issuer, and they should mature at such times and in
such amounts as will be sufficient to cover the full
and timely payment of all principal, premium (if
any), and interest on the bonds.
Certain additional criteria apply to effect a legal
defeasance in the variable-rate mode. Standard &
Poor’s short-term rating addresses the likelihood of
full and timely payment of purchase price. If, as in
legal defeasance, the indenture were to be dis-
charged, the put feature would no longer be avail-
able to the bondholders—a risk inconsistent with
the rating on the transaction. To maintain the
integrity of the rating and ensure full and timely
payment of debt service, as well as purchase price,
Standard & Poor’s looks for the following:
■That defeasance be eliminated in all variable-rate
modes; or
■That the defeasance period in variable-rate modes
be limited by requiring a mandatory redemption
or purchase in whole to be scheduled no later
than the first possible purchase date (whether
mandatory or optional) or interest adjustment
date; or
■That the trustee receive written evidence from
Standard & Poor’s that the defeasance would not
result in the reduction or withdrawal of the then-
current ratings.
To ensure that sufficient money will be provided
in the variable-rate mode for future payments to
bondholders, defeasance deposits must be made at
the maximum rate allowable on the bonds due to
the interest reset feature of the bonds. The escrow
agreement should address not only the interest reset
feature, but also the potential of bondholders’ ten-
dering their bonds during the defeasance period and
the resulting liquidity issues that arise. To account
for possible tenders, escrow funds must either be
held in cash or in an investment that matures or
would be redeemable at par no later than the first
possible purchase date (whether mandatory or
optional) or interest adjustment date.
The residual interest or the difference between
the maximum floating rate provided for by the
escrow fund and the actual variable rate of inter-
est may also raise concerns during the defeasance
period. If this excess flows back to the underlying
obligor and the obligor were to file for bankrupt-
cy during the defeasance period, a bankruptcy
court might apply the automatic stay provisions
and delay future payments out of the escrow fund.
To address this scenario, Standard & Poor’s will
look for either that the residual interest flow back
to the credit provider or a legal opinion stating
that the bankruptcy of the obligor would not, by
the application of the automatic stay provisions of
Section 362(a) of the U.S. Bankruptcy Code, delaythe use of money in the escrow fund to pay princi-
pal and interest on the bonds. Alternatively, if the
underlying obligor carries an investment-grade rat-
ing, Standard & Poor’s may be able to conclude
that the likelihood of the obligor going bankrupt
during the defeasance period is consistent with the
rating on the bonds, and the legal opinion would
not be needed.
The trustee and any other participant integral
to the tender process (sending or receiving
notices, transferring money, or paying bondhold-
ers) must remain in their position during a defea-
sance where bondholders have retained their right
to tender the bonds.Trustee’s Role
In LOC-backed transactions, the trustee is obligated
to fulfill its fiduciary responsibilities. Standard &
Poor’s relies on the trustee to follow the terms of
the bond documents and to draw upon the LOC in
accordance with its terms. In standby LOC transac-
tions, the trustee should remain in place beyond the
payment in full of the bonds (including maturity)
until the applicable preference period has expired.
Indemnity
The trustee may not require indemnity for draws
upon the LOC or for accelerations. If the trustee is
allowed to require an indemnity prior to accelerat-
ing the maturity of the bonds, bondholders might be
exposed to credit-cliff risk. An acceleration of a
transaction’s maturity often occurs in response to an
event of default resulting from nonreinstatement of
LOC interest coverage. If the trustee in this instance
were allowed to wait for satisfactory indemnity
before taking action required by the indenture, the
bonds would remain outstanding without corre-
sponding credit support for interest coverage.
Resignation or removal of the trustee
No resignation or removal of the trustee should be
effective until the appointment of a successor
trustee. Full and timely payment is compromised
any time a vacancy exists in the position of trustee.
Terms of the transaction must provide for the
appointment of a successor trustee prior to the res-
ignation or removal of the trustee then in effect.
Either the LOC must be transferable or a new LOC
must be issued to the successor trustee.
In many deals, draws on the LOC are made, and
purchase price for optional and mandatory tenders
is paid by the tender agent or some other party,
rather than by the trustee. In these transactions, the
same concern with respect to a vacancy in that
position would exist, and as a result, the provisions
used for the resignation/removal of the trustee
would also apply to the resignation/removal of the
party in question.Municipal Structured Finance214 Standard & Poor’s Public Finance Criteria 2007