UNITED STATES
 

SECURITIES AND EXCHANGE COMMISSION
 

WASHINGTON. D.C. 20549 ACT Icf7 - /9LfO
 

DIVISION OF
 

INVESTMENT MANAGEMENT SETION

RULE ;;0. - 7 

PUBLIC 

A V AILABIL 7 -;) 0 - c¡ 1/ 

July 20, 1994
 

Ada W. Glass, Esq.

Orrck, Herrgton & Sutclife 

599 Lexigton Avenue
 

New York, NY 10022
 

Dear Mr. Glass: 

Your letter dated July 19, 1994 (a copy of which is attched) requests that the 

Division of Investment Management agree that the short-term municipal ratings assigned to 

Series C Revenue Anticipation Warrts issued by the State of Calorna ("RAWs") wil be 

treated as long-term debt ratings under pargraph (c)(3)(ii) of rule 2a-7 if the RAWs are 

converted into Varable Rate Instruments (as this term is defined in pargraph (a)(21) of rule 

2a-7) that are eligible for purchase by money market funds ("Synthetic RAWs"). You 

represent that, consistent with this defintion, upon adjustment of the interest rate of a 

Synthetic RAW, the market value of the Synthetic RAW can reasonably be expected to 

approxiate its par value. 

You state that the RAWs wil mature in 22 months, and the entire pricipal and interest amount wil be payable on Apri 25, 1996. Prcipal and interest on the RAWs is 

guarantee by the unconditional obligation of a consortium of fourteen bans ("Bans") to 

purchase the RAWs on the maturity date under the terms described in your letter.1 

The RAWs wil receive "short-term" ratings from three nationaly recognied 

statistical rating organations ("NRROs") as follows: Moody's Investors Service -­

MIG-1; Stadad & Poor's Coiporation -- SP-1; and Fitch Investors Service -- F-1 +. Thus, 

the RAWs wil 
 be rated by the Requisite NRROs (as such term is defined in pargrph 

(a)(13) of rule 2a-7) withi the highest generic ratig category for short-term municipal


obligations (withi which there may be sub-categories or gradations indicatig relative 

stading). You represent that the short-term obligations of each of the Ban are also rated

in the highest generic short-term categories by a NRRO. Not al the Bans wil have longterm debt obligations rated in one of the two highest generic long-term rating categories by a
 

NRRO. You also advised that the short-term debt of the issuers of the Demand Features 

(as that term is defined in pargraph (a)(4) of the rule) wil have the highest short-term debt

ratings from the Requisite NRROs. 

The obligations of the Bans are severa; that is, if one Ban defaults in its obligation 

to repurchase its portion of the RAWs, the other Bans are not required to assume 

the obligation of the defaultig Ban and purchase more than their alotted shares. 
- 2 ­

The Synthetic RAWs wil be subject to a conditional Demand Feature. The Demand 

Feature wil permit the holder of a Synthetic RAW to "put" the instrment back to the put 

provider on each interest rate reset date. In your letter and subsequent telephone cals, you 

advised that the Demand Feature "wil be subject to customar conditions on its exercise," 

including the downgrade of the ratings of the RAWS or any Ban to below investment 

grde. 

Pargraph (c)(3)(ii) of rule 2a-7 provides that an instrment subject to a conditional 

Demand Feature is an Eligible Security (as that term is defined in pargrph (a)(5) of rule 

2a-7) if: (1) the Demand Feature is rated by the Requisite NRROs in one of the two 

highest rating categories for short-term debt obligations; and (2) the underlying security is 

rated in one of the two highest rating categories for long-term debt obligations. If such 

instruments are not rated by a NRRO, they must be determined to be of comparble 

qualty. 

Based on your ora and written representations and without necessary agreeing with 

your legal analysis, the Division wil not object if money market funds purchasing the 

Synthetic RAWs treat the short-term ratings assigned to the RAWs as ratings assigned to 

long-term debt obligations for puiposes of pargraph (c)(3)(ii) of rule 2a-7. We note that, 

as with any other instrument, a money market fund may invest in Synthetic RAWs only if 

its board of directors (or the board' s delegate) determines that the Synthetic RAWs present 

minal credit risks (which determination must be based on factors pertg to credit 

qualty other than the rating assigned by an NRSRO). Pargraph (c)(3) of rule 2a-7. Ths

letter does not address whether Synthetic RAWs present minal credt risks. Because the 

Bans' obligations are severa, a fund must evaluate, among other thigs, the credit qualty

of each Ban. 

Sincerely, 4U8ARobert E. Plae 

Assistat Director
 
I)RRICK, HERRINGTON 

&: SUTCLIFFE 

July 19, 1994 DiTedDil
 

VIA TELECOPIER
 

Robert E. Plaze
 

Assistant Director
 

Division of Investment Management
 

Securities and Exchange Commission
 

Washington, D. C. 20549
 

Re: Status of Certain Synthetic Securities 

Backed by California RAWs as Eligible
 

Investments for Money Market Funds
 

Dear Mr. Plaze: 

As we discussed earlier today, this letter sets forth
 

our view as to why the synthetic securities described below are
 

eligible for purchase by money market funds under Rule 2a-7.
 

Background 

Tomorrow the State of California will price $4 billion
 

of revenue anticipation warrants ("RAWs") maturing in 22 months.
 

The entire amount of principal and interest due on the RAWs will
 

be payable in a single payment on April 25, 1996, the maturity
 

date of the RAWs (i. e., there will be no periodic payments of
 

interest prior to maturity). The RAWs are issuable in separate
 

series. Payment of principal and interest on the Series CRAWs
 

is effectively guaranteed by the unconditional obligation of a
 

consortium of 14 banks (the "Banks") to purchase the RAWs on the
 

maturity date, pursuant to a bond purchase agreement, at a
 

purchase price equal to the principal and accrued interest
 

thereon, if payment of the principal and interest of the RAWs is
 

not made in full by the State of California on the maturity date.
 

The obligations of the Banks under the bond purchase agreement
 

are several; that is, if one Bank defaults in its obligation to
 

repurchase its portion of the Series C RAWs, the other Banks are
 

not required to assume the obligation of the defaulting Bank and
 

purchase more than their allotted shares. The Series C RAWs will
 

be rated F-1+ by Fitch Investors Service ("Fitch"), MIG-l by
 

Moody's Investors Service ("Moody's") and SP-l by Standard &
 

Poor's Corporation ("S&P"), and will not be rated by any other
 

NRSRO. (Fitch, Moody's and S&P are referred to collectively
 

hereinafter as the Rating Agencies.) Each such rating represents
 

the highest generic rating category used by the assigning NRSRO
 

in rating short-term municipal obligations. The short-term debt
 

obligations of each Bank are rated "Al/Pl" or the equivalent.
 

59 Legtn Avenue · New York, New York 10022
 

Telephone 212 326 88 . Facsime 212 326 890
 

Sa Frci 415 392 1122 · Los Aneles 213 629 20io . Saciento 916 447 9200 · w.hingtn. DC. 202 628 4700
 
(tRRICK, HERRINGTON 

&: SUTCLIFFE 

Robert E. Plaze
 

Securities and Exchange Commission
 

July 19, 1994
 

Page 2
 

However, we understand that not all the Banks have long-term debt
 

obligations rated "M" or higher by an NRSRO.
 

Proposed Synthetic Securities
 

We represent CS First Boston and other investment


bankers as potential purchasers of the Series CRAWs. Our 

clients intend to repackage the Series C RAWs into synthetic
 

floating rate securities for sale to money market funds. While
 

the details of the synthetic securities to be issued may vary
 

from sponsor to sponsor, you may assume for purposes of this
 

letter that each such synthetic security (each, a "Synthetic
 

Security") will be a Variable Rate Instrument as defined in
 

paragraph (a) (21) of Rule 2a-7 (the "Rule"); that is, its
 

interest rate will adjust on set dates and upon such adjustment
 

its market value can reasonably be expected to approximate its
 

par value. Furthermore, such Synthetic Security will be subject
 

to a Demand Feature which permits the holder to "put" the
 

Synthetic Security to a bank or other put provider at a purchase
 

price equal to par plus accrued interest on each interest rate
 

reset date. The Demand Feature will be subj ect to customary
 

conditions on its exercise and will therefore not qualify as an


"Unconditional Demand Feature" as defined in paragraph (a) (19) of 

the Rule.
 

Analysis 

Based on earlier conversations with you we understand
 

that for the Synthetic Securities to be "Eligible Securities"
 

under paragraph (a) (5) of the Rule, in pertinent part, (1) the
 

Demand Feature must be rated by the Requisite NRSROs in one of
 

the two highest rating categories for Short-term debt
 

obligations, and (2) the underlying or "core" security (in this
 

case the Series C RAWs) must be rated in one of the two highest
 

rating categories for Long-term debt obligations. (We understand
 

the staff's interpretation of this provision under the existing
 

Rule to be substantially the same as what is set forth somewhat
 more explicitly in paragraph (c) (3) (ii) of proposed Rule 2a-7.) 

A question has arisen whether the ratings of F-1+,
 

MIG-1 and SP-1 by the Rating Agencies of the Series C RAWs are
 

sufficient to constitute ratings in one of the two highest rating
 

categories for Long-term debt obligations for purposes of the
 

Eligible Security determination under the Rule. Because these
 

NYl-59189.2 
(tRRICK, HERRINGTON 

&: SUTCLIFFE 

Robert E. Plaze
 

Securities and Exchange Commission
 

July 19, 1994
 

Page 3
 

ratings are generally recognized as short-term rather than long-


term ratings, concern has been expressed that these ratings may
 

not satisfy the Rule's requirement that the "core security" have
 

a Long- term rating in one of the two highest categories.
 

While we are not familiar with the reasons for the
 

Rating Agencies' determination to rate the California RAWs with a
 

rating customarily given to short-term obligations (i.e., those
 

maturing in a year or less), we believe that these ratings are
 

sufficient to meet the "core security" rating requirement
 

applicable to synthetic securities packaged with a conditional
 

Demand Feature under the Rule.
 

The Series C RAWs mature in 22 months, and are
 

therefore Long-term debt obligations within the Rule, by virtue
 

of paragraph (a) (9), which defines "Long-term" to mean "having a
 

remaining maturity greater than 366 days." The Rating Agencies
 

have rated the Series C RAWs in their highest generic rating
 

categories. Thus, the ratings appear to be long-term ratings
 

within the meaning of the Rule, notwithstanding that they are
 

ratings customarily given to short-term instruments. Although it
 

is rather unique for a rating agency to assign a rating
 

customarily applied to short-term obligations to an obligation
 

with a maturity greater than 366 days, the F-1+, MIG-1 and SP-1
 

ratings appear to satisfy in substance the requirements of the
 

Rule. Moreover, this situation is distinguishable from the case
 

where an issuer or put provider has a short-term rating which is
 

higher than its long-term rating. There is no other rating by
 

the Rating Agencies of the Series CRAWs, and the F-1+, MIG-1 and
 

SP-1 ratings appear to have the functional significance of a
 

traditional long-term rating. Therefore, it would appear to be
 

an overly technical reading of the Rule, and inconsistent with
 

the Rule's significant reliance on the judgment of rating
 

agencies, to find that because the Rating Agencies used short-


term nomenclature to designate their ratings of the Series C
 

RAWs, the Synthetic Securities cannot be purchased by money


market funds. 

Substantively, the Rating Agencies have determined that
 

the Series C RAWs are of high credit quality. The purpose of
 

requiring a rating of the core security for a synthetic security
 

is presumably to provide an additional element of protection to
 

money funds in the event that the conditional put is not
 

available because one of the conditions permitting the put
 

NYl-59189.2 
(tRRICK, HERRINGTON 

&: SUTCLIFFE 

Robert E. Plaze
 

Securities and Exchange Commission
 

July 19, 1994
 

Page 4
 

provider to avoid its obligation has occurred. The F-1+, MIG-1
 

and SP-1 ratings of the Series C RAWs appear more than sufficient
 

to provide this additional element of protection.
 

Long-Term Credit Ratings Of Consortium Banks
 

A concern has also been raised whether, notwithstanding
 

the ratings by the Rating Agencies, the Synthetic Securities may
 

not be Eligible Securities because not all of the Banks have
 

credit ratings in the two highest categories for Long- term debt
 

obligations. Therefore, the argument runs, if the Series CRAWs
 

were unrated so that a determination of credit quality depended
 

on an analysis of Bank ratings, the Bank ratings would be
 insufficient. 

However, the Series C RAWs are not unrated. Thus, a
 

fund has no choice but to look to the ratings assigned to the
 

Series C RAWs in making the Eligible Security determination. The
 

concern that funds might "game" the Rule by choosing to look
 

through to the rating of the underlying credit enhancers only
 

when it suited their purposes ís inapplicable in this context,
 

since the actual ratings assigned to the Series C RAWs preclude
 

reference to any other means of determining the creditworthiness
 

of the Series C RAWs for Eligible Security purposes.
 

For any synthetic securities where, as here, the "core
 

security" has been assigned an actual rating, there is no leeway
 

for "comparable quality arbitrage" by funds seeking to choose the
 

most favorable method of determining credit quality of the core
 

security. (Moreover, if funds were to be required to "look
 

through" to the credit ratings of the Banks, as a practical
 

matter, the presence of 14 banks with different credit ratings in
 

the consortium would make the comparable quality determination
 

difficult and unwieldy.)
 

Finally, while the terms of the Rule do not require
 

looking behind the ratings assigned by the Rating Agencies, which
 

are sufficient to provide the core security rating element
 

required by the Rule, if the staff were inclined to do so, we
 

believe that the Banks' short-term ratings should be taken into
 

account in light of the 22 month maturity of the Series CRAWs.
 

We note that within 9 months after issuance, both the Synthetic
 

Securities and the Series C RAWs will have actual final
 

maturities of less than 397 days. As mentioned above, the shortNYl-59189.2 
(tRRICK, HERRINGTON 

&: SUTCLIFFE 

Robert E. Plaze
 

Securities and Exchange Commission
 

July 19, 1994
 

Page 5
 

term rating of each of the Banks is A-1/P-1 or the equivalent
 

(i.e. the highest generic rating category for short-term debt
 obligations) . 

Conclusion 

Based on the analysis set forth above, we would
 

appreciate your confirming that Synthetic Securities having the
 

features described above will be Eligible Securities for money
 

market funds under the Rule. If you have any further questions,
 

please feel free to contact the undersigned at (212) 326-8819 or
 

Michael Voldstad of this office at (212) 326 - 8806. Thank you for
 

your prompt consideration of this matter.
 

Adam W. Glass
 

NYl-59189.2