A new system of rating the market risk of derivative products suggests that municipal issuers are dabbling far less in highly leveraged securities than their corporate and mortgage-backed cousins.

Standard & Poor's Corp. unveiled its new "r" rating yesterday, saying it will be applied to deals with "hidden or unusually significant" market risks not reflected in the agency's standard ratings, which assess only credit risk.

Of the $22 billion of outstanding securities that the agency deemed risky enough to earn the new rating, just $93 million, or less than one-half of one percent, are municipals.

Of that figure, $45 million were derivatized in the secondary market, meaning the issuer had no say in the matter. Only one issuer got an "r" in primary market activity: New York City received the rating for derivative structures it applied to two primary market issues totaling $48 million.

Richard Larkin, a managing director at Standard & Poor's, said even those two issues were probably tailormade for investors who specifically asked for the characteristics the rating agency is now flagging as indicative of market risk.


In contrast to the municipal market's meager showing on the new Standard & Poor's list, corporate issuers saw $11.6 billion of bonds tagged with an "r," and players in the structured finance market earned the rating on $4.7 billion of issues.

About 800 transactions in all earned the "r," which stands for "risk."

Municipal derivatives professionals reacted with caution to the move by Standard & Poor's, saying that the additional analytical information would be welcomed as long as it is not misinterpreted as a sign of impending disaster.

Others expressed confusion about the criteria used to select the 11 municipal deals that made the list, arguing that some even more highly leveraged transactions appear to have escaped detection at the agency.

Larkin said that might be because the agency's search through its outstanding issue list was complicated by the fact that many leveraged transactions were sold as portions of larger bond issues, and not separately identified as derivatives. He said if additional deals come to the attention of the agency that warrant an "r" rating, it will be assigned.

In a statement announcing the move, Standard & Poor's said the "r" symbol will be attached to "derivative, hybrid and certain other obligations that S&P believes may experience high volatility or high variability in expected returns due to noncredit risks created by the terms of the obligation."

Examples offered include securities whose principal or interest return is indexed to equities, commodities, or currencies; certain swaps and options; and interest-only and principal-only mortgage securities, because of the "extreme variability" caused by mortgage prepayments.

The agency said securities will be added or deleted from the list based largely on investor understanding of a particular structure. Derivatives that the market widely understands and accepts -- swaps keyed to common market indexes like the London interbank offered rate, for example -- will not be assigned an "r," Standard & Poor's said.

Leo C. O'Neill, president of Standard & Poor's, said the agency developed the new rating because it feared investors, especially on the retail side, might be lulled into a "false sense of security" by high credit ratings and fail to take into account that even triple-A securities can carry high levels of market risk. The agency is working on a method of quantifying the risk, O'Neill added, rather than simply flagging every transaction involved with the same "r" rating.

Standard & Poor's said that securities designated with an "r" symbol should not be interpreted as an "unacceptable investment."

Standard & Poor's "is simply saying that they carry risks other than credit risk that need to be examined as part of the investor decision-making process," the rating agency's statement said.

Fitch Investors Service has a similar system in place to highlight market risk on collateralized mortgage obligations, municipal derivatives, and certain mutual funds.

Moody's Investors Service could not be reached for comment yesterday.

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