able preference in the event of filing of a petition
under the U.S. Bankruptcy Code with respect to the
issuer, the borrower, any general partner of the bor-
rower, or any guarantor. Under the U.S. Bankruptcy
Code, a trustee in bankruptcy may set aside, or
recapture, certain payments on account of
antecedent debt made within a certain period of
time before filing a bankruptcy petition. Preference
opinions have indicated that any payments to bond-
holders from particular sources of funds will not be
recaptured as a preference in the event of bankrupt-
cy of a related party.
Standard & Poor’s no longer requests a prefer-
ence opinion for transactions that limit payment
sources to the following:
■Initial bond proceeds;
■LOC draws;
■Remarketing proceeds (as appropriate);
■Funds held by the trustee for at least 90 days (or
other appropriate preference period), during
which time there has been no bankruptcy filing
by or against the issuer, borrower, general part-
ners, or guarantors;
■Insurance proceeds paid directly to the bond
trustee; and
■Other money, including refunding proceeds,
accompanied by a future preference opinion.
Standard & Poor’s will continue to request pref-
erence opinions for the following:
■Deals in which LOCs have been provided for
antecedent debt if there is a pledge of new collat-
eral to the bank; and
■Transactions that may fall outside the jurisdiction
of the U.S. Bankruptcy Code; and
■Standard & Poor’s reserves the right to require a
preference opinion for any deal if circumstances
so warrant.
Credit Cliff Issues
A Standard & Poor’s rating reflects the probability
of full and timely payment to the bondholder until
final maturity, or such time as the bonds are paid in
full. Credit cliff events—that is, events that lead to
a termination or reduction of the amount or level
of credit support prior to such time—are, therefore,
important factors in analyzing these structures.
LOC expiration
Structures allowing for the expiration of the out-
standing LOC prior to bond maturity have a com-
mon potential credit cliff. Most bonds rated by
Standard & Poor’s have 20-to 30-year maturities,
while the LOCs supporting them rarely have initial
terms beyond seven years. The bondholder faces the
possibility of having purchased a rated LOC-backed
bond issue, but holding unrated and unsupported
bonds. To prevent such a scenario, an extension of
the LOC or a substitute LOC must be executed
prior to expiration of the existing LOC, or it is nec-
essary to take out the bondholders through a
mandatory redemption or a mandatory tender. Any
alternate LOC must meet the conditions for rating
maintenance or lead to a mandatory tender.
LOC substitution
A potential credit cliff arises from the provision of
a substitute LOC. To avoid such a scenario, any
substitution of the LOC must be accompanied by
written confirmation from Standard & Poor’s that
the provision of the substitute credit facility will
not, in and of itself, result in a reduction or with-
drawal of the then-current rating on the bonds (rat-
ing maintenance). Alternatively, a substitution may
be executed without certification of rating mainte-
nance if existing bondholders are taken out via a
mandatory tender or redemption on or prior to the
date of substitution. Note that either of these two
remedies is necessary prior to an assignment by the
bank of the LOC, or prior to the granting of partic-
ipation interests to additional banks (unless it is
clearly stated that the granting will not relieve the
provider of its obligation under the LOC).
Nonreinstatement
Another potential credit cliff arises from provisions
in the LOC that allow the bank to declare an event
of default under the reimbursement agreement or
nonreinstatement of interest coverage under the
LOC, following a draw for interest. Any notification
from the LOC provider to the trustee of these events
should lead to an immediate acceleration of the
bonds, mandatory redemption, or mandatory pur-
chase. In such a scenario, the LOC must have suffi-
cient interest coverage to cover all interest until it
ceases to accrue. Any waiver of events of default
should be contingent on written evidence of the LOC
provider’s reinstatement of principal and interest cov-
erage in full and rescission of the notice of event of
default under the reimbursement agreement.
Conversion
Conversion from one interest rate mode to another
can also give rise to credit concerns if the LOC
either expires on conversion or has insufficient
interest coverage for the new mode. The provision
of a substitute LOC with sufficient interest cover-
age and rating maintenance, or a mandatory
redemption or mandatory tender upon conversion,
can adequately address this concern.
Affirmative retention option
To mitigate the impact of credit cliff events, bond-
holders may be given the option to retain their
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