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

Municipal Structured FinanceInterestpayment due12/1nonreinstatement of interest coverage at the latestpossible date under the terms of the LOC. Thetrustee then accelerates the issue, and interest ceasesto accrue at the latest date in accordance with theindenture. Standard & Poor’s calculation of interestcoverage also considers delays in notices or paymentscaused by nonbusiness days. The timeline isan example of Standard & Poor’s calculation ofminimum interest coverage for a direct-pay LOCtransaction. Assume the following structure:■ Interest is paid on the first business day of eachmonth, based on a 365-day year.■ LOC interest coverage automatically reinstateson the tenth business day following a draw,unless the trustee is notified of nonreinstatement.■ If the trustee is notified of nonreinstatement, itwill immediately accelerate the bonds.■ Interest ceases to accrue upon the date of declarationof acceleration.If the trustee is paying interest for the month ofDecember, interest will be due on the first businessday of January. If Jan. 1 is a Friday, then onMonday, Jan. 4, the trustee will draw on the LOCand pay 31 days of interest. The LOC bank cansend notice of nonreinstatement as much as 10business days later. Since Saturdays, Sundays, andholidays are nonbusiness days, notice of nonreinstatementcould come as late as Tuesday, Jan. 19.The trustee would accelerate the bonds, and interestwould cease to accrue that day. Therefore, 19 daysof interest would have accrued in January. In additionto the 31 days of interest from December, thetotal minimum interest coverage would be 50 days.Note that if interest does not cease to accrue uponthe date of the declaration of acceleration, additionalcoverage will be needed. Additional coveragemay also be needed if there is a longer accrual periodbetween the bond closing date and the firstInterest Accrual ScenarioInterestpaymentdue(not abusinessday)Fri.1/1Interestpaid fordecemberMon.1/431 days accrued 19 days accrued50 days total interest accrualMLK Jr.holidayMon.1/18Notice of nonreinstatementreceived(acceleration)Tues.1/19interest payment date on the bonds (for example ifthe bonds closed on Nov. 20 and the first interestpayment date was Jan. 4).In standby LOCs, where nonpreference-proofmoney is the first source of payment to the bondholder,the worst-case scenario also includes theconsequences of the borrower’s bankruptcy. Inaddition to coverage for accrued interest, the LOCmust also cover the maximum amount of interestthat can be disgorged from bondholders if it weredeemed a preferential transfer. Most transactions ofthis type have individual features. The factors toconsider in calculation of interest coverage are:■ Schedule of loan payments;■ Timing of notice of bankruptcy;■ Events of default;■ Grace periods;■ Acceleration schedule; and■ Applicable preference period.Note that the LOC’s stated expiration termsshould take into account the applicable preferenceperiod as well.Tender ProcessStandard & Poor’s applies a similar analysis to thepayment of purchase price as it does in assessing thelikelihood of full and timely payment of regularlyscheduled principal and interest. If remarketing proceedsare the first source of funds to be used for tendersand LOC funds are the second, the trusteeshould be instructed to draw on the LOC in anamount equal to the total purchase price due to tenderingbondholders, less the amount of the remarketingproceeds on deposit prior to the draw timedeadline established in the LOC. It is important thatthe trustee only consider proceeds actually ondeposit, as opposed to proceeds that are expected tobe received. If the trustee were to draw on the LOCon the basis of expected proceeds and any expectedremarketings were to fail, a shortfall in total fundsavailable to pay tendering bondholders would jeopardizethe timeliness of payment. In most instances,it would be too late to make a second draw on theLOC to make up the shortfall and still make timelypayment of purchase price. Alternatively, there canbe reliance on expected proceeds if the remarketingagent provides an unconditional commitment todeliver remarketing proceeds by the time necessaryto pay tendering bondholders regardless of whetheror not expected remarketings are successful.Since the tender process often involves severaldifferent parties (trustee, tender agent, remarketingagent), proper coordination of the flow of informationand funds among the various participants isnecessary to ensure full and timely payment of purchaseprice to bondholders. As a result, the analysis212 Standard & Poor’s Public Finance Criteria 2007