Secondary-Market Derivative Products ............................................................................
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tandard & Poor’s Ratings Services rates secondary-
market derivative products, such as tax-exempt
synthetic floating rate receipts (synthetic floaters),
including the tender option and residual interest
tranches, principal and interest strips and auction
floater/inverse floater trust receipts—all based on
underlying deposits of municipal obligations.
The most frequently rated secondary market
derivative products are synthetic floaters created
by depositing fixed-rate municipal obligations into
a trust structure. Synthetic floaters with a tender
option, which are similar to primary market vari-
able rate demand obligations (VRDOs), are typi-
cally secured by a liquidity facility that provides
coverage for unremarketed tendered receipts.
Residual interest receipts are created as part of the
same synthetic floater structure, and do not have a
tender option.
The interest paid to residual interest holders gen-
erally equals the interest collected on the underlying
obligation, minus the interest rate payable to the
synthetic floater holders with the tender option and
fees. In a strip structure, some or all of the interest
payments associated with a bond are stripped from
the principal payments, and both are resold at a
discount from their face value to separate pur-
chasers. An auction floater/inverse floater receipt
structure allows two classes of variable-rate receipts
to be created from a single deposit of underlying
fixed-rate bonds. One class of receipt bears interest
on an auction basis, and the other captures the
residual interest from the underlying bonds.
All secondary-market derivative securities are
examined according to the following three analyti-
cal categories:
■Custodial or trust analysis;
■Legal analysis; and
■Structural analysis.Custodial Or Trust Analysis
The custodial or trust analysis concentrates on the
proper transfer of the underlying assets to the cus-
todian or trustee and their issuance as receipts. This
analysis is identical for all types of secondary-mar-
ket derivatives. The custodian or trustee should be
clearly instructed to:
■Receive the underlying securities from the deposi-
tor free and clear of any lien or encumbrance and
ensure that the deposit is irrevocable;■Establish and maintain a separately designated
account for each issue;
■Ensure that the underlying bonds that are
deposited into the custody or trust account are
not commingled with any of its other assets;
■Ensure that no current or subsequent fees are
taken from payments due to holders,
■Transfer payments in a timely fashion to holders.Legal Analysis
The legal analysis concentrates on bankruptcy and
taxability issues and is also identical for all second-
ary-market derivatives. The following legal opin-
ions are requested and examined:
■True sale opinion, if requested; and
■Tax opinion stating that there is no tax at the
trust structure (entity) level for federal, state,
and, in some cases, local purposes.
In additional to relevant opinions, the structure
must also meet additional legal criteria regarding
the structure. (See “Legal Criteria For U.S.
Structured Finance Transactions”).Structural Analysis
The structural analysis is tailored to each specific
derivative product and concentrates on the follow-
ing structural features:
■The flow of funds from the underlying bonds to
the receipt holders;
■The various payment events associated with the
structure;
■Designated sources of payment for each payment
event; and
■Compatibility of the trust and liquidity facility
termination events with the rating to be assigned
to the receipts.Tender Option Synthetic/
Residual Interest Synthetic Floaters
Synthetic floaters are variable-rate trust receipts evi-
dencing direct ownership interests in a deposit of
underlying obligations. Such obligations generally
have a fixed interest rate but can also bear interest
at a variable rate. Obligations deposited into a syn-
thetic trust can come from various municipal sec-
tors and come in a variety of forms, such as bonds,
notes and leases, among others. After the deposit of
the obligation into the trust structure, two classes