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

Pension Fund Credit Enhancement And Related Guarantee Programscompletion and lease-up at specified debt service coverageby the specified completion date. Please see,“Public Finance Criteria: LOC-Backed MunicipalDebt” for a full description of Standard & Poor’s criteriarelating to letters of credit.Freddie Mac, Fannie Mae,GNMA guarantees/FHA insurancePlease see, “Public Finance Criteria: Ginnie Mae,Fannie Mae And Freddie Mac MultifamilySecurities,” and “Public Finance Criteria: FHAInsured Mortgages” for a full description of ratingcriteria. Construction risk is typically fully mitigatedby the insurance and guarantees; however, transactiondocuments must accurately reflect the mechanics ofthe program, cash flow considerations and capitalizedinterest calculations must be incorporated into theanalysis, and Standard & Poor’s assumes a “worstcase” receipt of guarantee and insurance proceeds.Turnkey Contracts As Credit EnhancementsSponsors often use “turnkey” (“soup-to-nuts”) contractson major projects as a means of shifting constructionrisk away from equity and lenders. In aturnkey contract, the builder promises to deliver theproject complete on a certain day, and takes allresponsibility for design, engineering, procurement,construction, and testing. All the project owner hasto do is pay the contract costs, and “get the keys”to a fully functioning project at the end of theprocess. In appropriate circumstances, turnkey contractscan shift risk to the extent that they may beviewed as an indirect type of credit enhancement byproviding for timely and full completion on pain ofdamage or penalty payments, on which the projectmight be able to rely for debt service. Nevertheless,prompt payment of liquidated damages is more adesideratum than a reality.Turnkey or other construction contracts cannoteliminate all risk. Some risk generally remains, suchas force majeure and change-of-law events, whichby definition, cannot be controlled by the vendorand contractor. ■Pension Fund Credit EnhancementAnd Related Guarantee ProgramsStandard & Poor’s Ratings Services, upon request,will assign ratings to issues secured by publicpension fund credit enhancement programs.Even though some enhancement programs arerelatively short-term in nature, or signify a fractionof a pension fund’s accumulated assets, Standard &Poor’s analytical approach for public pension fundcredit enhancement program issue ratings focuseson the long-term credit quality of the fund’s sponsor,along with the pension fund’s independence,management, and operating performance. In otherwords, a pension fund’s credit enhancement programis not viewed in a vacuum: extraordinaryasset and cash flow coverage of credit enhancementprogram obligations does not automatically translateinto superior credit quality. Nonetheless, creditenhancement programs remain an important creditconsideration and will be analyzed in the context ofhow the program fits within the pension fund’soverall management and operating profile.Pension Fund GuaranteesCredit enhancement programs and related guaranteespertain to the extension of a pension fund’screditworthiness to debt instruments of other entitiesthrough letters of credit (LOCs), guaranteeagreements, liquidity agreements for commercialpaper (CP) or other short-term instruments, or liquidityagreements to honor optional “put” provisionson variable-rate debt.In one respect, the extension of pension fundguarantees is similar to the investment risk undertakenby a pension fund in its normal course ofbusiness, in that pension fund assets are placed ata level of risk in return for current or future compensationfor undertaking the risk of lending orpromising to advance assets. However, it is importantto note that the extension of pension guaranteesleverages existing assets, in addition to thenormal investment risk associated with the directownership of financial securities.In the extreme case of a securities marketprice decline, losses on owned investments by apension fund could be aggravated by requirementsto honor guarantees or other financialcommitments extended by the pension fund,increasing the potential for losses of fund assetsand reducing the ability of the pension fund tohonor its standing obligations for benefit paymentsto retirees.www.standardandpoors.com327