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

HousingTo avoid this structural risk, liquidity events suchas mandatory or optional tenders should be scheduledto precede the termination of the liquidity portionof the direct-pay instrument.Fannie Mae and Freddie Mac direct-pay structuresmay include a mandatory tender upon substitutionof an alternate credit facility without ratingmaintenance. This substitution could be problematicin the fixed-rate mode if the liquidity support hasexpired. To resolve this issue, the documents can:■ Limit substitution to the variable-rate modes;■ Provide that the credit facility portion or a liquidityfacility portion will be available to back thetender;■ Indicate that credit facility expiration leads to aredemption; or■ Indicate that substitution can only occur ifremarketing proceeds equal to the full purchaseprice of the bonds are to be on hand for the substitutionto occur, otherwise the credit facilitywill remain in effect or there will be a redemptionof the bonds if the credit facility is scheduledto expire.These suggestions resolve Standard & Poor’s liquidityconcerns that could negatively affect bondholders.Standard & Poor’s will continue toevaluate the direct-pay structure and legal documentsto ensure the necessary provisions are inplace to address this issue.Standby Credit FacilitiesFannie Mae and Freddie Mac provide another typeof credit enhancement on bond issues in the form ofa standby credit facility. In this structure, the GSE isobligated to make payments to the trustee in theamount of the mortgage payment once the paymentis a specified number of days delinquent. Since theGSE agreement does not cover investment earnings,all revenues must be invested in investments rated ashigh as the bonds. In addition, payment of trusteefees must be provided for in a no-default and postdefaultsituation. Similar to the cash flows requiredfor MBS as described below, standby credit facilitytransactions should include cash flows run with alag to take into account the timing of the GSE’s paymentto the trustee, as well as the regular paymentlag on the underlying project mortgage.Ginnie Mae ProgramsUnder the FHA (223)(f) Ginnie Mae coinsuranceprogram, used for rehabilitation and repair of existingmultifamily dwellings, the owner completes thenecessary repairs permitting the issuance of theMBS and obtains a mortgage loan on the projectfrom the lender. At this time, bond proceeds, heldin an acquisition fund by the trustee, are used toacquire the MBS. The Ginnie Mae security securingthe mortgage is assigned to the trustee.The Section 221 (d)(3) and (d)(4) programs (constructionand substantial rehabilitation) and Section232 program (nursing homes) are similar to the 223(f) program, where all bond proceeds are escroweduntil the permanent Ginnie Mae-backed security isacquired. In most 221 and 232 issues, there is aconstruction period in which disbursements aremade, and funds are released periodically from theescrowed program or project fund. (Some 221issues use an outside source for construction, eliminatingthe construction draws.) As the borrowerconstructs the project, disbursement draws arerequested from the FHA. Because the rating isbased solely on Ginnie Mae, no credit is given tothe FHA-insured advance (draw) until it is securitizedby Ginnie Mae. This process of converting theFHA-insured draw into a Ginnie Mae security,called a construction loan certificate (CLC), is performedby the co-insured lender, and takes about20 business days.The CLC bears an interest rate equal to the lowerof the temporary or permanent rate established bythe FHA under the mortgage note. As constructiondraws are made, they are converted into CLCsbearing the same interest rate and maturity. TheCLCs represent full collateralization by GinnieMae, which guarantee timely payment of intereston the 15th of the month and stated principal atmaturity. At the project’s completion and the mortgage’sfinal endorsement, all CLCs are exchangedfor a permanent loan certificate (PLC), which is thelong-term Ginnie Mae-backed security.The mortgagor makes its payments to the lenderon the first of each month. The lender, in turn, passesthese payments through to the bond trustee bythe 15th of that month (in the case of Ginnie Maeprograms), representing payments on the MBS. (Themortgage rate is higher than the rate on the MBS.This differential covers the lender’s servicing fee andthe Ginnie Mae guarantee fee.) If the mortgage paymentsare not paid by the owner, or are insufficientto pay the trustee the principal and interest due onthe MBS, the lender is required to pay the trusteethe amount due from its own monies. If the trusteefails to receive payment from the lender by the closeof business on the 15th, or the 17th if the MBS isheld in book entry, the indenture should require thetrustee to seek immediate payment from GinnieMae. Since Ginnie Mae guarantees timely payment,there is no need for a debt service reserve funds(DSRF) to cover liquidity risk.If the mortgagor prepays all or a portion of itsmortgage, this amount will be prepaid to the lenderand then passed on to the trustee as a prepaymenton the Ginnie Mae security. The prepayment260 Standard & Poor’s Public Finance Criteria 2007