Since 1984, Standard & Poor's Rating Services has assigned principal stability fund ratings (PSFRs) and fund credit quality/volatility ratings (FC&VRs) to fixed-income funds globally. We updated and clarified some aspects of our methodology for PSFRs to add net asset value (NAV) deviation ranges for each rating category and to clarify our analysis of certain issues during these unusual market times (please see "Principal Stability Fund Ratings Criteria Updated," published March 10, 2009, on RatingsDirect and outlined below). We do not anticipate any rating changes resulting from this criteria update.
This article updates the methodology in "Principal Stability Fund Ratings Criteria," published Feb. 2, 2007, on RatingsDirect and at www.standardandpoors.com.
Expanded NAV Deviation Ranges For Each PSFR Category
Our current PSFR criteria only address when the marked-to-market NAV of a 'AAAm' rated fund drops below 0.9985. We are adding the following marked-to-market NAV (per share) ranges for all PSFR categories:
'AAAm': 0.9975 to 1.0025
'AAm': 0.9970 to 1.0030
'Am': 0.9965 to 1.0035
'BBBm': 0.9960 to 1.0040
'BBm': 0.9950 to 1.0050
'Dm': Less than 0.9950
If the NAV for a fund in one of these categories exceeds these ranges, we would typically take rating action.
Analyzing Current Market Stress In Funds
Our 'AAAm' PSFRs are characterized by, but not limited to, the following:
Maximum weighted average maturity (WAM) of 60 days or less;
Minimum of 50% in 'A-1+' securities, and maximum of 50% in 'A-1' securities; and
Maximum final maturity of floating-rate securities is two years.
We also evaluate management's response to events that may result in one or more of these measures weakening and whether those events impair the fund's ability to maintain its principal value. Specifically, we will evaluate items such as the scope of the issue, frequency of occurrence, proactive measures taken by fund management, cash flows, security pricing, and NAV deviation to determine if the fund still warrants a 'AAAm' rating.
Although our PSFRs do not initially address the willingness and/or ability of a sponsor to support a rated fund, we will review the measures a sponsor chooses to take to support its NAV during times of market stress. Historically, the types of support have generally included of one or more of the following: credit support agreements, letters of credit, purchasing distressed assets out of the fund at amortized cost, making cash investments in the fund, and/or creating an escrow/reserve account with highly rated institutions in the name of the fund.
Notification Of The Impact Of Market Events On Funds
We become aware of events impacting funds either through direct communication with fund management or via our frequent surveillance of rated funds that begins immediately after we assign a fund rating. Because surveillance reports for PSFRs are sent up to one week after the report date and the turnover of portfolio assets is high given their short-term maturity, we expect issuers to maintain open and constant communication with us and to contact us promptly if and when they become aware of developments that may affect fund principal stability.
Addressing issues
When we receive a surveillance report, our team of dedicated fund rating surveillance analysts reviews the statistics and holdings reports. When our review and analysis reveals something outside of our framework, we verify the relevant information for accuracy with the provider of information. Upon verification, our analysts assigned to the fund in question contact the fund management representatives to discuss the details surrounding the issue. We expect highly rated funds to be proactive in dealing with issues as they arise.
Although each situation is unique, in all cases we attempt to determine the severity of the developments and whether they were "active" or "passive." For instance, regarding severity, if the WAM of a fund moved one day over the maximum for a particular rating category, that would not necessarily be equivalent to a MMF NAV being reported at $0.9980. An "active" situation is a result of actions taken by the fund's management versus a "passive" situation, which occurs separately from any action the fund manager takes. An "active" example is a fund's WAM exceeding the stated maximum because fund management purchased securities with longer final maturities despite the effect the purchase had on the fund's overall maturity. A "passive" example would be a fund's WAM exceeding the stated maximum because of a larger-than-expected redemption where management liquidated short investments resulting in an extended maturity.
The following are some examples of how we would typically respond to issues outside framework.
Example #1: A 'AAAm' rated fund is holding paper from an issuer rated 'A-1' and the issuer is downgraded to 'A-2'. When this occurs, we discuss with the investment manager its independent view of the downgraded issuer and its plan of action (hold, sell, reduce exposure) to determine whether, in our view, the plan is generally compliant with 'AAAm' ratings. Our conclusion is based on a review of but not limited to:
Dollar amount and percentage of exposure;
Remaining days to maturity;
If the issuer is on CreditWatch Negative or is assigned a negative outlook;
Our long-term rating on the issuer;
The fund's asset flows; and
Current market liquidity.
Example #2: A money-market fund reports a WAM that is beyond the 60-day limit for 'AAAm' rated funds. When this occurs, we investigate the cause (that is, active or passive) and when management expects the WAM to be back in line with expectations. For instance, if management indicates it had a large unexpected redemption, we will ask how management is improving its lines of communication with shareholders to minimize the chances of this occurring again. We will also ask, among other things, if management performed a "what-if" or scenario analysis to estimate the affect of cash-flow volatility on the fund's WAM. If exceeding the maximum WAM is due to active behavior of fund management and appears to be a persistent issue, we may lower the rating or set a lower maximum WAM for that fund.
Declining NAVs
As part of our rating process, we discuss with fund management its policies and procedures for dealing with a declining NAV and a downgraded or distressed security so if that situation occurs, we understand how each fund's management is likely to address the problem. As indicated in the examples above, when such events occur, we have an active dialogue with fund management, and determine whether its plans are consistent with the fund's current rating.
Principal stability rated fund criteria provide that all rated funds have written policies that initiate action well before the fund is at risk of its NAV dropping below $0.995 (a 0.50% deviation; also know as "breaking the buck"). These policies may include, but are not limited to daily pricing, board notification, and timing of when the board would be required to meet. When the marked-to-market NAV of a 'AAAm' rated fund drops below 0.9985, we contact fund management to discuss cause(s) of the decline and activities/meetings occurring at fund management and/or board level, and we request daily pricing/NAV reporting. If the marked-to-market NAV drops below 0.9980, we may put the fund on CreditWatch with negative implications for the time the NAV remains below 0.9980, and we would typically adjust the rating to 'AAm' if the NAV drops below 0.9975.
Bifurcating assets in a rated fund
Continued deterioration in the credit market during the past year has caused declining credit quality of assets in a number of rated portfolios. Some fund managers have attempted to lessen the negative impact by removing the distressed assets from the rated portfolio and placing those assets into a separate account. Each situation involving a bifurcated portfolio is distinct and complex. We review fund bifurcation on a case-by-case basis by evaluating the following aspects:
The fund composition at the time distressed assets were removed from the fund;
Legal and structural distinctions between the fund and the account or fund that holds bifurcated assets;
Shareholder losses based on the market value of bifurcated or distressed assets;
Redemption restrictions on the fund that are predicated on the bifurcated assets; and
Changes in the fund's policy and investment guidelines.
After reviewing the details of the bifurcation, we will analyze how these factors influence a rating. For example, if we believe a principle stability rated fund would pay less than a $1.00 per share NAV if the bifurcation were not executed, we would view it as commensurate with a distressed exchange and lower the issue rating to 'Dm' before raising it to a level that reflects the then-current ability to maintain principal value. This approach is consistent with our methodology regarding distressed exchanges outlined in "Rating Implications Of Exchange Offers And Similar Restructurings," published Jan. 28, 2009, on RatingsDirect).
Many of the recent market events have been temporary in nature and have been corrected by management. We will continue to evaluate severity, causes, effects, and remedies of events to determine whether rating changes are needed.
Analytic services provided by Standard & Poor's Ratings Services (Ratings Services) are the result of separate activities designed to preserve the independence and objectivity of ratings opinions. The credit ratings and observations contained herein are solely statements of opinion and not statements of fact or recommendations to purchase, hold, or sell any securities or make any other investment decisions. Accordingly, any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision. Ratings are based on information received by Ratings Services. Other divisions of Standard & Poor's may have information that is not available to Ratings Services. Standard & Poor's has established policies and procedures to maintain the confidentiality of non-public information received during the ratings process.
Ratings Services receives compensation for its ratings. Such compensation is normally paid either by the issuers of such securities or third parties participating in marketing the securities. While Standard & Poor's reserves the right to disseminate the rating, it receives no payment for doing so, except for subscriptions to its publications. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
