include: trustee and servicer responsibilities and
compensation; legal provisions such as actions to be
taken in the event of a mortgage loan default;
redemption provisions and procedures governing
mortgage loan advances; commencement of amorti-
zation and final endorsement, to name a few.
Project construction period
Bond proceeds are deposited in the construction
fund on behalf of the issuer. Throughout the con-
struction period, the trustee authorizes mortgage
loan advances to the mortgagor in accordance with
the building loan agreement. The trustee should dis-
perse only properly endorsed mortgage insurance
advances. By restricting disbursements to amounts
insured by the FHA, the trustee is assured of having
sufficient high-quality assets to redeem all outstand-
ing bonds, if necessary.
During the construction period, the mortgagor
owes interest at the construction loan rate on the
portion of the mortgage loan principal that actually
has been advanced. Failure to make a monthly
interest payment on the due date constitutes a
default under the mortgage note.
Note amortization versus final endorsement
Standard & Poor’s regards the commencement of
mortgage note amortization as the critical event in
FHA-insured programs. Starting on this date, the
mortgagor’s obligation under the mortgage note
includes repayment of principal, as well as interest
on the mortgage loan.
The bond indenture should state explicitly the
date that note amortization will commence, as set
forth in the FHA firm commitment. The amortiza-
tion schedule should reflect the principal amount of
the mortgage note as initially endorsed by the FHA
unless modified by the agency at final endorsement.
Standard & Poor’s evaluation of the adequacy of
mortgage revenues to meet bond debt service pay-
ments also is predicated on these assumptions.
Failure to begin amortization on the specified date
constitutes a default under the mortgage. The bond
indenture should instruct the trustee to initiate the
assignment process if the mortgagor does not cure
such a default within the 30-day grace period.
If an issuer permits extension of the commence-
ment of note amortization, the following provisions
are necessary to simulate note amortization:
■The extension period is limited to a set period of
time. In no event may note amortization be extend-
ed beyond the date three months prior to expiration
of the construction fund investment agreement,
unless the investment agreement is extended or min-
imum reinvestment rates are assumed following
investment agreement expiration.■The trustee receives cash flows provided by an
independent third party. Such cash flows should
demonstrate that sufficient revenues will be avail-
able to (a) pay bond debt service for the term of
the bonds as originally scheduled in the projected
cash flows; (b) pay all fees and expenses of the
trustee and mortgage servicer; and © pay all
other fees and expenses incurred by the trustee
during the extension period.
■If project revenues prove insufficient to satisfy
the above cash flow projections, the trustee
should receive cash or an unsecured LOC in the
amount of the projected shortfall. The LOC
should come from an institution whose unsecured
long-term debt is compatible with the rating
assigned to the bonds. Unqualified counsel opin-
ions are required for each kind of shortfall cover-
age: (a) if a revenue shortfall is covered by a cash
contribution or LOC, the trustee must receive an
opinion of counsel stating that the contribution
would not be considered a preference under the
provisions of Section 547(b) of the Bankruptcy
Code; (b) in addition, the trustee should receive
an opinion of counsel stating that the contribu-
tion would not be subject to the automatic stay
provisions of Section 362(a) of the Bankruptcy
Code; and all opinions of counsel should be ren-
dered by an attorney in the field of bankruptcy
who is acceptable to the trustee.
■The trustee should conclude that extending the
commencement date of note amortization would
not adversely affect the bondholders or jeopard-
ize the FHA contract for mortgage insurance.
Such extension also should not adversely affect
the tax-exempt status of the bonds. The inden-
ture should expressly state that extension of the
date for commencement of amortization is not
permitted if this is the case.
The assignment process
The mortgagor is considered to be in monetary
default if a scheduled mortgage note payment is
not received on the due date. Thirty days after the
due date, the trustee is entitled to institute the
assignment process. If a mortgage note default
occurs prior to projected completion, the trustee
files a claim for mortgage insurance benefits based
on the FHA’s initial endorsement of the mortgage
note. The FHA may process the claim in either of
two ways:
■The FHA may require the trustee to turn over
the remaining construction fund balance. In this
case, the FHA’s payment of benefits is based onHousing252 Standard & Poor’s Public Finance Criteria 2007