S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Appropriation-Backed Obligationsand the rating assignment will be determined by thecredit characteristics of the pledged revenue source,not the appropriation risk.Maintenance and insuranceThe government obligor should agree to maintainthe financed property in good repair and to insureit against loss or damage in an amount at leastequal to the purchase option value or replacementcost, whether or not repair and replacement aremandated by the agreement. If the payments aresubject to abatement in the event the property isdamaged, destroyed, or taken under a provision ofeminent domain, the government obligor mustmaintain business interruption insurance for at least24 months. Where applicable, special hazard insurancecoverage is required unless the financed facilitypasses Standard & Poor’s natural hazard test.Self-insurance for property damage risks is permitted.Adequate reserve levels must be maintainedand reviewed annually by an independent consultantor professional risk manager. Annual notificationto the trustee that reserve levels are adequatemust be made. Self-insurance is not an acceptablealternative to commercial coverage for earthquakerisk when the government obligor’s obligation islimited only to self-insurance reserves and does notextend to the municipality’s general resources.Debt-service reserve fundA debt service reserve equal to maximum semiannualdebt service or three months’ advanced (andunconditional) funding of debt service, or an equivalentcombination of reserves and advance funding,may be beneficial on leases and service contractsthat provide for abatement for lost use of propertyowing to damage or destruction, or to those instrumentswhere late budget passage risk exists. Inaddition, no debt service reserve is allowable if bothlease or service contract payments and debt servicepayments are not due until three months haveelapsed in the government’s fiscal year, once againallowing for the possibility of late budget adoption.Lessor features and bankruptcy riskMost appropriation-backed obligation transactionsrated by Standard & Poor’s are between a governmentalobligor and a non-profit public benefit corporation,as lessor, which has been establishedspecifically for the purposes of the lease transaction.These lessors, typically, are filers under Chapter 9 ofthe U.S. bankruptcy code and are considered bankruptcyremote. Alternative arrangements include:■ For lessors not judged to be bankruptcy remote,there must be a sale and absolute assignment bythe lessor of lease rental payments to the trustee,thereby ensuring timely payment to the bondholdersif the lessor becomes insolvent. Theassignment should be accompanied by a legalopinion stating that as a result of the assignment,bankruptcy of the lessor would not cause thelease and lease payments to be considered propertyof the lessor’s estate. The automatic stay provisionsof the bankruptcy code should not applyand therefore would not cause an interruption ofrental payments to the bond trustee.■ Insolvency-proofing the lessor is an alternativeapproach. The lessor should be set up as a singlepurposeentity (SPE) that is prohibited fromengaging in any business—other than owning therated project—and from incurring additionaldebt, unless it is rated at least as high as theStandard & Poor’s rated lease-secured debt.Furthermore, the SPE may not sell the projectexcept to another entity that meets these criteriaunless Standard & Poor’s rates the entity’s seniordebt at least as high as the lease obligation. Theseprovisions should appear in the lessor’s partnershipagreement or articles of incorporation and inthe trust indenture. Please refer to Standard &Poor’s criteria on SPEs for more detailConstruction riskConstruction risk is present in virtually all publicfinance transactions, but it typically introduces creditrisk only in those transactions where debt service paymentis contingent on project completion and/oracceptance. In those state’s where such a risk is present,Standard & Poor’s will perform a constructionanalysis for all issues where completion of the project,that is securing the lease payments, is required priorto the commencement of rental payments supportedby appropriated funds. For further clarification referto Public Finance Criteria: Assessing ConstructionRisk in Public Finance.Special considerations for vendor leasesVendor equipment and developer office leasesreceive further scrutiny in the rating processbecause the municipal lessee is not the party primarilyresponsible for the sale of securities. It is oftenthe vendors and/or developers that have a greaterinterest in the actual debt financing. Therefore,Standard & Poor’s closely assesses the followingareas in determining appropriation risk:■ Government support: Are the appropriate highlevelgovernmental officials supportive of thelease project, the lease provisions, and the saleof securities?■ Essentiality: Is the vendor equipment or developerlease essential? Making the case that essentiality ishigh for developer-owned office leases is also morewww.standardandpoors.com105