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

Federal Leasesis important to make sure that government leasepayments will match debt service due dates. Mostfederal leases are structured with monthly lease paymentsmade in arrears. Most federal leases are alsostructured with a base rent component and an operatingrent component. To achieve an investmentgrade rating, base lease payments will need to equalor exceed debt service requirements. If the lessor hasoperating or maintenance responsibilities,Standard & Poor’s evaluates the operating rentsunder very conservative expenditure estimates withreliance on historical costs for similar buildings inthe area. In addition, an operating reserve equivalentto a minimum of one month’s rent is required.Standard & Poor’s also evaluates the ability ofthe lessor to make the required capital repairs onthe facility during the life of the bonds. To do this,an independent engineer’s report is required. Ifannual cash flows are not sufficient to make therequired capital repairs in each year, Standard &Poor’s will require a capital reserve fund that caneither be funded upfront or from excess cash flowover the life of the bonds.Construction RiskConstruction risk occurs when the government’slease rental payment is dependent on the completionof the project to its specification. If constructionrisk is present, Standard & Poor’s requires aconstruction risk analysis be performed.Payment and performance bonds alone, given thehistorical lack of timeliness and sufficiency of suchpayouts, are insufficient to fully mitigate constructionrisk. For further clarification refer to PublicFinance Criteria: Assessing Construction Risk inPublic Finance.Public Private PartnershipsStandard & Poor’s has rated transactions wherethe bonds are secured by a pledge of the rent paymentsunder a lease between the maintenance andoperations (M&O) contractor and the developerand not between the federal government and thedeveloper. The credit risks associated with this typeof transaction include:■ The private nature of the projects being financed;■ The initial term of the lease not extending to thelife of the bonds; and■ The lack of a marketability of the project.To achieve rating separation from the private developerand an investment grade rating for this type ofstructure the following elements must be present:Strong legal structure■ The term of the lease has sufficient renewaloptions to extend to the life of the bonds;■ There must be an executed contract between thefederal government and the M&O contractor tomanage the facility which may or may not extendto the term of the lease;Mitigating The Renewal RiskThe following factors, if present, can mitigate lease renewal risk.Strong project essentialityThe project facility under consideration should be extremely essential to the operations of the issuing federal governmental agency.Significant renewal notificationThere should be a significant renewal notification period if the federal agency is not going to renew the lease.LocationThere should be certain characteristics of the leased facility that would be difficult to duplicate, thus enhancing the likelihood of leaserenewal. An example would be the location of the project facility. If there were limited availability of sites sufficient to meet the federalagency’s needs, thus making it unlikely that adequate space would be available to the agency for any future relocation, it wouldenhance the likelihood of renewal.Renewal rates are likely to be competitiveAn analysis of the cost of relocation should be performed to ensure that if the agency were to seek relocation at the renewal optiondate, and a similar relocation cost were to be required and amortized over a 20-year lease, the projected rental amount would beabove their present renewal rate.Other GSA optionsEven if the government agency desires not to renew the lease, the GSA has the option to renew and replace the agency with anotherfederal government tenant(s).www.standardandpoors.com109