WASHINGTON -- Some real estate companies are attempting to sell tax-exempt securities derived from office building leases they have negotiated with state and local governments without the knowledge or consent of the municipalities, rating officials said yesterday.
Major investment banking firms have presented such unauthorized building lease deals, with values ranging up to $200 million, to Standard & Poor's Corp. and Moody's Investors Service with requests for ratings in recent months, the officials said.
But when the rating firms contacted the government agencies whole leases were being securitized, they found that these agencies were unaware of the deals and had not agreed to them, the officials said. The rating agencies refused to rate the deals.
Steve Nelli, a Standard & Poor's vice president who has been monitoring the building deals, declined to identify the firms involved. He said he generally gets calls from individuals on a firm's "real estate side" about the deals, rather than from underwriters in the municipal finance division.
He described the deals as "first cousins" to the growing number of unauthorized vendor equipment lease deals being encountered in the market. But, he said, "in some ways they are a lot scarier than vendor equipment leases because they are much larger" and can "look just like state-supported debt," such as state office building lease issue.
"You'd be shocked if you saw the dollar size" of these deals, which typically range between $50 million and $100 million and have been found in several states, he said.
Robert Tucker, Moody's assistant director, said his agency also has come across some unauthorized big-ticket estate lease deals in recent months where a building owner or developer tried to securitize a stream of lease payments being made by a government under a lease-purchase agreement.
He warned that "there's definitely a potential" for significant damage to issuers and investors from such deals if they go to market. Among other things, he pointed out, the real estate corporation might go bankrupt and cause the total loss of lease payments to investors.
Both agency officials said the poor commercial real estate market appears to be the catalyst in the movement among developers and building owners to try to turn their lease assets into ready cash. In some cases, the developers may be trying to avoid bankruptcy, they said.
Because the agencies have adhered to their policies of requiring the government's consent before rating such deals, none of those presented to the agencies thus far have actually gone to market, except in one case where Tucker said the government agreed to go along with the securitization.
But Nelli said he believes some deals like the ones seen by the rating agencies have been sold unrated and without the governmental lessee's consent, posing a substantial danger and a potential for "confusion in the marketplace."
"What if the state decides to cancel the lease," citing a nonperformance or other opt-out clause in the lease contract, he asked, adding that that could leave a lot of investors up a creek.
But Tucker downplayed the likelihood that many unauthorized deals have been sold unrated and pose a threat to investors.
"It would be highly unusual for a $100 million deal to come to market unrated," he said. Selling such an unauthorized deal to sophisticated investors, who usually are interested in issues of that size, would be especially "hard to do," he added.
But he nevertheless conceded that "I'm sure it must happen occasionally."
One $66.7 million certificate of participation deal sold a year ago gained the reluctant support of New Jersey after the lease deal was initiated by one of the state's lessors, Hartz Mountain Corp., Nelli said.
That deal, securitizing a lease for the New Jersey Transit Corp. building in Trenton, was negotiated by Merrill Lynch & Co. and insured by Financial Security Assurance.
"I wouldn't say that we consented" to the deal, said Larry Singer, who was the New Jersey's finance director at the time. "But we were aware of the transaction, and based on certain concessions, we allowed them to use state disclosure material."
The concessions that New Jersey won involved passing through some of the benefit of converting the once-taxable building lease into tax-exempt securities, Singer said. "No one is hurt if the state benefits from the sale," he added.
But Nelli warned that with unauthorized deals, none of the benefits of tax exemption may accrue to the governmental lessee. And when that happens, not only is the state victimized, but the tax-exempt status of the offerings may actually be in doubt because they have provided no public benefit, he said.