To avoid this structural risk, liquidity events such
as mandatory or optional tenders should be sched-
uled to precede the termination of the liquidity por-
tion of the direct-pay instrument.
Fannie Mae and Freddie Mac direct-pay struc-
tures may include a mandatory tender upon substi-
tution of an alternate credit facility without rating
maintenance. This substitution could be problemat-
ic in the fixed-rate mode if the liquidity support has
expired. To resolve this issue, the documents can:
■Limit substitution to the variable-rate modes;
■Provide that the credit facility portion or a liquid-
ity facility portion will be available to back the
tender;
■Indicate that credit facility expiration leads to a
redemption; or
■Indicate that substitution can only occur if
remarketing proceeds equal to the full purchase
price of the bonds are to be on hand for the sub-
stitution to occur, otherwise the credit facility
will remain in effect or there will be a redemp-
tion of the bonds if the credit facility is scheduled
to expire.
These suggestions resolve Standard & Poor’s liq-
uidity concerns that could negatively affect bond-
holders. Standard & Poor’s will continue to
evaluate the direct-pay structure and legal docu-
ments to ensure the necessary provisions are in
place to address this issue.Standby Credit Facilities
Fannie Mae and Freddie Mac provide another type
of credit enhancement on bond issues in the form of
a standby credit facility. In this structure, the GSE is
obligated to make payments to the trustee in the
amount of the mortgage payment once the payment
is a specified number of days delinquent. Since the
GSE agreement does not cover investment earnings,
all revenues must be invested in investments rated as
high as the bonds. In addition, payment of trustee
fees must be provided for in a no-default and post-
default situation. Similar to the cash flows required
for MBS as described below, standby credit facility
transactions should include cash flows run with a
lag to take into account the timing of the GSE’s pay-
ment to the trustee, as well as the regular payment
lag on the underlying project mortgage.Ginnie Mae Programs
Under the FHA (223)(f) Ginnie Mae coinsurance
program, used for rehabilitation and repair of exist-
ing multifamily dwellings, the owner completes the
necessary repairs permitting the issuance of the
MBS and obtains a mortgage loan on the project
from the lender. At this time, bond proceeds, held
in an acquisition fund by the trustee, are used toacquire the MBS. The Ginnie Mae security securing
the mortgage is assigned to the trustee.
The Section 221 (d)(3) and (d)(4) programs (con-
struction and substantial rehabilitation) and Section
232 program (nursing homes) are similar to the 223
(f) program, where all bond proceeds are escrowed
until the permanent Ginnie Mae-backed security is
acquired. In most 221 and 232 issues, there is a
construction period in which disbursements are
made, and funds are released periodically from the
escrowed program or project fund. (Some 221
issues use an outside source for construction, elimi-
nating the construction draws.) As the borrower
constructs the project, disbursement draws are
requested from the FHA. Because the rating is
based solely on Ginnie Mae, no credit is given to
the FHA-insured advance (draw) until it is securi-
tized by Ginnie Mae. This process of converting the
FHA-insured draw into a Ginnie Mae security,
called a construction loan certificate (CLC), is per-
formed by the co-insured lender, and takes about
20 business days.
The CLC bears an interest rate equal to the lower
of the temporary or permanent rate established by
the FHA under the mortgage note. As construction
draws are made, they are converted into CLCs
bearing the same interest rate and maturity. The
CLCs represent full collateralization by Ginnie
Mae, which guarantee timely payment of interest
on the 15th of the month and stated principal at
maturity. At the project’s completion and the mort-
gage’s final endorsement, all CLCs are exchanged
for a permanent loan certificate (PLC), which is the
long-term Ginnie Mae-backed security.
The mortgagor makes its payments to the lender
on the first of each month. The lender, in turn, pass-
es these payments through to the bond trustee by
the 15th of that month (in the case of Ginnie Mae
programs), representing payments on the MBS. (The
mortgage rate is higher than the rate on the MBS.
This differential covers the lender’s servicing fee and
the Ginnie Mae guarantee fee.) If the mortgage pay-
ments are not paid by the owner, or are insufficient
to pay the trustee the principal and interest due on
the MBS, the lender is required to pay the trustee
the amount due from its own monies. If the trustee
fails to receive payment from the lender by the close
of business on the 15th, or the 17th if the MBS is
held in book entry, the indenture should require the
trustee to seek immediate payment from Ginnie
Mae. Since Ginnie Mae guarantees timely payment,
there is no need for a debt service reserve funds
(DSRF) to cover liquidity risk.
If the mortgagor prepays all or a portion of its
mortgage, this amount will be prepaid to the lender
and then passed on to the trustee as a prepayment
on the Ginnie Mae security. The prepaymentHousing260 Standard & Poor’s Public Finance Criteria 2007