Standard & Poor's Corp. last week issued ratings criteria for debt service fund transactions.

The tramactions present rating complications because they can involve an issuer's reliance on guaranteed investment contracts, forward delivery agreements, or other derivative structures. Issuers, however, are increasingly using such transactions to lower debt costs.

"As with other types of derivatives, the issuer needs to understand the risks and rewards associated with their use," the rating agency said in a release. "If used prudently, these instruments should not have an adverse impact on an issuer's credit quality."

The rating agency will consider, for example, the possibility that the prorider of a forward delivery agreement could become insolvent. If the issuer was obligated to make its debt payments directly to the provider, the insolvency could interrupt payments to bondholders.

So Standard & Poor's will examine insolvency opinions on debt service fund deals. The opinion should include three main provisions, the rating agency said.

First, the opinion should state that payments the provider has already made into the debt service fund cannot be reclaimed by creditors or other parties if the provider goes bankrupt. In some instances, bankruptcy laws allow payments made before an insolvency to be reclaimed.

Second, it should state that payments out of the debt service fund to bondholders cannot be frozen or held up by a conservator, receiver, or liquidator.

And third, the opinion should state that securities in the debt service fund will not be included as part of the provider's assets.

Standard & Poor's has criteria for acceptable debt service fund investments, including minimum ratings in some cases. Without an insolvency opinion, the rating agency "would look only at the rating of the counterparty, and not at the rating. of the securities being provided" when assessing the debt service fund.

In some cases, however, the debt service fund investments are unimportant from a credit standpoint.

If the issuer can make a debt payment due on bonds without relying on funds already deposited in the debt service fund, the creditworthiness of the fund is obviously less important.

The rating agency gave two exampies. A general obligation issuer with unlimited taxing power would not be tied to the debt service fund. But a transportation issuer with no rate-setting power would have to get an insolvency opinion on a debt service fund transaction or face rating scrutiny.

Standard & Poor's is also concerned about the potential effect of early termination payments on credit quality. If a debt service fund agreement terminates before maturity, an issuer may have to make a significant payment to the provider.

"Issuers with limited revenue-raising flexibility should consider structural features, such as subordinating termination payments to debt service payments or amorthing such payments over a period of time, to mitigate any risks to their creditworthiness," Standard & Poor's said.

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