In a just-published "Credit FAQ piece, "What Effect Will The Certificate Of Deposit Accounts Registry Service Program Have On Fund Ratings?, S&P writes, "The recent market turmoil has prompted portfolio managers, investment managers, and treasury professionals to look for investments that add value without sacrificing yield or diversification. Recently, Standard & Poor's Ratings Services has received numerous inquiries regarding how we view the liquidity and credit quality of the Certificate of Deposit Accounts Registry Service (CDARS) program in regards to principal stability fund ratings (PSFRs), fund credit quality ratings (FCRs), and liquidity assessments."

The FAQ explains, "We have criteria regarding our assessment of certificates of deposit (CDs) and collateralized CDs for taxable and tax-exempt PSFRs, FCRs, and liquidity assessments.... Our responses to the following questions provide an indication of how we assess the risks of these securities in relation to our analysis of PSFRs, FCRs, and liquidity assessments. This Credit FAQ should be considered in conjunction with previously published criteria."

Among the Frequently Asked Questions are: "What is the CDARS program?" S&P says, "CDARS is a program offered by nearly 3,000 member financial institutions of the CDARS network and is designed to provide investors the benefit of Federal Deposit Insurance Corp. (FDIC) insurance for deposits up to $50 million. Generally, investors place large deposits with a member, who then places the investors' deposits into CDs issued by participating banks. CDs issued through CDARS generally are in amounts less than the FDIC insurance maximum so that each CD's principal and interest remains eligible for full FDIC insurance. Currently the FDIC insurance maximum is $250,000 per depositor through Dec. 31, 2013. After the extension date, the maximum amount is scheduled to return to $100,000 per depositor.... CDARS CDs' maturities generally range from four weeks to five years.... Typically, early breakage penalties exist and generally vary based on the CD's maturity."

They also ask, "How does Standard & Poor's treat noncollateralized CDs compared to CDARS CDs?" S&P answers, "In PSFRs and FCRs, noncollateralized CDs that do not qualify for FDIC insurance take on the same credit rating as was assigned to the issuing bank. Portfolio exposures no greater than 5% per issuing bank are consistent with our investment-grade PSFR criteria.... For both PSFRs and FCRs, to the extent the underlying deposits fall within FDIC coverage amounts, we classify CDARS equivalent to the U.S. sovereign credit rating. How does Standard & Poor's view the credit risk associated with CDs issued by CDARS? In our opinion, because CDARS-issued CDs are FDIC insured, we view the credit risk as equal to the U.S. government sovereign credit rating (currently 'AAA')."

Another question is, "How does Standard & Poor's view the liquidity risks associated with CDARS CDs?" S&P says, "In our opinion, potential areas of liquidity risk in CDARS CDs include: Inherent illiquidity: CDARS CDs are nonnegotiable, not DTC eligible, and are not traded in an active secondary market; Payment delays: When the FDIC has to make a payment on deposits, it pays the insured amount to the participating bank, and the participating bank pays the investors; Custodian bank failure: Another potential liquidity risk may occur where the investor's money is in the custody of a network member that has failed."

They also ask, "What other concerns does Standard & Poor's have regarding CDARS CDs?" The FAQ responds, "Early breakage penalties: CDARS CDs can have penalties from 50% to 100% of the interest due depending on the CDs' maturity. Typically, the earlier a CDARS CD is broken prior to maturity, the greater the penalty. Because the interest penalty owed may be unearned at the time of the early breakage, the assessed penalty may result in a loss of initial principal. Coverage under relevant guidelines: The FDIC insurance limits are not based solely on the CDARS CD amount, but rather on the total aggregate exposure of an individual investor at a participating bank. We would take into account how investors determine whether their aggregate deposits (including their CDARS CD exposures) are within FDIC insurance limits and CDARS guidelines."

S&P continues, "How will Standard & Poor's evaluate CDARS CDs given your PSFR criteria? We will evaluate CDARS CDs similar to the analysis for other highly rated, short-term instruments.... From a credit perspective, we deem CDs issued through CDARS to be 'AAA/A-1+' equivalent. CDARS CDs count toward our 10% limited liquidity/illiquid basket for PSFRs because these CDs are nonmarketable securities, may impose fees for early withdrawal, and may have a delay in receiving monies from FDIC insurance payments."

Finally, they ask, "How would Standard & Poor's evaluate similar FDIC products?" S&P says, "In evaluating other similar types of FDIC products, such as the Institutional Deposits Corp.'s Insured Deposit Liquidity Account and Insured Network Deposits, we would take a similar approach in applying our criteria to assess such pooled FDIC-insured accounts." Note that Crane Data has yet to see any CDARS or "pooled FDIC insurance" products appear in money market mutual funds, but that some less-regulated pools appear to be dabbling in the sector.

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