CHICAGO - The trustee for $6 million of unrated bonds issued for a private Iowa college will ask a judge next week to allow it to enter a forbearance agreement with the school as a pre-emptive step ahead of an expected technical default on debt service coverage ratios.

Lawyers for the trustee, Wells Fargo Bank NA, say they face a dilemma and court guidance is needed because bondholders have not stepped up to direct the trustee.

Several market participants described the situation as unusual given both the lack of bondholder direction and the Iowa Wesleyan College's effort to strike an agreement ahead of the actual technical default.

The college wants a resolution to stave off potential action from bondholders, and the trustee is willing to give the college time to correct the technical default as it's up to date on all bond payments and is expected to continue to making all scheduled payments.

The small liberal arts school in Mount Pleasant, Iowa has missed the mark on maintaining a 1.10 times debt service coverage ratio over the last several years and expects its latest fiscal year results will also fall short, triggering an event of default.

The school intends to implement strategies recommended by an independent consultant and eventually achieve and maintain the required coverage ratios, but still expects to miss the coverage threshold through 2017.

The bonds are secured by a loan agreement and supported by a mortgage on a student union and activities center. The trustee wants to avoid being forced under the bond covenants to accelerate bond repayment or foreclose on the property given the poor resale prospects.

"The college has expressed to the trustee a strong desire to reach a long term solution regarding the projected defaults," a trustee court filing said. "The fact that an event of default does not today exist ….and that the proposed Forbearance Agreement seeks to forbear in the exercise of remedies for defaults that may continue to occur over the next three years creates uncertainty as to whether the trustee is entitled to act at this juncture under the bond documents."

A hearing is set for Sept. 24 before in Hennepin County, Minn. District Court.

Under terms of the forbearance agreement, the trustee would agree not to exercise any remedies against the college while the college would be required to continue to perform under all the terms of the bond documents outside of the projected defaults on coverage.

The agreement outlines terms under which a termination date of the forbearance may be declared, either through breaches of bond obligations or at the direction of more than 35% of holders. The college, founded in 1842, is required to abide by a number of additional covenants that includes revised debt service coverage ratios and it must provide additional reports. It must meet semi-annual targets on student enrollment and maintain a liquidity threshold.

"From the trustee's perspective, the college's proposal to enter into the Forbearance Agreement is a prudent exercise of the trustee's discretion," according to court filings submitted by Wells Fargo lawyers at Dorsey & Whitney LLP.

The filing says the college expects to be able to continue to make its scheduled payments on the bonds and the alternative of accelerating the bonds and exercising remedies presents uncertainty since it is not clear whether the pledged property that the trustee could attach and liquidate would be sufficient to repay the bonds.

The unrated, tax-exempt bonds were sold in 2006 on the school's behalf through the Iowa Higher Education Loan Authority. They refunded bonds from a 2000 issue and raised new money for housing and parking projects.

A special covenant required the school to set charges and tuition at a rate to cover operations, upkeep of the facilities, and maintain the 1.10 times debt service coverage ratio. The offering statement warned that in the event of a foreclosure there were "very limited" potential uses for the property and likely limited interest from other parties.

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