S&P revised their proposed criteria, most notably by applying strict leverage limits to only the AAA rating category. The limit imposes a 75:1 maximum ration to all credits, while original proposition included a dichotomy between structured finance at 20:1 and municipal credits at the now-adopted 75:1. While this uniformity concedes that a hard cap should consider the most-credit worthy insured portfolio (as The Dragon advised), the level of the limit is debatable.
The nature of the risk premium shows that the leverage ratio for bond insurers should be substantially higher than banks of equivalent creditworthiness as pointed out here and exemplified here. The exact level is admittedly part art, making an outright condemnation of S&P's limit difficult. However within the realm of what S&P had been considering, the rating agency certainly took the right path.
The wording of some of the modifiers and tests such as the capital adequacy model suggests S&P opened the criteria to more discretion of its analysts, another point for which we argued. The overall construction of the model still resembles a Rube Goldberg project, but less rickety. This is worse news for the future accuracy of S&P's model than for the guarantors. Having a rigid model allows the guarantors to game the system. For starts, lower credits and and stop-loss structures just became more attractive, especially for guarantor's seeking a AAA rating and on large and structured finance credits where expected recoveries are lower.
For all intensive purposes, this is really only immediately applicable to Assured Guaranty.
That explains why Assured made some convincing points regarding the recovery strength unique to guarantors which S&P applied. Given recent events in put-back litigation, its shocking that similar adjustments aren't made on the structured finance side. To S&P's credit, neither The Dragon nor Assured called for such adjustments. Then again, there were greater concerns.
There are other disappointments. For example:
-Investing in self-insured obligations considered a negative after low hurdle is met despite no additional credit risk taken on.
-Applying higher that expected stress losses to largest obligors test that contemplates "benign" environment.
-Largest obligors test measured across ratings categories and not sub-sector.
Nonetheless, this model is a drastic improvement and we applaud S&P for addressing areas of concern. Assured made a non-committal press release after the model was announced (and their stock shot up over 10%). While we are not going to rebuild the capital adequacy model, Assured's business risk profile is likely to be the top score given the industry score (of 2, second best) and the guarantor's being the best positioned in the industry. The business risk profile is determined by a matrix of industry score and competitive position.
Furthermore, the company's operating performance, management, financial flexibility, and liquidity scores should be the best in the industry. Even if Assured scored the worst possible - a 6 - on capital adequacy, it could reach the top half of scores with modifications from those other modifying scores. Given a top business risk profile, Assured would have to score in the bottom half of the financial risk profile score to fall out of the AA category. That should not be the case and - without actually applying many of the metrics - we'll bet it will not be the case.