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

Other CriteriaIn addition, Standard & Poor’s assesses the extentto which engineering and design are complete, withequipment procured when construction begins;investment-grade projects tend to have completedthese tasks earlier than noninvestment-grade projects.Standard & Poor’s analyzes the independent engineer’sconclusions on the adequacy of contingenciesfor schedule and budget, and related assumptions.Standard & Poor’s also evaluates performancerequirements and incentives for project contractorsalong with the financial and technical capacity ofthe contractors. Projects that require constructionmonitoring by an expert third party, such as anindependent engineer, enhance construction surveillancewith this oversight mechanism.Cash Flow ConsiderationsAnd Capitalized Interest CalculationsFor financings that are cash-flow dependent, suchas mortgage revenue bonds for multifamily finance,sufficient funds must be available to pay debt serviceduring the construction period. Project capitalizationshould demonstrate sufficient amounts ofcapitalized interest to ensure bondholders will bepaid in full and on time during construction. Theseconsiderations vary according to bond structureand use of credit enhancements, among otherthings. In situations where bond proceeds are usedto fund construction and there is no constructionperiod credit enhancement, Standard & Poor’s willanalyze the following:■ Earnings during the construction period. Likeother transactions, in which funds are held inescrow during development, Standard & Poor’swill stress the effect of investment earnings oncoverage levels. Standard & Poor’s analysisinvolves a comparison of construction fundinvestment earnings and the mortgage note interestrate. If the construction fund investment rateis lower than the mortgage interest rate, thencash flows should assume that all monies shouldremain in the construction fund account until thelatest date they can be drawn under the bonddocuments (late draw). If the mortgage rate islower than the construction fund rate, then itshould be assumed that all funds are drawn dayone and the mortgagor is making mortgage payments.On a case-by-case basis, income may beshown during the construction period,■ Length of construction period. Standard & Poor’swill assume a delay in reaching constructioncompletion, as well as lease-up and stabilization.Delays will vary depending on Standard & Poor’sanalysis of construction risk, including the opinionof an independent construction consultant insome instances. For low risk projects, a sixmonthdelay might be sufficient, whereas formoderate risk projects, one year might be inorder. High-risk construction may call for delaysof 18 months or longer.■ Rental income. Standard & Poor’s will examinecase-by-case whether rental income exists duringconstruction. An example of where rental incomecould be shown would be in low risk constructionsituations, such as military housing transactions,where units are on line at the outset of thetransaction and demand is extremely deep. In anyevent, Standard & Poor’s will assume maximumoccupancy of 95%. Occupancy assumptionscould be lower if the market analysis cannot substantiate95%.■ Trending of income and expenses. If rentalincome is present in a particular transaction, notrending of income and expenses will be takeninto account, except on a case-by-case basis.■ Debt service coverage. Coverage of debt shouldalways be at least 1x for investment grade ratings.Standard & Poor’s will determine case bycase what the coverage level should be dependingon analysis of construction risk and the rating onthe bonds.Shortfalls in bond cash flows can be covered byequity contributions or other paid-in cash at closing,letters of credit (LOCs), available funds underan HFA parity program and other rated creditenhancements.Covering Construction Risk With Credit EnhancementsWhen construction risk is moderate to high, creditenhancement during the construction and lease-upphase may be needed for investment grade ratings.This is often the practice in single-asset affordablehousing transactions. Credit enhancements are typicallyin the form of a LOC from a bank rated ashigh as the bonds, or Freddie Mac, Fannie Mae,GNMA, FHA insurance or guarantees.LOCsThe LOC should remain in place until the projectachieves stabilization at full occupancy at a predetermineddebt service coverage ratio for at least oneyear. Once the project achieves stabilization, theLOC may be released. The rating during the creditenhancement period will be limited by the rating ofthe credit enhancer. The LOC amount should coverbond principal amount and interest to a specifiedcompletion date. The trust indenture should have amandatory draw on the LOC and a correspondingmandatory redemption of the bonds from LOC proceedsin the event that the project does not reach326 Standard & Poor’s Public Finance Criteria 2007