S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Federal LeasesFederal LeasesPrivate developers continue to show a stronginterest in using the capital markets to financeconstruction, or refinance existing mortgages byusing federal lease payments as security. However,credit quality on these transactions can vary widelydepending on the contractual, lease-term, and structuralprovisions of the lease. Standard & Poor’sRatings Services rates transactions that are backedby lease rental payments from several different U.S.agencies. Although all of these structures aresecured by lease rentals paid by the U.S. government,some transactions carry more risk. Reflectingthis risk differential, the rating distribution on theseissues ranges from ‘AAA’ to ‘BBB’, with the preponderanceoccurring at the ‘AA’ level.Most federal lease agreements are not structuredwith a public debt financing in mind. Each federallease has different features and needs to be evaluatedon a case-by-case basis. Most prominent inmany of the federal lease transactions is the riskassociated with the involvement of an unrateddeveloper as lessor. To mitigate the developer risk,Standard & Poor’s requires that the lessor be a single-purposecorporation or limited partnership(SPE) with restrictions on future indebtedness andits operations limited to the leased property. Pleaserefer to Standard & Poor’s criteria on SPEs formore detail. In addition, Standard & Poor’s willrequire a non-consolidation opinion between theSPE and its principals. However, significant developerrisk exists with the construction and operationof the facility. Four key areas that should be carefullyevaluated are:■ Appropriation risk;■ Structural risks;■ Cash flow risks; and■ Construction risk.As with municipal leases where the lease extendfor the full term of the bonds, the most importantfactor in determining credit quality is the government’sobligation to make lease payments subject tothe government’s access to the facility, as well as thelessor’s successful performance of all of its obligationsunder the lease. This is defined as the appropriationrisk. Certain government leases do notcarry the appropriation risk in that the government’sobligation is absolute and unconditional, subject tothe terms of the lease. If this is the case, an opinionwill be required from the agency’s general counsel’soffice stating that the lease rental payments are generalobligations of the U.S. government, backed byits full faith and credit. As long as the construction,structural and cash flow risks associated with thecontract have been full mitigated, such obligationswill carry a rating of AAA.There are two other types of appropriation riskthat federal leases carry. In some instances, the obligationto make lease payments is subject toCongress making an appropriation to the agencyfor a specific function, such as military housing.Under this scenario, the military department is obligatedto make the lease payment if Congress appropriatesany funds to the agency for housing militarypersonnel. The only way the military departmentwould not be obligated to pay is if Congress appropriatedthe funds for military housing and includedspecific language stating that the specific lease orclass of leases were not to be paid. The essentialityof the function to the government is important.The second type of appropriation risk is that ofthe congressional line item. This type of appropriationis more visible and would undergo a very stringentanalysis of essentiality. Risks associated withthe congressional line item appropriation involvenot only the funding of specific governmental programsbut also the importance of a single site to thedelivery of services provided by the program. Sincedemographics and cost structures change over time,it could have an impact on where and how the governmentwants to provide services.Structural RiskThe lease structure governs the environment underwhich the government’s lease payments are made.There are four basic elements that could have animpact on credit quality:■ The match of the lease-term to the term of thedebt obligation;■ Lessor obligations under the lease;■ Rent off-set rights by the government; and■ The government’s termination rights underthe lease.Historically, the term of a federal lease hasmatched the term of the debt obligation. However,this has recently become the exception rather thanthe norm due to increased federal budgetary pres-www.standardandpoors.com107