LOC could be terminated without any change to
the rating of the bonds.
Single-draw confirmation
Some confirmation LOCs have no terms for rein-
statement. They are available only for a single
draw. Upon any wrongful dishonor or repudiation
of the facing LOC, the trustee must be instructed to
draw for the full stated amount of the confirmation
LOC and redeem or accelerate the bonds.
Sources of payment
In a LOC-backed transaction, the trustee is
instructed to make payment of principal, interest,
premium, and purchase price in accordance with
the prioritized list of sources of payment. In addi-
tion to the facing LOC as a source of payment, the
trustee must also be specifically instructed to use
the confirmation LOC as a source of payment.
Timeliness of LOC draws
It is important to synchronize the trustee’s draw
instructions under the bond indenture with the pay-
ment terms of the facing LOC and the confirmation
LOC to ensure that each credit facility is drawn on
to provide full and timely payment. In the case of
bonds supported by both a facing and a confirma-
tion LOC, the trustee’s draw instructions must
leave sufficient time to draw on the confirmation
LOC in order to provide full and timely payment
upon the wrongful dishonor or repudiation of the
facing LOC.
Draw procedures
Terms of a confirmation LOC include the proce-
dures for the trustee to properly conduct a draw.
The terms must allow draws under any circum-
stance of facing LOC repudiation or wrongful dis-
honor. In addition, the confirmation LOC should
not require the trustee to represent the drafts of the
dishonored draw on the facing bank as a condition
of honoring a draw on the confirmation LOC. This
enables the trustee to draw on the confirmation
LOC following bank insolvency even if either the
facing LOC is repudiated before it is drawn on, or
the dishonored drafts are not properly returned to
the trustee.
Preference concerns
A key question about confirmation LOC structures
is whether or not, subsequent to a fronting bank
insolvency, the FDIC as receiver could recover pay-
ments made to bondholders by the trustee that were
derived from a draw on the facing LOC. This con-
cern is based on the theory that the payments either
were not made in the ordinary course of business of
the bank, were made in the preference of one credi-
tor over another, or were made to prevent theapplication of the bank’s assets in the manner pre-
scribed by the National Banking Act.
In a January 1991 statement, the FDIC addressed
this concern by stating that, in its view, a court
would hold that the FDIC, as receiver or conserva-
tor, could not recover payments made to bondhold-
ers from the trustees draw under the facing LOC.
Based upon this statement, Standard & Poor’s does
not have additional preference concerns for U.S.
confirmation LOC structures beyond those evident
within other fully credit-enhanced structures.
If the fronting bank is a non-U.S. bank,
Standard & Poor’s will research the possibility of
whether payments from the fronting LOC bank
could be disgorged under the bankruptcy law of
that country. If there is such a possibility, a solution
could be that upon the fronting bank’s insolvency,
the trustee will no longer draw on that LOC, but
rather, will directly draw upon the confirmation
LOC to avoid this preference concern.LOC-Backed Commercial Paper
Standard & Poor’s also rates municipal commercial
paper (CP) programs secured by LOCs. With a
direct-pay LOC, a depositary draws for the entire
principal of and accrued interest on the CP notes at
maturity. The proceeds from the sale of new CP
notes are used to reimburse the bank for the draw
on the LOC.
In a CP program, the depositary usually acts as
issuing and paying agent. The depositary issues,
authenticates, and delivers new CP notes on the
issuer’s instructions. It also pays the notes at matu-
rity and ceases CP note issuance at the issuer’s and
LOC bank’s requests. To ensure adequate LOC cov-
erage, the depositary determines that the amount of
any new CP plus the amount of outstanding CP
does not exceed the LOC commitment. Typically,
the CP notes mature within 270 days and, in any
event, no later than the 15th day prior to LOC
expiration. The bank is obligated to honor draws
to pay principal and interest on all CP notes until
they mature, despite any early termination of its
agreement with the issuer.
The depositary’s authority to issue CP can be
revoked temporarily or permanently by the issuer
or the bank. In such a case, the depositor may not
issue any new CP, and the LOC must continue to
support all outstanding CP. If the bank gives a
cease issuance order, only the bank can rescind such
instruction.
In the event that the LOC provides for an early
termination of the bank’s commitment, based on an
event of default under the reimbursement agree-
ment, the bank immediately notifies the depositary
of the default and instructs the depositary to ceaseMunicipal Structured Finance216 Standard & Poor’s Public Finance Criteria 2007