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

Secondary Market Derivative ProductsSecondary Market Derivative ProductsStandard & Poor’s Ratings Services rates secondarymarketderivative products, such as tax-exemptsynthetic floating rate receipts (synthetic floaters),including the tender option and residual interesttranches, principal and interest strips and auctionfloater/inverse floater trust receipts—all based onunderlying deposits of municipal obligations.The most frequently rated secondary marketderivative products are synthetic floaters createdby depositing fixed-rate municipal obligations intoa trust structure. Synthetic floaters with a tenderoption, which are similar to primary market variablerate demand obligations (VRDOs), are typicallysecured by a liquidity facility that providescoverage for unremarketed tendered receipts.Residual interest receipts are created as part of thesame synthetic floater structure, and do not have atender option.The interest paid to residual interest holders generallyequals the interest collected on the underlyingobligation, minus the interest rate payable to thesynthetic floater holders with the tender option andfees. In a strip structure, some or all of the interestpayments associated with a bond are stripped fromthe principal payments, and both are resold at adiscount from their face value to separate purchasers.An auction floater/inverse floater receiptstructure allows two classes of variable-rate receiptsto be created from a single deposit of underlyingfixed-rate bonds. One class of receipt bears intereston an auction basis, and the other captures theresidual interest from the underlying bonds.All secondary-market derivative securities areexamined according to the following three analyticalcategories:■ Custodial or trust analysis;■ Legal analysis; and■ Structural analysis.Custodial Or Trust AnalysisThe custodial or trust analysis concentrates on theproper transfer of the underlying assets to the custodianor trustee and their issuance as receipts. Thisanalysis is identical for all types of secondary-marketderivatives. The custodian or trustee should beclearly instructed to:■ Receive the underlying securities from the depositorfree and clear of any lien or encumbrance andensure that the deposit is irrevocable;■■■■Establish and maintain a separately designatedaccount for each issue;Ensure that the underlying bonds that aredeposited into the custody or trust account arenot commingled with any of its other assets;Ensure that no current or subsequent fees aretaken from payments due to holders,Transfer payments in a timely fashion to holders.Legal AnalysisThe legal analysis concentrates on bankruptcy andtaxability issues and is also identical for all secondary-marketderivatives. The following legal opinionsare requested and examined:■ True sale opinion, if requested; and■ Tax opinion stating that there is no tax at thetrust structure (entity) level for federal, state,and, in some cases, local purposes.In additional to relevant opinions, the structuremust also meet additional legal criteria regardingthe structure. (See “Legal Criteria For U.S.Structured Finance Transactions”).Structural AnalysisThe structural analysis is tailored to each specificderivative product and concentrates on the followingstructural features:■ The flow of funds from the underlying bonds tothe receipt holders;■ The various payment events associated with thestructure;■ Designated sources of payment for each paymentevent; and■ Compatibility of the trust and liquidity facilitytermination events with the rating to be assignedto the receipts.Tender Option Synthetic/Residual Interest Synthetic FloatersSynthetic floaters are variable-rate trust receipts evidencingdirect ownership interests in a deposit ofunderlying obligations. Such obligations generallyhave a fixed interest rate but can also bear interestat a variable rate. Obligations deposited into a synthetictrust can come from various municipal sectorsand come in a variety of forms, such as bonds,notes and leases, among others. After the deposit ofthe obligation into the trust structure, two classeswww.standardandpoors.com225