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

Municipal Structured FinanceLOC could be terminated without any change tothe rating of the bonds.Single-draw confirmationSome confirmation LOCs have no terms for reinstatement.They are available only for a singledraw. Upon any wrongful dishonor or repudiationof the facing LOC, the trustee must be instructed todraw for the full stated amount of the confirmationLOC and redeem or accelerate the bonds.Sources of paymentIn a LOC-backed transaction, the trustee isinstructed to make payment of principal, interest,premium, and purchase price in accordance withthe prioritized list of sources of payment. In additionto the facing LOC as a source of payment, thetrustee must also be specifically instructed to usethe confirmation LOC as a source of payment.Timeliness of LOC drawsIt is important to synchronize the trustee’s drawinstructions under the bond indenture with the paymentterms of the facing LOC and the confirmationLOC to ensure that each credit facility is drawn onto provide full and timely payment. In the case ofbonds supported by both a facing and a confirmationLOC, the trustee’s draw instructions mustleave sufficient time to draw on the confirmationLOC in order to provide full and timely paymentupon the wrongful dishonor or repudiation of thefacing LOC.Draw proceduresTerms of a confirmation LOC include the proceduresfor the trustee to properly conduct a draw.The terms must allow draws under any circumstanceof facing LOC repudiation or wrongful dishonor.In addition, the confirmation LOC shouldnot require the trustee to represent the drafts of thedishonored draw on the facing bank as a conditionof honoring a draw on the confirmation LOC. Thisenables the trustee to draw on the confirmationLOC following bank insolvency even if either thefacing LOC is repudiated before it is drawn on, orthe dishonored drafts are not properly returned tothe trustee.Preference concernsA key question about confirmation LOC structuresis whether or not, subsequent to a fronting bankinsolvency, the FDIC as receiver could recover paymentsmade to bondholders by the trustee that werederived from a draw on the facing LOC. This concernis based on the theory that the payments eitherwere not made in the ordinary course of business ofthe bank, were made in the preference of one creditorover another, or were made to prevent theapplication of the bank’s assets in the manner prescribedby the National Banking Act.In a January 1991 statement, the FDIC addressedthis concern by stating that, in its view, a courtwould hold that the FDIC, as receiver or conservator,could not recover payments made to bondholdersfrom the trustees draw under the facing LOC.Based upon this statement, Standard & Poor’s doesnot have additional preference concerns for U.S.confirmation LOC structures beyond those evidentwithin other fully credit-enhanced structures.If the fronting bank is a non-U.S. bank,Standard & Poor’s will research the possibility ofwhether payments from the fronting LOC bankcould be disgorged under the bankruptcy law ofthat country. If there is such a possibility, a solutioncould be that upon the fronting bank’s insolvency,the trustee will no longer draw on that LOC, butrather, will directly draw upon the confirmationLOC to avoid this preference concern.LOC-Backed Commercial PaperStandard & Poor’s also rates municipal commercialpaper (CP) programs secured by LOCs. With adirect-pay LOC, a depositary draws for the entireprincipal of and accrued interest on the CP notes atmaturity. The proceeds from the sale of new CPnotes are used to reimburse the bank for the drawon the LOC.In a CP program, the depositary usually acts asissuing and paying agent. The depositary issues,authenticates, and delivers new CP notes on theissuer’s instructions. It also pays the notes at maturityand ceases CP note issuance at the issuer’s andLOC bank’s requests. To ensure adequate LOC coverage,the depositary determines that the amount ofany new CP plus the amount of outstanding CPdoes not exceed the LOC commitment. Typically,the CP notes mature within 270 days and, in anyevent, no later than the 15th day prior to LOCexpiration. The bank is obligated to honor drawsto pay principal and interest on all CP notes untilthey mature, despite any early termination of itsagreement with the issuer.The depositary’s authority to issue CP can berevoked temporarily or permanently by the issueror the bank. In such a case, the depositor may notissue any new CP, and the LOC must continue tosupport all outstanding CP. If the bank gives acease issuance order, only the bank can rescind suchinstruction.In the event that the LOC provides for an earlytermination of the bank’s commitment, based on anevent of default under the reimbursement agreement,the bank immediately notifies the depositaryof the default and instructs the depositary to cease216 Standard & Poor’s Public Finance Criteria 2007