Standard & Poor's Corp. Friday announced a new program for identifying the underlying quality of securities carrying various forms of credit enhancement.
All enhanced issues already rated by Standard & Poor's -- whether municipal bonds with insurance or letters of credit, corporate bonds, asset-backed securities, or internationally issued structures -- will be eligible for an underlying rating at the request of investors and issuers.
For the program to work, however, the issuing entity must comply with the rating agency's normal assessment process, including surveillance, and pay an annual fee, according to William Chew, senior vice president in municipal finance at Standard & Poor's.
"We have to have issuer consent to provide it, since they are the chief source of ongoing information," Mr. Chew said. Some investor requests for underlying ratings, therefore, may go unfulfilled.
The program, entitled SPUR, is scheduled to issue several underlying ratings by the end of this month. Currently, many insured municipal bonds do not have underlying ratings from either Standard & Poor's or Moody's Investors Service.
Market demand for underlying ratings has swelled recently, in line with the general thirst for information while credit quality has been deteriorating. Mr. Chew said both issuers and investors -- particularly institutional traders -- have clamored for the SPUR service.
"The requests come most heavily where there's lots of volatility, such as health care," he said. "Issuers want the market to know they are double-A or single-A."
Asked whether issuers expect an interest-cost savings by having a strong underlying rating, Mr. Chew said that despite "different views" on the issue, "There's beginning to be consensus that there can be some savings."
Insured municipal bonds routinely trade well below the "natural" triple-A credits sold by issuers whose unadorned credit quality is considered the best. In fact, most insured bonds trade at the upper range of single-A bonds, according to several portfolio managers of insured bond funds.
Underlying ratings would assist analysts and traders in determining the complete credit picture of a municipal bond. Although bond insurers give 100% principal and interest protection to investors, professional traders exploit the minute differences in underlying credit quality when bargaining for a price.
One institutional bond trader said the underlying rating is more likely to be used by the seller than the buyer. With a hospital, for example, an underlying A-plus rating could be a "selling point," he said.
"They can say not only is it a good clean hospital that's insured, but it can stand on its own," said the trader, who asked not to be identified.
Another insured-bond trader maintained that very little trading differential exists between bonds backed by the major insurance companies, so there is scant room to strike a bargain. Also referring to hospital issues, he said the state of issuance is a more important factor than the underlying rating in eking out price gains.
"It's a state-by-state thing," this trader said. "The rarer the multistate name, the better it's going to trade. The state's exemption is the intrinsic part of [the value], not the underlying rating."
After receiving a request for the underlying rating, Standard & Poor's will publish the rating through its usual information conduits -- CreditWeek, CreditWire, and the Municipal Bond Book.