PubFinCriteria_2006_part1_final1.qxp

nonreinstatement of interest coverage at the latest

possible date under the terms of the LOC. The

trustee then accelerates the issue, and interest ceases

to accrue at the latest date in accordance with the

indenture. Standard & Poor’s calculation of interest

coverage also considers delays in notices or pay-

ments caused by nonbusiness days. The timeline is

an example of Standard & Poor’s calculation of

minimum interest coverage for a direct-pay LOC

transaction. Assume the following structure:

■Interest is paid on the first business day of each

month, based on a 365-day year.

■LOC interest coverage automatically reinstates

on the tenth business day following a draw,

unless the trustee is notified of nonreinstatement.

■If the trustee is notified of nonreinstatement, it

will immediately accelerate the bonds.

■Interest ceases to accrue upon the date of decla-

ration of acceleration.

If the trustee is paying interest for the month of

December, interest will be due on the first business

day of January. If Jan. 1 is a Friday, then on

Monday, Jan. 4, the trustee will draw on the LOC

and pay 31 days of interest. The LOC bank can

send notice of nonreinstatement as much as 10

business days later. Since Saturdays, Sundays, and

holidays are nonbusiness days, notice of nonrein-

statement could come as late as Tuesday, Jan. 19.

The trustee would accelerate the bonds, and interest

would cease to accrue that day. Therefore, 19 days

of interest would have accrued in January. In addi-

tion to the 31 days of interest from December, the

total minimum interest coverage would be 50 days.

Note that if interest does not cease to accrue upon

the date of the declaration of acceleration, addition-

al coverage will be needed. Additional coverage

may also be needed if there is a longer accrual peri-

od between the bond closing date and the first

interest payment date on the bonds (for example if

the bonds closed on Nov. 20 and the first interest

payment date was Jan. 4).

In standby LOCs, where nonpreference-proof

money is the first source of payment to the bond-

holder, the worst-case scenario also includes the

consequences of the borrower’s bankruptcy. In

addition to coverage for accrued interest, the LOC

must also cover the maximum amount of interest

that can be disgorged from bondholders if it were

deemed a preferential transfer. Most transactions of

this type have individual features. The factors to

consider in calculation of interest coverage are:

■Schedule of loan payments;

■Timing of notice of bankruptcy;

■Events of default;

■Grace periods;

■Acceleration schedule; and

■Applicable preference period.

Note that the LOC’s stated expiration terms

should take into account the applicable preference

period as well.

Tender Process

Standard & Poor’s applies a similar analysis to the

payment of purchase price as it does in assessing the

likelihood of full and timely payment of regularly

scheduled principal and interest. If remarketing pro-

ceeds are the first source of funds to be used for ten-

ders and LOC funds are the second, the trustee

should be instructed to draw on the LOC in an

amount equal to the total purchase price due to ten-

dering bondholders, less the amount of the remar-

keting proceeds on deposit prior to the draw time

deadline established in the LOC. It is important that

the trustee only consider proceeds actually on

deposit, as opposed to proceeds that are expected to

be received. If the trustee were to draw on the LOC

on the basis of expected proceeds and any expected

remarketings were to fail, a shortfall in total funds

available to pay tendering bondholders would jeop-

ardize the timeliness of payment. In most instances,

it would be too late to make a second draw on the

LOC to make up the shortfall and still make timely

payment of purchase price. Alternatively, there can

be reliance on expected proceeds if the remarketing

agent provides an unconditional commitment to

deliver remarketing proceeds by the time necessary

to pay tendering bondholders regardless of whether

or not expected remarketings are successful.

Since the tender process often involves several

different parties (trustee, tender agent, remarketing

agent), proper coordination of the flow of informa-

tion and funds among the various participants is

necessary to ensure full and timely payment of pur-

chase price to bondholders. As a result, the analysis

Municipal Structured Finance

212 Standard & Poor’s Public Finance Criteria 2007

Interest
payment due

12/1

Notice of non-

reinstatement

received

(acceleration)

Tues.

1/19

Mon.

1/18

MLK Jr.

holiday

Mon.

1/4

Interest

paid for

december

Fri.

1/1

Interest

payment

due

(not a

business

day)

31 days accrued 19 days accrued

50 days total interest accrual

Interest Accrual Scenario