PubFinCriteria_2006_part1_final1.qxp

(Nancy Kaufman) #1

involves an examination of details such as who
receives the tender notices and who pays the pur-
chase price to tendering bondholders.
In some transactions, payment of purchase price
to bondholders is made by the tender agent rather
than the trustee. If the LOC is written to the trustee
and the trustee is instructed by the indenture to
make draws on the LOC, the trustee must be
instructed do one of the following: (1) transfer the
money received from an LOC draw to the tender
agent, while allotting adequate time for the tender
agent to pay bondholders prior to the close of busi-
ness on the purchase date; or (2) direct the LOC
bank to pay all proceeds of a tender draw directly
to the tender agent.
Another acceptable option is to have the LOC
bank authorize and the indenture instruct the ten-
der agent to make all tender draws directly, without
involving the trustee. Remarketing proceeds must
also be transferred from the remarketing agent to
the party paying purchase price in adequate time
for payment to be made to bondholders prior to the
close of business on the tender date. In the case of
mandatory tenders, undelivered bonds must be
deemed tendered.


Purchase price reinstatement


Any time all or a portion of tender price is paid
from proceeds of a drawing on the LOC and the
LOC coverage amount reduces upon honoring of
the draw, the concept of purchase price reinstate-
ment is an important factor. Bonds that are pur-
chased with LOC money must not be released to
the new purchasers until the agent holding these
bonds has received written confirmation from the
LOC bank that the LOC has been reinstated to its
full amount of coverage for the bonds in question;
otherwise, bondholders could be exposed to credit
cliff risk by holding bonds that are not supported
by the LOC.


Remarketing discount


Most put bonds only allow the bonds to be remar-
keted at par. On some transactions, the remarketing
can be at a discounted price. To ensure full pay-
ment to tendering bondholders, the discount must
be limited to the amount of LOC coverage specifi-
cally for remarketing discounts.


Expiration of the put option


The short-term component of a dual rating on a
put bond reflects the likelihood of full and timely
payment of purchase price upon a mandatory or
optional tender. As with principal and interest, the
likelihood of payment is equal to the likelihood of
the bank’s honoring a draw for purchase price. The
bondholder is insulated from the performance of
the issuer or the underlying obligor. Events of


default due to bankruptcy or technical default by
the issuer or underlying obligor should not lead to
the immediate expiration of the put option, which
would be inconsistent with the short-term rating of
the transaction.

Optional Redemptions
Certain transactions are structured so that payment
of premium or principal associated with an option-
al redemption is not covered by the LOC. For such
an event, the trustee shall not send out a notice of
redemption to the bondholders unless there are suf-
ficient preference-proof funds on deposit prior to
the giving of notice, or such notice will be condi-
tional and contain language to the effect that the
redemption will be rescinded in the event there are
not sufficient preference-proof funds on hand prior
to the scheduled redemption date.

Investments
Funds held by the trustee, for which an investment
loss could lead to a lack of full and timely payment,
must be restricted in their investment. This is most
common when the LOC is scheduled to fund earlier
than the payment date or when preference-proof
funds are being held as a payment source. Permitted
investments may only be investments rated by
Standard & Poor’s at least equal to the then-current
rating on the bonds. The investment must mature
within 30 days or as needed for full and timely pay-
ment on the bonds.

Defeasance
In a true legal defeasance, the bonds are deemed
paid, the trust estate is released, the trust indenture is
discharged, and, generally, the LOC is released. The
trust indenture and LOC are replaced by an escrow
of funds, which provide for the payment of any debt
service. Criteria for defeasance are designed to
address both the credit quality of the escrow account
and the legal structure of the escrow. Except for
municipalities eligible to file for bankruptcy under
Chapter 9 of the Bankruptcy Code, defeasance
should be accomplished with sufficient preference-
proof (as defined in the following sentence) funds to
pay for principal and interest until the bonds’ matu-
rity, or earlier redemption. As in any other payment
structure, preference-proof funds include:
■Funds provided under an LOC;
■Money accompanied by a preference opinion of
counsel experienced in bankruptcy matters; or
■Funds “aged” for the proper preference period,
depending on the details of the transaction.
The preference-proof funds may be held in the
form of either cash or direct obligations of the U.S.
If U.S. government obligations are used, they
should not be redeemable at the option of the

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