligible Assets BMA

Pool of Assets Liabilities

Fixed Income Current dividends

Equity Projected dividends

Cash Expenses
Gross-up (if applicable)
Other liabilities

Discounted eligible
g assets must be at least equal
q to liquidation
q preference.
p

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18.
 Ratings
g Process
R
Reporting
ti requirements
i t Surveillance
– As of date of original issuance
– Monthly Basic Maintenance Report
– Upon redemption of shares
– Upon request by S&P
– Annual audited financial state (includes BMA)

Electronic notification required

– Red flag level
– Failure
– Cure

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19.
 New Developments
• Municipal Bond Case – Davis v. Kentucky (197 S.W.3d 557)
– Issue: whether states can exempt their municipal bonds from taxes while
taxing such bonds issued by other states?
– Procedural History: the lower courts ruled that it was unconstitutional for
the state to tax interest payments only on bonds issued outside of
Kentucky. The Federal Court has granted cert.
– Currently, states treat interest on bonds issued by governmental entities
i th
in their
i states
t t more ffavorablybl th
than iinterest
t t on b
bonds
d iissued
dbby
governmental entities in other states.
– Possible ramifications – the state tax advantage of owning in-state
bonds versus out-of-state bonds could disappear, states with high tax
burden could face devaluation of their bonds and increased borrowing
costs

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20.
 New Developments
• Agreed
A d Upon
U P
Procedures
d (AUP)
– Parties involved
– Acknowledgement letters
– Standard and Poor’s response

• Tender Option Bonds

– Updated accounting treatment
– How the funds are affected

Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.
21.
 Contact Information

David Tesher, Managing Director – CDO Group

212-438-2618
d id t h @
david_tesher@sandp.com
d
Francesca Neilson, Director – CDO Group
212-438-5056
_ @ p
francesca_neilson@sandp.com
Jean-Baptiste Carelus, Director – CDO Group
212-438-3910
jean-baptiste_carelus@sandp.com
E i Hudson,
Eric H d A
Associate
i Director
Di – CDO G
Group
212-438-3407
Eric_hudson@sandp.com
Gwen Fink, Associate – CDO Group
212-438-2455
Gwen_fink@sandp.com
www.standardandpoors.com
www.ratingsdirect.com
ti di t

Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.
22.