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United Financial Technologies
UFTCF Master Participation Agreement
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UFT Commercial Finance INSTITUTIONAL SERVICES
Reserved Tender Advance Facility DOCUMENTATION
CREDIT ENHANCEMENT SERVICES

In the operation of either the CVRDN or MVRDN, the role of pre-qualified, sophisticated, investment grade commercial banks, finance companies, insurance companies, investment banks and guarantors as a source of quality credit enhancement is undeniable. As such, United FT understands that institutional participation and support of the foundational credit enhancement practices must be a focus in assuring the effective adoption of these instruments in the marketplace. With this in mind, a wide-spread institutional educational and recruitment program has been undertaken in order to illustrate the benefits of issuance of letters of credit and the establishment of the Reserved Tender Advance Facilities as alternative credit tools to traditional term loans, credit lines, leverage facilities, and mortgage structures.

The following profiles each available form of credit enhancement vehicle used in support of the various components and operations of the CVRDN or MVRDN, as the case may be.

Principal Letter of Credit as a principal enhancement to a CVRDN

A Principal Letter of Credit is issued by an investment grade bank, financial institution or a qualified guarantor for the purposes of supporting the principal portion of a CVRDN upon a note conversion. The Principal Letter of Credit is secured with assets or collateral usually directly associated with the underlying purpose of the finance. For example, the Principal Letter of Credit would be secured by a collateral position taken upon a building that is being acquired with Note Proceeds or secured by title to certain goods that are being bought or financed with Note Proceeds.

The Principal Letter of Credit serves two key functions in the operations of the CVRDN. First, it represents one of the cornerstone supports in the credit enhancement of the CVRDN Series such that the CVRDN will be rated a minimum A1 by a major rating agency. Therefore, the CVRDN is investment grade quality, and thus, marketable into the institutional marketplace. Second, because it is unlikely that the underlying assets/collateral for the Principal Letter of Credit could be quickly and cost effectively liquidated upon short notice, the Principal Letter of Credit is an important source of liquidity in the event of an optional tender of any portion of the Notes to which that Principal Letter of Credit applies. The Principal Letter of Credit is able to be drawn to cover a shortfall of principal payments required during the normal operation of the Notes in accordance with the Note terms.

One or more Principal Letters of Credit may be issued at any time following the issuance of the CVRDN Series as and when Note Proceeds are scheduled for release by the Note Issuer in favor of the project or operation that is being financed. Specifically, upon CVRDN issuance, the Notes are issued in a convertible form and secured for principal via the operation of an Interim Reserved Tender Advance Facility (see below).

The Interim Reserved Tender Advance Facility is ultimately supported by the interim asset management of the Note Proceeds arising from the issuance of the CVRDNs. When funds are required to finance the project or operation for which the CVRDNs were issued, one or more Principal Letters of Credit are delivered to the Trustee of the Note Series. This triggers a Note Conversion which, in practical terms, permits the substitution of the Principal Letters of Credit for an equal value of Note Proceeds. Once a Principal Letter of Credit has been issued and accepted, not only is the amount of available Note Proceeds reduced by an amount equal to the face value of the Principal Letter of Credit as they are applied to the intended underlying project, but the value of the Interim Reserve Tender Advance Facility is also reduced by a corresponding amount since that portion of principal security for the Notes within the Series now rests solely upon that particular Principal Letter of Credit.

Interest Letter of Credit as an interest enhancement to a CVRDN or MVRDN

The issuance of an Interest Letter of Credit in relation to a CVRDN or MVRDN works to secure the payment of interest on a revolving basis throughout the term of the Notes. The Interest Letter of Credit is issued as a direct-pay credit, drawable monthly by the Trustee of the Notes for the payment of interest due on each scheduled Payment Date. Interest due is calculated on an interest-only basis at the prevailing rates adjusted every 7 days throughout that monthly interest period. Upon the draw of the Interest Letter of Credit, its face value is reinstated and the Interest Letter of Credit Issuer is reimbursed for the amount drawn.

Additionally and dependent upon the underwriting or credit requirements of any one of the institutions that are credit enhancing the principal portion of the Notes, the Note Issuer may be required to set aside an amount of funds equal to a pro rata portion of interest due for a certain period of time as an interest reserve to assure that funds are readily available to reimburse amounts drawn under the Interest Letter of Credit. This results in better guarding against a risk of interest default which could directly and negatively impact each respective principal underwriter.

Generally, the Interest Letter of Credit will be secured by either cash or other acceptable collateral to be deposited with or pledged in favor of the Interest Letter of Credit issuing institution. The face value of the Interest Letter of Credit is calculated to be equal to 35 days’ interest at a cap rate minimally equal to 12% or as high as 18% (dependent on prevailing 30-day LIBOR) calculated over a 365-day year. Although not required, the Interest Letter of Credit may be issued by the same institution that issues one or more of the Principal Letters of Credit or underwrites all or any portion of the applicable type of RTAF, as the case may be.

Interim Reserved Tender Advance Facility (“Interim RTAF”) as a principal enhancement to a CVRDN

The Interim RTAF is a foundational ingredient in the customary operation of the CVRDN. Every CVRDN is issued with a view to raise debt finance by the Issuer in “bulk” for the purposes of subsequent application of those proceeds into the Issuer’s designated area of commercial operation or industry. Bearing this in mind, there is a period of time during the life of a CVRDN when all or a portion of Note Proceeds – prior to being deployed into their ultimately intended commercial application – are awaiting allocation. During that period, the Note Proceeds are still accruing interest at a variable rate that is hovering just basis points over 30-day LIBOR, with that interest remaining payable to the Noteholders pursuant to the Note terms. It is at the point when CVRDN Proceeds have been raised, but have not yet been actively applied to the commercial operations of the Issuer, that the unallocated Note Proceeds are placed initially in a reserve account under management with a pre-qualified Interim Asset Manager that has been selected and engaged by the Issuer as the means to offset accruing interest on those Note Proceeds.

The Interim Asset Manager’s objectives are to (i) preserve the principal value of proceeds under management, and (ii) generate a yield on the Note Proceeds under management that meets and likely exceeds the interest rate accruing on the Note Proceeds placed under its management. In some cases, the Interim Asset Manager may be managing some portion of Note Proceeds for as long as three years or more following the initial issuance date of the CVRDN Series, depending upon the speed and frequency at which the Issuer deploys Note Proceeds to its ultimately intended commercial operation. With each such deployment of funds, the Interim Asset Manager’s funds under management decreases by a like amount, and its responsibility for generating yield on those deployed fund thereafter passes away.

While Note Proceeds are under interim management, the operation of the Interim Asset Manager is coordinated with the establishment of an Interim RTAF. An RTAF is constituted by a two-party credit agreement that sets certain terms and conditions under which credit will be granted to the Issuer at a future date upon first call therefore by the CVRDN Trustee. Like any RTAF structure that may be employed within the framework of CVRDN issuance, the Interim RTAF exhibits two of the cornerstone components of every RTAF: (a) the Interim RTAF serves as a means to credit enhance the principal portion of the convertible CVRDNs prior to the RTAF being supplanted by the credit enhancement that is afforded via a Principal Letter of Credit, and (b) the Interim RTAF provides liquidity to cover the purchase price of the principal portion of all or any portion of the CVRDNs that may be repurchased on behalf of the Issuer in the event of the exercise of an optional tender that is not otherwise satisfied or upon any call for principal by the Note Trustee as permitted under the Note conditions.

The operation of an Interim RTAF, however, relates primarily to the activities of the Interim Asset Manager on behalf of the Issuer. Specifically, a thorough evaluation of the investment strategy of the Interim Asset Manager is the basis by which the RTAF Provider will agree to the establishment of an Interim RTAF. The strategy must be reviewed, approved and underwritten by the Interim RTAF Provider prior to the commencement of asset management operations such that all instruments, securities or investments that are or will be acquired by the Interim Asset Manager meet certain investment eligibility criteria that have been agreed by the Interim RTAF Provider. Then, upon the Interim RTAF Provider’s approval of the Interim Asset Manager’s operation, the Interim RTAF becomes the vehicle for credit enhancing those CVRDNs which principal amount of proceeds have been placed under management with the Interim Asset Manager.

The credit enhancement constituted by an Interim RTAF – like the enhancement created via the issuance of a conventional Principal Letter of Credit – is secured upon any call for a principal payment thereagainst by taking a first position on CVRDNs that are purchased with the proceeds of the Interim RTAF, which CVRDNs are ultimately supported by the corresponding, underlying investment value of the interim asset management portfolio as such has been approved and monitored by the Interim RTAF Provider.

Commercial Reserved Tender Advance Facility (“Commercial RTAF”) as a principal enhancement to a CVRDN

In that the Commercial RTAF is first and foremost part of the family of RTAF structures employed within the framework of CVRDN issuance, the Commercial RTAF exhibits two of the same key attributes of every RTAF: (a) the Commercial RTAF serves as a means to credit enhance the principal portion of the convertible CVRDNs upon issuance, and (b) the Commercial RTAF provides liquidity to cover the purchase price of the principal portion of all or any portion of the CVRDNs that may be repurchased on behalf of the Issuer in the event of the exercise of an optional tender that is not otherwise satisfied or upon any call for principal by the Note Trustee as permitted under the Note conditions. Also, like any RTAF, the Commercial RTAF is established prior to issuance of the CVRDNs at market as the basis to support the investment grade rating of the CVRDNs, thus better assuring their marketability within the money market/institutional subscriber base.

The primary difference between a Commercial RTAF and most other types of RTAF structures comes down to the nature of the underlying collateral and, as an extension of that, the day-to-day means of administering the Commercial RTAF. The nature of the ultimate collateral/security that stands to secure the operation of a Commercial RTAF upon a call for payment thereunder is derived from the active management of the Note Proceeds by the Issuer or the Issuer’s affiliated operating entity in the commercial area or industry for which the CVRDN financing was raised. The functionality of a Commercial RTAF does not call for the short-term involvement of an Interim Asset Manager in fund management functions, but rather the active hand of the Issuer in the management of Note Proceeds within the area of the Issuer’s commercial expertise.

For example, an Issuer of CVRDNs that is doing business in a specialized niche of the commercial mortgage lending industry could issue its CVRDNs at market, establish a Commercial RTAF with a suitable Commercial RTAF Provider that has agreed with the collateral protections and operating safeguards observed by the Issuer within the customary framework of its lending practices, place proceeds in the reserve account for Issuer’s management, and then commence a program of commercial lending within the transactional context of the reserve account (or an alternate, RTAF-approved transactional account or theater) in which mortgage paper that has been underwritten by the Issuer (or its commercial operating affiliate) regularly substitutes for the cash collateral held on the account. In this example, the commercial mortgage paper may, pursuant to the commercial strategy of the Issuer as previously approved by the Commercial RTAF, be either held and inventoried or sold-off at a future date such that the cash proceeds of such sale will, again, substitute for collateral within the transactional account, thereby replenishing available cash for continuing transactional operations.

Depending first upon the soundness of the commercial operating model, this type of on-going practice of collateral substitutions creates a dynamic that minimally maintains the net asset value of underlying collateral such that it corresponds directly to the principal value of CVRDNs that are secured or credit enhanced for their principal portion by the operation of the Commercial RTAF. Thus, upon a call from the Trustee for the Commercial RTAF to disburse a payment sufficient to cover the purchase price of a block of optionally tendered CVRDNs, the Commercial RTAF takes a secured position against the Notes that are purchased with the RTAF proceeds (the “Pledged Note Collateral”). Ultimately, such Notes are supported by the value of the underlying collateral that is constituted by the portfolio of mortgage paper being held in custody within the Issuer’s reserve or designated transactional account.

In many respects, when it comes to working with commercial collateral that has a transactional dynamic more closely resembling securities or financial instruments than “brick and mortar” hard assets, the Commercial RTAF functions as a potentially more efficient hybrid between a RTAF and a conventionally issued Principal Letter of Credit. The Commercial RTAF can provide the underlying transactional fluidity of an RTAF for the active management and implementation of a pre-approved investment or commercial operating strategy while relying upon a collateral-base consisting of more conventional commercial assets that may more closely be associated with securing the issuance of a Principal Letter of Credit. Moreover, by the proper operation of a Commercial RTAF, an Issuer that is well-suited in its commercial operations to the application of a Commercial RTAF may not have a need to convert its CVRDNs by way of the delivery of one or more Principal Letters of Credit in order to apply Note Proceeds to its business model.

As such, the Issuer’s front-loaded costs of doing business as may stem from the issuance costs of a Principal Letter of Credit give way to more modest Commercial RTAF establishment fees and are thereafter supplemented by subsequent transactionally-based collateral substitution fees that are payable to the RTAF Provider upon each transaction completion – in and out – of the reserve or transactional account. In this way, the Issuer is paying its fees to the RTAF Provider in a manner consistent with its rate of active revenue generation through its commercial practices within its transactional account environment. This creates a set of conditions that eases demand on Issuer’s operating cash flows while potentially enhancing annualized returns to the Commercial RTAF Provider, dependent upon frequency of collateral substitutions.

Collateralized Reserved Tender Advance Facility (“Collateralized RTAF”) as a principal enhancement to a MVRDN

The MVRDN, through the incorporation of a Collateralized RTAF, constitutes an exceptional and cost-effective alternative to the issuance of a collateralized fund obligation (“CFO”) by a qualified hedge fund or asset management firm. The Collateralized RTAF secures the principal portion of an MVRDN while the Interest Letter of Credit secures the payment of monthly interest due. When taken together, these mechanisms enable the Issuer as Borrower to access debt capital sourced from the institutional capital markets on a non-leveraged and more cost effective basis than what may be customarily available to it when using traditional bank credit lines, leverage facilities or engaging in the issuance of a CFO.

Specifically, the MVRDN qualifies for purchase as an alternative to acquiring short-term liquidity money-market instruments, giving the MVRDN an exceptional capital base from which it may operate within the marketplace. With the help of a Collateralized RTAF, the capital resources that may be brought to bear for the benefit of the alternative investment sector as MVRDN Issuers are exceptionally broadened in scope and depth. In short, the MVRDN complies with many of the same restrictions and exemption guidelines that the VRDN satisfies while bringing with it a more manageable and lower cost debt capital source for the benefit of the Issuer as Borrower.

The efficient operation of the Collateralized RTAF is relied upon heavily as a cornerstone of the MVRDN when applied as a surrogate for a conventional CFO in the alternative investment market. Understanding the Collateralized RTAF requires an understanding of the core nature of a standard RTAF. Any RTAF is constituted by a two-party credit agreement that sets certain terms and conditions under which credit will be granted to the Issuer at a future date upon first call therefore by the Note Trustee or fiduciary of an MVRDN Series. Like any RTAF structure that may be employed within the framework of MVRDN issuance, the Collateralized RTAF exhibits two of the foundational components of every RTAF: (a) the Collateralized RTAF serves as a means of credit enhancement of the principal portion of the MVRDNs; and (b) in the event of the exercise of an optional tender that is not otherwise satisfied or upon any call for principal by the Note Trustee as permitted under the Note conditions, the Collateralized RTAF provides liquidity to cover the purchase price of the principal portion of all or any portion of the MVRDNs that may be repurchased on behalf of the Issuer.

The establishment of a Collateralized RTAF hinges on two issues: (i) the Collateralized RTAF Provider’s evaluation and approval of the investment strategy of the MVRDN Issuer; and (ii) the amount of equity available from the Issuer or other third party to cover first-losses resulting from a depletion of the net asset value under the MVRDN Issuer’s management or control pursuant to the approved investment strategy. The former calls for the investment strategy to be reviewed, approved, and underwritten by the Collateralized RTAF Provider prior to the commencement of asset management operations such that all instruments, securities or investments that are or will be acquired by the Issuer as the Asset Manager meet certain investment eligibility criteria that have been agreed by the Collateralized RTAF Provider. The latter calls for those equity funds that, in the case of a conventionally operated CFO, would normally be posted in favor of a bank or other leverage capital provider be availed by the Issuer (via the establishment of an equity reserve) in favor of the Collateralized RTAF Provider.

The equity reserve, when taken together with certain loss triggers that will be agreed between the Issuer and the RTAF Provider, will mitigate principal risk or ‘first losses’ in the operation of the Issuer’s investment portfolio. The equity reserve can be as little as 5% of the total principal amount of MVRDNs outstanding in a given Note Series or as substantial as 25% of that total, dependent upon the Collateralized RTAF Provider’s assessment of principal loss risk stemming from the operation of the Issuer’s sanctioned investment strategy. The Collateralized RTAF allows the Collateralized RTAF Provider to credit enhance the full principal portion of the MVRDN Series issued without absorbing the principal risk associated with net asset value depletion on the Issuer’s portfolio. The credit enhancement constituted by a Collateralized RTAF is secured upon any call for a principal payment thereagainst by taking a first position on MVRDNs that are purchased with the proceeds of the Collateralized RTAF, which MVRDNs are ultimately supported by the corresponding, underlying investment value of the asset management portfolio as approved and monitored by the Collateralized RTAF Provider as supplemented, as and when needed, by the equity reserve.

Within a conservative risk management framework in which the MVRDN Issuer, as the Asset Manager, is assuming a position to absorb first-loss or principal risk on its investment portfolio, the Collateralized RTAF represents a new and sustainable revenue opportunity for suitable credit enhancement firms, financial institutions or insurance companies.

Principal Reserved Tender Advance Facility (“Principal RTAF”) as a principal enhancement to a MVRDN

The Principal RTAF is an innovative means of enabling an institution that seeks to gain investment exposure into the alternative investment market to do so by taking up a role as the Principal RTAF Provider and thereby participating in selected investment fund opportunities on a non-cash basis. To appreciate how the Principal RTAF becomes effective and useful to an investment manager or fund as an MVRDN Issuer, first one must understand the general objectives behind the use of any RTAF. An RTAF is constituted by a two-party credit agreement that sets certain terms and conditions under which credit will be granted to the Issuer at a future date upon first call therefore by the Note Trustee or fiduciary of an MVRDN Series. Like any RTAF structure that may be employed within the framework of MVRDN issuance, the Principal RTAF exhibits two of the foundational components: (a) the Principal RTAF serves as a means of credit enhancement of the principal portion of the MVRDNs; and (b) in the event of the exercise of an optional tender that is not otherwise satisfied or upon any call for principal by the Note Trustee as permitted under the Note conditions, the Principal RTAF provides liquidity to cover the purchase price of the principal portion of all or any amount of the MVRDNs to be repurchased on behalf of the Issuer.

In short, the RTAF has been engineered and designed to marry together certain established structured product underwriting norms with more traditional liquidity facilities. Bearing this in mind, and as had been described in the previous section with regard to the operation of a Collateralized RTAF, the Principal RTAF secures the principal portion of an MVRDN while the Interest Letter of Credit secures the payment of monthly interest due. When taken together, these mechanisms enable the Issuer as Borrower and investment manager to access debt capital sourced from the institutional capital markets on a non-leveraged and more cost effective basis than what may be customarily available. Specifically, the MVRDN qualifies for purchase as an alternative to acquiring short-term money-market instruments, giving it an exceptional capital base from which it may operate within the marketplace.

The establishment of a Principal RTAF in support of an MVRDN Series hinges on two issues: (i) the Principal RTAF Provider’s evaluation and approval of the investment strategy of the MVRDN Issuer; and (ii) the profile of the MVRDN Issuer as the asset or investment manager. The former calls for the investment strategy to be reviewed, approved and underwritten by the Principal RTAF Provider prior to the commencement of asset management operations such that all instruments, securities or investments that are or will be acquired by the Issuer as the Asset Manager meet certain investment eligibility criteria that have been agreed by the Principal RTAF Provider. The latter acts a basis to demonstrate track record and stability of the Asset Manager, thus helping to allay concerns as to foreseeable business risk or fraud risk.

Upon the Principal RTAF Provider’s approval of the Asset Manager’s operation, the Principal RTAF becomes the vehicle for credit enhancing the full principal portion of the MVRDNs whose principal amount of proceeds will be placed under management with the Asset Manager. The credit enhancement constituted by a Principal RTAF is secured upon any call for a principal payment there against, by taking a first position on MVRDNs that are purchased with the proceeds of the Principal RTAF, which MVRDNs are ultimately supported by the corresponding, underlying investment value of the investment portfolio.

In contrasting the Collateralized RTAF to the Principal RTAF, there is a difference which goes expressly to where the principal risk rests in the event of a depletion of the net asset value of the underlying investment portfolio due to market value loss of investments within the portfolio. In a Collateralized RTAF, the MVRDN equity reserve as raised from third party investors or the Issuer’s own resources, when taken together with certain loss triggers that will be agreed between the Issuer and the Collateralized RTAF Provider, will provide a back-stop against actual first loss risk in the operation of the Issuer’s investment portfolio. Thus, in the operation of a Collateralized RTAF, the MVRDN Issuer is directly responsible for any of its losses and the Collateralized RTAF Provider is at all times fully covered for the full principal value drawable under its operation.

In the context of the Principal RTAF, however, there is no third party equity reserve set aside for the benefit of the Principal RTAF Provider. The lack of equity to cover first losses transfers the principal risk in the operation of the investment portfolio squarely to the Principal RTAF Provider. At first glance, this may seem a difficult underwriting model to promote. After all, any losses to the net asset value of the portfolio are 100% borne by the Principal RTAF Provider. However, in reevaluating this position, it is not an untenable risk for parties that otherwise would have been willing to participate as a source of equity to the equity reserve that is set aside under the operation of the Collateralized RTAF.

These equity investment participants are bearing principal risk in relation to the performance of the Issuer’s investment portfolio, and for that right, they have contributed hard cash with a view to potential preferential gains. They are actively seeking exposure to the investment strategy being manned by the MVRDN Issuer as an Asset Manager with a view to participating in the portfolio’s future yield. Against this backdrop, the role of Principal RTAF can be a superior alternative to making a traditional equity investment in an investment fund or strategy.

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Joanne Marlowe-Noren
UFT Commercial Finance
Reserved Tender Advance Facility