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

Housinginclude: trustee and servicer responsibilities andcompensation; legal provisions such as actions to betaken in the event of a mortgage loan default;redemption provisions and procedures governingmortgage loan advances; commencement of amortizationand final endorsement, to name a few.Project construction periodBond proceeds are deposited in the constructionfund on behalf of the issuer. Throughout the constructionperiod, the trustee authorizes mortgageloan advances to the mortgagor in accordance withthe building loan agreement. The trustee should disperseonly properly endorsed mortgage insuranceadvances. By restricting disbursements to amountsinsured by the FHA, the trustee is assured of havingsufficient high-quality assets to redeem all outstandingbonds, if necessary.During the construction period, the mortgagorowes interest at the construction loan rate on theportion of the mortgage loan principal that actuallyhas been advanced. Failure to make a monthlyinterest payment on the due date constitutes adefault under the mortgage note.Note amortization versus final endorsementStandard & Poor’s regards the commencement ofmortgage note amortization as the critical event inFHA-insured programs. Starting on this date, themortgagor’s obligation under the mortgage noteincludes repayment of principal, as well as intereston the mortgage loan.The bond indenture should state explicitly thedate that note amortization will commence, as setforth in the FHA firm commitment. The amortizationschedule should reflect the principal amount ofthe mortgage note as initially endorsed by the FHAunless modified by the agency at final endorsement.Standard & Poor’s evaluation of the adequacy ofmortgage revenues to meet bond debt service paymentsalso is predicated on these assumptions.Failure to begin amortization on the specified dateconstitutes a default under the mortgage. The bondindenture should instruct the trustee to initiate theassignment process if the mortgagor does not curesuch a default within the 30-day grace period.If an issuer permits extension of the commencementof note amortization, the following provisionsare necessary to simulate note amortization:■ The extension period is limited to a set period oftime. In no event may note amortization be extendedbeyond the date three months prior to expirationof the construction fund investment agreement,unless the investment agreement is extended or minimumreinvestment rates are assumed followinginvestment agreement expiration.■ The trustee receives cash flows provided by anindependent third party. Such cash flows shoulddemonstrate that sufficient revenues will be availableto (a) pay bond debt service for the term ofthe bonds as originally scheduled in the projectedcash flows; (b) pay all fees and expenses of thetrustee and mortgage servicer; and © pay allother fees and expenses incurred by the trusteeduring the extension period.■ If project revenues prove insufficient to satisfythe above cash flow projections, the trusteeshould receive cash or an unsecured LOC in theamount of the projected shortfall. The LOCshould come from an institution whose unsecuredlong-term debt is compatible with the ratingassigned to the bonds. Unqualified counsel opinionsare required for each kind of shortfall coverage:(a) if a revenue shortfall is covered by a cashcontribution or LOC, the trustee must receive anopinion of counsel stating that the contributionwould not be considered a preference under theprovisions of Section 547(b) of the BankruptcyCode; (b) in addition, the trustee should receivean opinion of counsel stating that the contributionwould not be subject to the automatic stayprovisions of Section 362(a) of the BankruptcyCode; and all opinions of counsel should be renderedby an attorney in the field of bankruptcywho is acceptable to the trustee.■ The trustee should conclude that extending thecommencement date of note amortization wouldnot adversely affect the bondholders or jeopardizethe FHA contract for mortgage insurance.Such extension also should not adversely affectthe tax-exempt status of the bonds. The indentureshould expressly state that extension of thedate for commencement of amortization is notpermitted if this is the case.The assignment processThe mortgagor is considered to be in monetarydefault if a scheduled mortgage note payment isnot received on the due date. Thirty days after thedue date, the trustee is entitled to institute theassignment process. If a mortgage note defaultoccurs prior to projected completion, the trusteefiles a claim for mortgage insurance benefits basedon the FHA’s initial endorsement of the mortgagenote. The FHA may process the claim in either oftwo ways:■ The FHA may require the trustee to turn overthe remaining construction fund balance. In thiscase, the FHA’s payment of benefits is based on252 Standard & Poor’s Public Finance Criteria 2007