DBRS Rates Merrill Lynch Derivative Products AG at AAA

Dominion Bond Rating Service (DBRS) has today assigned a rating of AAA to Merrill Lynch Derivative Products AG’s (MLDP or the Company) Counterparty Obligations. The trend is Stable.

The assigned rating is predicated upon the capital requirements, organizational structure and framework for operations defined in the Intermediation and Security Agreement (the Agreement) made among MLDP, Merrill Lynch Capital Services, Inc. and Merrill Lynch Capital Markets Bank Limited (collectively, the Originators). The rating places particular importance on several key strengths, including the following:

(1) Transaction/counterparty eligibility: MLDP is permitted to act as an intermediary for swap transactions between the Originators and their counterparties. While MLDP can enter into traditional swap transactions, the majority of transactions it is involved in are actually Termination Swaption/Guarantee Transactions, for which MLDP is responsible for being able to pay a fixed amount to the counterparty. MLDP’s responsibility for fixed payment amounts on most of its swap transactions eliminates much of the risk from the portfolio in terms of funding adequacy. Additionally, there are considerable limitations on the ability of MLDP to transact with non-investment-grade counterparties, and, more generally, the Company does not typically enter transactions with counterparties rated lower than an A (low) equivalent. While MLDP has the flexibility to work with counterparties that qualify as “unrated”, exposure to such entities is limited to no greater than 4% to 10% of the aggregate notional principal amount of all swap transactions depending on portfolio size.

(2) Collateral/capital formulae: The formula is calculated on a daily basis and takes into account payment obligations under the Swaption/Guarantee Transactions, as well as the market value of MLDP’s outstanding swap transactions based on certain formulae. DBRS believes that the formula used to determine collateral requirements is adequate for determining requirements based on MLDP’s swap portfolio at any given time, as well as being able to capture any developing market conditions to adjust collateral requirements when appropriate. Similarly, the capital requirement is actually the most conservative of three different calculations – a ratings-based concentration test, as well as ten-year and 30-year simulations of a proprietary capital adequacy model. Moreover, minimum stated capital is $300 million, and should the long-term rating of Merrill Lynch & Co., Inc. (ML) drop lower than three categories above investment grade, then MLDP must ensure that there is a capital cushion of 20% above what the capital formula indicates is required. Notwithstanding these measures, the adequacy calculations are based on volatility assumptions and marked-to-market valuations to determine termination payments. MLDP typically carries both excess capital and collateral.

(3) Liquidity: In addition to capital and collateral requirements, MLDP also ensures on a daily basis that it has adequate liquidity to ensure that it can meet all payment requirements over the subsequent 90 business days to ensure obligations would be met without difficulty during periods of manager transition.

(4) Operational control/processes: In concert with the various calculations monitored daily, MLDP is forbidden from entering into new transactions if any deficiencies are not cured within the allotted period (typically one day). Moreover, MLDP typically holds more capital (excess capital) than is calculated. Finally, uncured deficiencies trigger the management period, during which the designated contingent manager is responsible for overseeing the successful fulfilment of all existing payment obligations.

(5) Contingent manager agreement: MLDP is required to have a contingent manager agreement in place at all times, with the contingent manager becoming instrumental once ML no longer holds investment-grade ratings. At that point, the contingent manager would shadow all activities conducted by MLDP during a pre-management phase in preparation for assuming full administrative responsibility should the management phase be triggered by an uncured capital deficiency, other event of early termination or ML insolvency.

(6) Importance to ML business: MLDP has proven to be an important part of ML’s business mix. Having a AAA-rated vehicle to act as a swap intermediary where required helps ML earn business it perhaps would otherwise forego. The primary cost to ML and the Originators remains the allocation of capital to MLDP.

Note:
All figures are in U.S. dollars unless otherwise noted.