S&P Global Ratings periodically evaluates its application of criteria as facts and circumstances change and as markets mature. Based on the characteristics of convertible option bonds (COBs) issued over the past several years, typically by state or local housing finance agencies (HFAs) for mortgage revenue bond programs, we believe that assigning a dual rating would enhance the transparency of our analysis around the long-term and short-term features of these bonds.

HFAs typically issue COBs to preserve private activity bond volume cap for future issuance as volume cap carryover dates draw closer. In addition, during periods when the yield curve is inverted and tax-exempt to taxable spreads widen, HFAs may issue COBs to maximize short-term investment earnings. This Credit FAQ addresses some frequently asked questions regarding S&P Global Ratings' revised approach to rating COBs for mortgage revenue bond programs. We recently modified our approach to align our analytical view with certain structural elements of COB obligations.

Frequently Asked Questions

What primary factors does S&P Global Ratings consider in rating COBs in mortgage revenue bond programs?

In accordance with our "Methodology For Rating U.S. Public Finance Mortgage Revenue Bond Program" criteria, published Oct. 10, 2022, on RatingsDirect, and as further explained in our "Methodology For Linking Long-Term and Short-Term Ratings," published April 7, 2017, S&P Global Ratings will consider:

• The original maturity of the obligation;
• The rating on the program under which the COBs will be issued, including the effect, if any, of the COB issuance on the strength of the program;
• The certainty that funds will be available to pay tendering bondholders in full on the mandatory tender date in the event the bonds are not remarketed;
• The structure of the COBs (i.e. fixed or floating); and
• The HFA's optionality and bondholders' ability to retain bonds after the mandatory tender date.

COBs typically have long-dated maturities with the possibility of tender over a shorter period depending on short-term market access at a tender date. We expect to assign a dual rating at the initial issuance date to reflect the long-term and short-term credit quality of these obligations and will rate subsequent remarketing(s) to evaluate any rating impact from any change to the elected bond structure.

What impact does the time to the mandatory tender date have on the COB ratings?

COBs are typically issued with both an earlier optional tender date and a final mandatory tender date. The mandatory tender functions similarly to a demand feature, but is exercised at the HFA's discretion. We will no longer differentiate between short-term and long-term ratings for COBs based on the timing of the mandatory tender(s). By applying our dual rating, we believe the analysis reflects both the long-term credit rating based on the long-term maturity date of the COB and the program's liquidity and/or market access required to remarket the bonds on the mandatory tender date(s). We apply our criteria "Methodology For Linking Long-term And Short-Term Ratings" to determine the short-term component of the dual rating.

How does S&P Global Ratings evaluate market access?

Generally, HFAs with highly rated debt obligations, legal authority for the takeout debt, and information availability (through ongoing disclosure or through transaction documents) should have market access as necessary. But in some cases, to gain additional insights for our analysis, we may ask HFAs about market interest on previous and similar type of transactions.

What if COBs are issued in variable-rate mode?

For COBs structured as variable-rate demand obligations (VRDOs) with a rated third-party letter of credit or liquidity facility, S&P Global Ratings will follow its "Methodology For Analyzing Letter Of Credit And Bank Liquidity-Supported Transactions," published March 20, 2023, as applicable. For variable-rate transactions relying on self-liquidity, S&P Global Ratings will follow its "Commercial Paper, VRDO, And Self-Liquidity" criteria, published July 3, 2007. We will typically assign dual ratings in either case above.

For any variable-rate structure, whether publicly or privately sold, we will utilize our high/low vector assumptions by the different rating categories to stress the cash flows. (For the full criteria, see "Methodology To Derive Stressed Interest Rates In Structured Finance," published Oct. 18, 2019).

What information is most commonly requested for the COB rating?

• Consolidated cash flows updated to reflect the maximum reinvestment rate assumptions for the COB proceeds, according to the applicable rating category, as set forth in "Methodology And Assumptions For Stressed Reinvestment Rates For Fixed- Rate U.S. Debt Obligations," published Dec. 22, 2016;
• Additional cash flow scenarios as outlined in our "Methodology For Rating U.S. Public Finance Mortgage Revenue Bond Programs" criteria, published Oct. 10, 2022, depending on the structure of the COBs transaction and the program's asset-to-liability parity;
• Legal documents and disclosure documents related to the COBs;
• Planned investment for the proceeds of COBs;
• For variable rate structures supported by self-liquidity, a letter from management addressed to S&P Global Ratings describing its liquidation procedures in detail with the major parties named and their roles defined;
• For variable-rate structures supported by external liquidity, letter of credit or liquidity facility documents; and
• Continuing Covenant Agreement or private placement documents for HFAs considering direct purchases (private placements).

Related Research

• Methodology For Rating U.S. Public Finance Mortgage Revenue Bond Programs, Oct. 10, 2022
• Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• S&P Global Ratings Definitions, June 9, 2023
• Commercial Paper, VRDO, And Self-Liquidity, July 3, 2007
• Methodology For Analyzing Letter of Credit And Bank Liquidity-Supported Transactions, March 20, 2023
• Contingent Liquidity Risks In U.S. Public Finance Instruments: Methodology And Assumptions, March 5, 2012