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

Forward Purchase Contracts And ‘AAA’ Defeased BondsForward PurchaseContracts And ‘AAA’ Defeased BondsStandard & Poor’s Ratings Services reviews forwardpurchase contracts (FPCs) in conjunction withnewly refunded bonds and outstanding ‘AAA’ ratedrefunded bonds. The FPC analysis involves a reviewof legal structure and the sufficiency and credit qualityof the assets placed in escrow. As with traditionalrefunded bonds, in order to provide a rating on anescrow that is accompanied by a FPC, Standard &Poor’s relies on counsel, escrow agents, accountants,and other experts and advisors for accuracy and completenessof the information provided.FPCs involve the sale by the issuer of its residualearnings from an escrow to a third party, theFPC provider, who receives an economic benefitbased on the nature of the residual interest purchased.The issuer receives a purchase price fromthe FPC provider that generally is equal to thepresent value of the future reinvestment income.The residual rights sold to the FPC provider (theseller) may include:■ The issuer’s right to receive excess reinvestmentincome, if any, after the payment of debt serviceon the bonds;■ The issuer’s right to direct the reinvestment ofmaturing proceeds of the initial escrowed securities;and■ The issuer’s right to substitute the reinvestedsecurities held by the escrow agent in the escrowfund.Many outstanding escrow agreements are silentwith respect to an issuer entering into an FPC subsequentto the escrow’s closing date and frequently,FPCs are executed afterwards. Because FPCs arenot considered eligible investments for ratedescrows, Standard & Poor’s believes that theescrow agreement should be amended to providefor the subsequent execution of the FPC. We wouldalso expect counsel to consider whether bondholderapproval should be obtained before the escrowagent enters into a FPC.FPC Rating CriteriaTo obtain a ‘AAA’ rating on an escrow that has aFPC, Standard & Poor’s first looks for compliancewith our defeasance criteria (see “Public FinanceCriteria: Defeasance”). Additionally, since the FPCprovider is purchasing the residual interest in theescrow account, Standard & Poor’s determineswhether such interest would cause the escrowedfunds to be affected by a potential insolvency of theFPC provider.FPC analysisStandard & Poor’s examines whether the FPC or theescrow agreement include the following provisions:■ The decision to purchase the newly deliveredsecurities from the FPC provider should be at theescrow agent’s option and, in general, at thedirection of the issuer.■ The FPC provider should have no right to substituteany of the initial escrow securities prior totheir maturity. After the maturity of the initialsecurities, to the extent that the FPC providerdelivers to the escrow agent new securities pursuantto the FPC, the FPC provider may retainthe right to deliver substitute securities withlonger maturities providing those newly deliveredsecurities mature on or before the next bond paymentdate. Because the initial escrow securitiesmatured in accordance with the terms of theescrow (and the original verification report), thedelivery of the new securities does not require anew verification report as the original escrowstructure presumed no investment earnings afterthe initial escrowed securities matured.■ The FPC or the escrow agreement should providefor independent accounting firm verification of thesufficiency of the escrow funds prior to any withdrawalof monies from the escrow. This shouldnot be confused with substituting securities providedpursuant to the FPC, which does not require anew verification report. The documents shouldmake provisions for, or reserve for, the cost ofthese additional verification reports, if applicable.■ The escrow agent should not be permitted toaccept any newly delivered securities from anotherFPC provider unless the FPC has been transferredto that provider and evaluated byStandard & Poor’s as evidenced by written confirmationof the rating of the escrow.■ The FPC provider or any subsequent FPCprovider, if applicable, has no lien or claimwww.standardandpoors.com223