Bills recently introduced by key members in the House and Senate would set up a major deterrent to banks and other equity investors seeking to force issuers to fork over termination payments for lease-back deals. The prospect of such deal terminations threatened to jeopardize the fiscal conditions of transit agencies and electrical utilities last year after credit rating downgradings of insurers on the deals.

The identical "Close the SILO/LILO Loophole Act of 2009" bills were introduced in the House by Rep. John Lewis, D-Ga., chairman of the House Ways and Means Committee's oversight panel, and in the Senate by Sen. Robert Menendez, D-N.J., chairman of the Senate Banking Committee's housing, transportation, and community development subcommittee.

The bills would levy a 100% excise tax on any termination payments collected by private investors in these deals, with the aim of deterring such collections and recouping the federal tax benefits represented by the termination payments.

Public transit agencies and electrical utilities entered into sell-in/lease-out and lease-in/lease-out, or SILO and LILO, transactions with private investors from the 1980s through part of this decade. In SILOs and LILOs, banks and other private parties buy equipment and facilities belonging to nonprofit transit, governmental, and utility entities. They then lease the property back to the tax-exempt public entities. As a result, private investors could take advantage of the tax deductions for depreciation of the property, and tax-exempt public entities could benefit from up-front payments for the property.

However, the Internal Revenue Service decided in 2000 and 2005 that LILOs and SILOs were abusive tax shelters. The government began pursuing lawsuits challenging the deals and last August offered to settle with corporate taxpayers and other investors for 80% of the tax savings they realized under the lease-back transactions.

Downgrades of guarantors such as Ambac Assurance Corp. and American International Group Inc. triggered technical defaults on the contracts last year, and some banks began seeking termination payments from the governmental entities.

Many market participants speculated that private investors who demanded termination payments were seeking to eke out some benefit from the transactions, which were no longer profitable as a result of the IRS legal challenges and global settlement.

About 30 transit agencies in the country were affected by such lease-back defaults last year.

The Washington Metropolitan Area Transit Authority settled a lawsuit late in the year with KBC Bank NV of Belgium for an undisclosed amount after the deal's guarantor, AIG, had its rating downgraded and the bank sought a $43 million termination payment.

At least one electrical utility, Indiana's Hoosier Energy Rural Electric Cooperative Inc., was affected as well. Its private counterpart in a lease-back deal sought about $120 million in termination payments after the Ambac downgrading. Standard & Poor's reduced Hoosier's credit rating to BBB-minus from A-minus, and put it on credit watch negative as a result.

The bills introduced by Menendez and Lewis "could have an impact on the pending litigation between Hoosier and John Hancocke_SDRq Life Insurance Co., said Jeff Panger, a Standard & Poor's director and analyst on the downgrading.

"At the end of the day, the credit watch and downgrade was an issue of the litigation," he said, adding that if the litigation ends the credit rating agency may reevaluate the utility.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.