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