A growing number of banks are managing mutual funds that invest in tax-exempt municipal bonds.

Standard & Poor's Corp. recently revised its guidelines for rating funds that invest in smaller issues. The following article was excepted from S & P's CreditWeek.

Standard & Poor's Corp. has expanded its tax-exempt fund ratings to accommodate funds that invest in unrated municipal paper and municipal paper with a single rating other than from S&P.

The municipal sector differs from other sectors in that for some funds, particularly single-state funds, much of the debt issued is either unrated or rated by a single nationally recognized statistical rating organization (NRSRO).

In assigning ratings to tax-exempt money market and bond funds, S&P has widened its analytical scope to factor in all such. ratings assigned to individual securities. This policy change allows S&P to take a broad-based portfolio approach in analyzing all tax-exempt mutual funds.

Credit Research

In order to rate tax-exempt mutual funds that hold securities S&P has not rated, S&P must be able to assess the funds' credit evaluation methods.

Therefore, in conjunction with all ratings assigned to tax-exempt funds (both current and future), S&P will conduct a detailed review of each fund's credit analysis procedures. This will entail an in-person meeting with each fund's credit research staff to examine its analytical practices, policies, and methodologies.

The examination will cover security evaluation, market analysis, security selection, asset dispersion, diversification, pricing, ongoing monitoring of credits, sources of secondary market information, response to distressed credit situations, resource dedication, and staff qualifications.

Included will be a review of credit files for specific securities in several sectors, to get a strong sense of the analytical process.

Where appropriate, S&P also will sample securities it has not rated to assess their credit quality using S&P's rating services and portfolio assessment service.

Discussion also will focus on the use of NRSRO ratings, any internal rating system used, and the process in which the fund's approved list of securities is presented to and reviewed by the fund's board of directors.

Additionally, secondary market factors - such as size of issues, liquidity, and marketability - will be examined.

Securities rated by nationally recognized organizations other than S&P are eligible investments in S&P-rated funds. Unrated securities also are eligible on a case-by-case basis.

S&P may discount ratings by other organizations based on where each security would likely be classified under S&P's rating scale.

In most cases, such a discount would involve no more than a one rating-category drop. But in some sectors, where S&P believes other organizations depart significantly from S&P's rating standards, discounts may be more than one category.

Generally, S&P will deem such a security to be of lesser quality if:

* The security is within a sector or category of municipal securities where there tend to be material differences in the ratings assigned to like securities by the various nationally recognized organizations, or

* The security is within a sector or category of municipal securities in which the organizationrating the security has limited market presence.

S&P's rating guidelines state that for a money market fund to be rated AAAm, at least 75% of the securities held by the fund should be rated either SP-1 or A1-plus (S&P level 1). The remainder of the securities should be rated SP-1 or Al (S&P level 2).

In considering other rating scales, S&P will make the following distinctions.

1. Securities not rated by S&P that have been assigned the highest short-term rating by another nationally recognized statistical rating organization typically will be considered S&P level 2, except as noted in items 2, 3 and 4 below.

2. Securities not rated by S&P that have been assigned the highest short-term rating by another nationally recognized organizations and have a longterm rating comparable to S&P's AA or better generally will be considered S&P level 1.

3. Securities not rated by S&P that have been assigned the highest short-term rating by another NRSRO by virtue of credit support from an entity rated A 1 - plus by S&P will be considered S&P level 1.

4. General-obligation debt not rated by S&P and issued by a municipality that has an SP1-plus short-term unsecured debt rating will be considered S&P level 1.

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