The Handbook of Municipal Bonds

CHAPTER 61

The Use of Letters of Credit in Connection with Municipal Securities

Todd P. Zerega, ESQ. Reed Smith LLP

 

 

 

Letters of credit (LOCs) are frequently used by issuers⁷²⁹ of municipal securities to enhance the creditworthiness, and thus marketability, of municipal debt securities. LOCs are issued by banks or other financial institutions and typically evidence an obligation by the bank or financial institution to pay the principal and interest on a municipal security to the beneficiary of the LOC.⁷³⁰ By using a LOC in connection with the issuance of their municipal securities, issuers seek to reduce their borrowing costs by increasing the creditworthiness and liquidity of their securities. Similarly, purchasers of municipal securities backed by a LOC are attracted to the increased creditworthiness of the security and the increased liquidity the LOC may provide in case of an event of default, exercise of a tender option or maturity of the security. This chapter will outline the basic mechanics of a LOC-backed municipal security (LOC-backed security) and review some of the considerations that an analyst for a potential investor should consider before investing in such a security.

Note: This chapter is presented for informational purposes only and is not intended to constitute legal advice.

OVERVIEW OF LOCS

LOCs issued in the United States are generally governed by Article 5 of the Uniform Commercial Code (UCC) as it has been enacted in the various states. The UCC is a ...