Ratings

Authorizing legislation for a GSE is reviewed thoroughly. If the GSE is newly created, the congressional conference report may be reviewed as it provides history and background on the structure and function of the GSE. The conference report can provide insight into purpose, the service provided, and the method of providing it.

If the GSE has existed for some time, the authorizing legislation and all amendments are studied. Business lines or operations may be adjusted over time, making a review of amendments and any legislative history critical for a full understanding. Standard & Poor's may also review other government-related information, such as related legislation or regulations, congressional oversight hearings, and reports by the General Accounting Office, the Congressional Budget Office, or other governmental entities.

Finally, Standard & Poor's prefers to meet with members or staff of congressional committees with jurisdiction over the GSE. This provides a clearer understanding of the legislative process, current legislative initiatives, and the relationship between the GSE and Congress.

Congressional legislation creating the GSE is a statement that a public purpose is being served. When financial assistance is provided, it can take differing forms. Support can be:

• Direct financial, as in a line of credit with the U.S. Treasury or annual congressional appropriations. It can also take the form of separate legislation that provides financial relief as in the legislation in the late 1980s that created the Financial Assistance Corp. to issue government-backed debt to assist the then-financially troubled Farm Credit System; or
• Indirect financial, as in the ability to issue debt exempt from Securities & Exchange Commission (SEC) registration, eligibility for national bank repurchase agreements (repos) without reserve requirements and other favored treatments in the securities markets. These benefits, along with others listed in the authorizing legislation, characterize "agency status" for the debt and other securities, which allows access to the private capital markets worldwide at yields below high-grade corporate debt.

Ongoing federal support for a GSE can be shown through devices such as annual appropriations from Congress or the ability to borrow from the Federal Financing Bank. If there are appropriated funds, a review of appropriation requests and actual funding is important.

Historical statements or examples of federal commitment are important. For example, the legislation providing for financial assistance to the Farm Credit System in the late 1980s showed that Congress was ready to stand behind that entity. And, more recently in 1994, as the initial proposal to privatize Sallie Mae was being discussed, a letter from the Secretaries of Education and Treasury stated that any program developed "must maintain the GSE's financial safety and soundness." If such statements are lacking, the political atmosphere in the executive and legislative branches would be further evaluated.

Congress established the GSEs for a public purpose, and the federal government has since supported them in their mission. While the business plans, operations, and financial position are analyzed, the issue-specific debt ratings are based on the support of the legislative and executive branches of the federal government. Actions of Congress and the executive branch relating to the safety and soundness of the GSEs, especially over the past decade, have enhanced interest in the underlying business fundamentals.

In its business analysis of GSE securities, Standard & Poor's looks for such things as prudent business practices and providing services as efficiently as possible within the GSE's public purpose. An analysis of financial statements, business lines, and policies is extremely important. These factors determine whether any financial support from the U.S. government may be needed, the nature of the support, and the willingness of Congress or the executive branch to provide it.

After a thorough review of documentation, Standard & Poor's usually meets with management. The meeting provides a more detailed understanding of the GSE's business and policies and the ties to the federal government. Management analysis includes an understanding of management's relationship with its authorizing or other appropriate committees in Congress.

Historically, the weaker the GSE is on its own financial terms, the stronger the government support tends to be. But this may not always continue. Because the analysis of these specific GSE securities depends so heavily on the links to the federal government, any change or weakening of federal support would need to be carefully reviewed.

An agency of the U.S. government performs a function for the government. For example, departments of the executive branch, such as State, Treasury, Labor, and Housing & Urban Development, are examples of agencies of the federal government. However, certain U.S. government-related entities, such as GSEs, are not agencies.

The term agency, when used with federally related entities, is not entirely accurate, but is derived from references in authorizing legislation. Characteristics of debt and mortgage-backed securities issues from GSEs can be similar to those of federal government securities.

Agency status applies to characteristics listed in legislation or regulation that allow certain securities of federal government-related entities to enter the market with attributes of U.S. government securities. Major elements are:

• Exempt from SEC registration (see government security);
• Legal for investment by U.S. financial institutions, such as national banks, savings and loans, and credit unions;
• Issued and payable through the Federal Reserve;
• Eligible to be purchased and held by U.S. national banks without limitations; and
• Exempt from U.S. state and local taxes.

Included in the definition of agency status can be access to funds through the U.S. Treasury and a requirement that Treasury approve issuance. These attributes basically provide incentives for certain financial institutions, such as commercial banks, to purchase them.

Agency status affects the issuer's cost of funds. Yields tend to be lower than those for comparable corporate securities, in part because these securities are perceived as being of high quality and are attractive for purchase by a broad investor base, increasing demand and thus driving down cost of funds.

While agency status for securities is important, it is only one element that Standard & Poor's reviews when assigning an issue-specific rating or assessment.

Authorizing legislation enacted by the U.S. Congress and signed into law by the President creates an entity to serve a public purpose. The authorizing legislation defines the business lines of the entity, its powers, and its ability to issue debt, as well as the governing body, which usually is a board of directors. The legislation can specify a certain number of Presidential appointees to the board of directors and can also define the capital structure. The entity can only operate within the scope of its authorizing legislation.

To date, entities created have been monoline in nature. That means the entity cannot decide to diversify into other businesses on its own accord, even if economic conditions warrant. It can, however, build expertise within its legislatively defined area.

Full faith and credit, when used with U.S. government securities, is an explicit obligation to which the full tax and other revenues of the federal government are pledged to the payment of that obligation. A full faith and credit pledge does not always mean timely payment of principal and interest or protection against a call of that security by the issuer. The federal government is only committed to pay under the terms and conditions of the offering or the guarantee. Thus, it is important to read the specific terms under which the government has pledged its full faith and credit.

Government-chartered corporations are corporate entities organized (chartered) under U.S. federal law. The enabling statute determines the rights and powers of government-chartered corporations at the federal level. The term government- or federally chartered corporation can also apply to GSEs and instrumentalities (see Instrumentality).

The term government security is often associated with exemptions under the Securities Exchange Act of 1934. Included are:

• Direct obligations of, or obligations guaranteed as to principal or interest by, the U.S.;
• Securities issued or guaranteed by corporations that are designated by the Secretary of the Treasury for exemption where there is a public interest; and
• Securities issued by or guaranteed by any corporation that are specifically exempted by Congress in a federal statute.

Securities that qualify as government securities are issued or guaranteed by more than 15 different entities/agencies of the U.S. government and corporations created by acts of Congress. Some government securities are backed by the full faith and credit of the U.S., and some are not.

The term government-sponsored enterprise (GSE) has been used to describe certain off-budget entities created by the U.S. Congress. Existing GSE securities do not have the explicit full faith and credit support of the U.S. government. Entities usually referred to as GSEs are not included in the federal budget. The group of entities normally identified as GSEs are:

• Federal Farm Credit Banks;
• Federal Home Loan Banks;
• Federal Home Loan Mortgage Corp. (Freddie Mac);
• Federal National Mortgage Association (Fannie Mae); and
• Student Loan Marketing Association (Sallie Mae).

In 1996, Congress passed legislation that provided for the privatization of Sallie Mae. However, that legislation maintains the legal status of Sallie Mae's GSE debt.

Standard & Poor's uses the same criteria to evaluate the securities of the GSEs listed above, as well as those of the Financing Corp (FICO), Resolution Funding Corp (REFCORP) and the Tennessee Valley Authority (TVA).

Implicit government support describes the view that the federal government will support an entity financially if it encounters difficulties, even though there is no legal obligation to do so. It is this belief among investors that allows a federally related entity continued access to the capital markets when it is in serious financial difficulty. Elements of the authorizing legislation, ability to issue securities with the characteristics known as agency status, congressional oversight hearings, U.S. General Accounting Office reports, and votes and statements by Congress all provide information important to Standard & Poor's in making a decision on the level of implicit support. This view is strengthened by the fact that the federal government historically has provided financial assistance when needed.

An instrumentality is an entity through which the federal government carries out some of its functions. For example, the Federal Home Loan Banks are described as U.S. instrumentalities. Federal entities that serve a government purpose and are not agencies are generally referred to as instrumentalities.

Risk to the government refers to the inherent default risk of a federally related entity operating under its authorizing legislation, but without assuming an infusion of cash by the federal government. In evaluating the risk to the government, it is the underlying or inherent credit quality of the entity that is reviewed.

Risk to the investor refers to the risk of a delayed or missed payment of principal and interest, when due, to investors of securities issued by certain federally related entities and rated or assessed by Standard & Poor's. Certain securities are backed by the full faith and credit of the U.S. For others, it is the strength of links between the entity and the federal government and implicit government support that lead to the ultimate determination of whether the federal government is likely to support these securities, even though it has no legal obligation to.

The term wholly owned government corporation refers to a corporation created by Congress whose equity is entirely held by the U.S. government. The Government National Mortgage Association (Ginnie Mae) and the TVA are examples of wholly owned government corporations.