PubFinCriteria_2006_part1_final1.qxp

Forward Purchase Contracts and ‘AAA’ Defeased Bonds ................................................

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tandard & Poor’s Ratings Services reviews forward

purchase contracts (FPCs) in conjunction with

newly refunded bonds and outstanding ‘AAA’ rated

refunded bonds. The FPC analysis involves a review

of legal structure and the sufficiency and credit quali-

ty of the assets placed in escrow. As with traditional

refunded bonds, in order to provide a rating on an

escrow that is accompanied by a FPC, Standard &

Poor’s relies on counsel, escrow agents, accountants,

and other experts and advisors for accuracy and com-

pleteness of the information provided.

FPCs involve the sale by the issuer of its resid-

ual earnings from an escrow to a third party, the

FPC provider, who receives an economic benefit

based on the nature of the residual interest pur-

chased. The issuer receives a purchase price from

the FPC provider that generally is equal to the

present value of the future reinvestment income.

The residual rights sold to the FPC provider (the

seller) may include:

■The issuer’s right to receive excess reinvestment

income, if any, after the payment of debt service

on the bonds;

■The issuer’s right to direct the reinvestment of

maturing proceeds of the initial escrowed securi-

ties; and

■The issuer’s right to substitute the reinvested

securities held by the escrow agent in the escrow

fund.

Many outstanding escrow agreements are silent

with respect to an issuer entering into an FPC sub-

sequent to the escrow’s closing date and frequently,

FPCs are executed afterwards. Because FPCs are

not considered eligible investments for rated

escrows, Standard & Poor’s believes that the

escrow agreement should be amended to provide

for the subsequent execution of the FPC. We would

also expect counsel to consider whether bondholder

approval should be obtained before the escrow

agent enters into a FPC.

FPC Rating Criteria

To obtain a ‘AAA’ rating on an escrow that has a

FPC, Standard & Poor’s first looks for compliance

with our defeasance criteria (see “Public Finance

Criteria: Defeasance”). Additionally, since the FPC

provider is purchasing the residual interest in the

escrow account, Standard & Poor’s determines

whether such interest would cause the escrowed

funds to be affected by a potential insolvency of the

FPC provider.

FPC analysis

Standard & Poor’s examines whether the FPC or the

escrow agreement include the following provisions:

■The decision to purchase the newly delivered

securities from the FPC provider should be at the

escrow agent’s option and, in general, at the

direction of the issuer.

■The FPC provider should have no right to substi-

tute any of the initial escrow securities prior to

their maturity. After the maturity of the initial

securities, to the extent that the FPC provider

delivers to the escrow agent new securities pur-

suant to the FPC, the FPC provider may retain

the right to deliver substitute securities with

longer maturities providing those newly delivered

securities mature on or before the next bond pay-

ment date. Because the initial escrow securities

matured in accordance with the terms of the

escrow (and the original verification report), the

delivery of the new securities does not require a

new verification report as the original escrow

structure presumed no investment earnings after

the initial escrowed securities matured.

■The FPC or the escrow agreement should provide

for independent accounting firm verification of the

sufficiency of the escrow funds prior to any with-

drawal of monies from the escrow. This should

not be confused with substituting securities provid-

ed pursuant to the FPC, which does not require a

new verification report. The documents should

make provisions for, or reserve for, the cost of

these additional verification reports, if applicable.

■The escrow agent should not be permitted to

accept any newly delivered securities from anoth-

er FPC provider unless the FPC has been trans-

ferred to that provider and evaluated by

Standard & Poor’s as evidenced by written con-

firmation of the rating of the escrow.

■The FPC provider or any subsequent FPC

provider, if applicable, has no lien or claim

Forward Purchase

Contracts And ‘AAA’ Defeased Bonds

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