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

Cross Sector Criteria■ Substitute to a provider with a rating of at least‘AA-/A-1+’ willing to offer substantially similarrates and terms as the original agreement;■ Secure credit enhancement to the investmentagreement from a provider rated at least‘AA-/A-1+’;■ Collateralize the agreement to a level sufficient tomaintain the rating on the bonds; or■ Terminate the agreement, only with the bondissuer’s consent, and payment to the issuer of allinvested principal plus accrued interest to thetermination date.Any of the provisions above should be resolvedwithin 30 days of the downgrade of the provider.The provision to terminate the agreement withissuer consent (fourth option) above is only acceptableto the extent the related bond document stipulatesthat in the event the issuer elects to terminatethe investment agreement, the issuer takes appropriaterating notification actions. Standard & Poor’sneeds to review the alternate investment(s) for consistencywith the original financing, and the abilityof the alternate investment(s) to support the ratingon the bonds. In all instances, Standard & Poor’swill need to be notified to verify that one of theremedies will be utilized.These guidelines shall not apply unless theprovider, under the investment agreement, agrees toeffect any of the (first through third options) aboveat its own cost, unless the termination option(fourth option) above is accepted by the issuer.Exceptions may occur only in certain instanceswhere a substantial number of investment agreementswith multiple providers lead to more thanample liquidity at a given rating level, as may bethe case with some state housing finance agencyissues under parity bond resolutions or state revolvingfund programs. A likely scenario for terminationto occur would be if market conditions resultin reinvestment rates equal to or higher than that ofthe original agreement thereby providing sufficientinvestment earnings for the bond issue.Unlike parity resolutions, stand alone issues typicallyhave minimal excesses built into the structureand therefore are less likely to have the financialcapacity necessary to withstand the consequences ofa drop in prevailing interest rates—possibly requiringan upfront payment to enter into a substituteinvestment agreement providing similar rates andterms to the original agreement, or accepting alower reinvestment rate. Without this “make-wholeprovision”, the investment agreement would not beeligible to be used for bonds rated higher than theprovider’s rating.Standard & Poor’s views the performance of theprovider under the make-whole provision as integralto preserving the bond rating. If it is assumedthat prevailing interest rates have fallen and thatthe termination option is not practical, the agreementwill continue using one of the remaining threeoptions. The collateralization option requires notonly sufficient levels and types of collateral, butalso appropriate legal opinions that protect the collateralin the case of an insolvency of the provider(see below). The remaining options of finding asubstitute provider or enhancement for the agreementmay require costs for the provider dependingon market conditions.Following either of these sets of guidelines, bondissues rated in the ‘AAA’ and ‘AA’ categories mayutilize investment agreements with eligibleproviders with ratings as low as ‘AA-/A-1+’. Issuersshould recognize that use of lower rated providersinvolves requirements that should be considered atthe bidding stage so that the potential providers areaware of the additional requirements that make theagreements acceptable for rated transactions. Notethat this criteria only applies to transactions ratedin the ‘AAA’ and ‘AA’ categories. On transactionsdependent on investment earnings, for bonds rated’AA-’ and below, Standard & Poor’s applies astraight weak-link approach, whereby the rating ofthe bonds cannot be any higher than that of thelowest rating of any dependent provider.In addition, transactions structured to have theinvestment agreement as the only security for thebonds, such as an escrow, cannot benefit from thiscriteria, as the bonds are solely dependent uponpayment from the investment agreement provider. Ifthere is no additional security for the bonds, therating of the bonds is capped at the rating of theinvestment agreement provider.General TermsThe second aspect reviewed is the structure of theagreement to ensure it works appropriately with themechanics of the financing. Standard & Poor’sreviews the general terms of the investment contractfor consistency with the legal documents and theassumptions under the cash flows. Standard & Poor’swill compare the interest rate under the investmentagreement, basis for calculating interest, the interestaccrual dates and payment dates under the contract.Additionally, the investment agreement’s maturitydate should match the maturity date of the applicablefund, or the cash flows should model Standard &Poor’s then-current minimum reinvestment assumptionsafter the investment agreement maturity date.To the extent that investment agreements areobtained subsequent to the initial rating, Standard &Poor’s will review all outstanding agreements eachtime the rating is reviewed to assure that the terms ofthe agreements are appropriate for the bond rating.54 Standard & Poor’s Public Finance Criteria 2007