WASHINGTON - Credit agencies are monitoring their ratings on transit agency leaseback transactions at a time when they are at growing risk of having to cough up billions of dollars as lease agreements with private investors go into default because of insurers' rating downgrades.

Standard & Poor's warned Wednesday that transit agencies face "credit factors" that necessitate close monitoring, within hours of Moody's Investors Service downgrading insurer Ambac Assurance Corp. to Baa1 with a developing outlook from Aa3 on review for downgrade.

The Moody's decision made Ambac the second of three insurers whose credit downgrades may trigger defaults on lease agreements held by at least 31 transit agencies in 18 states. Moody's also issued a reporter earlier this week showing concern for transit agency credit ratings.

American International Group Inc.'s credit rating downgrade prompted the first default between a transit agency and private investor in late October. The Washington Metropolitan Area Transit Authority has asked a federal court here to block KBC Bank of Belgium from collecting a $43 million termination payment on a leaseback deal done in 2002.

AIG was the principal guarantor for that deal, as well as for roughly three-quarters of the deals of the 31 transit agencies, according to Jeffrey Boothe, a partner at Holland & Knight LLP, which is representing some of those agencies.

Transit officials are now hustling for help on two fronts, asking the Treasury Department as well as Congress to intervene and prevent the insurer downgrades from triggering between $1.5 billion and $4 billion that the transit agencies could be forced to pay investors.

Boothe said yesterday that the investors may opt to settle their lease agreements with the transit authorities.

Investors "seem open to engaging in conversation about proceeding to unwind the transactions to just be done with them, get them off their books," Boothe said.

Standard & Poor's analysts said on Wednesday that leaseback transaction defaults could compound financial strains that already include state and local funding shortfalls, declining sales taxes revenues, and higher operating costs.

"Key credit factors that we will evaluate include transit operators' ability to limit their exposure by securing additional or replacement guarantors and extending or accessing additional liquidity to cover potential termination payments," the Standard & Poor's analysts said.

Moody's analysts said earlier this week that the situation could put downward pressure on transit debt issuers' ratings if the issuers' liquidity is strained or if their debt levels spike because of large payments on the defaulted leases. Transit agencies that pledged assets as security for the leaseback transactions could lose control of the assets, and defaults could possibly trigger cross-defaults in such agreements as standby bond purchases and derivative contracts, they said.

Under these tax-advantaged lease-back transactions done mostly in the 1990s to mid-2000s, transit agencies, counties, and cities sold or leased assets such as transportation equipment to private entities in exchange for cash, usually about 3% to 6% of the assets' value. The company could use the depreciation costs of the equipment to decrease its federal taxes while leasing the asset back to the transit agency.

The Internal Revenue Service designated the lease-in/lease-out or sell-in/lease-out deals as abusive tax shelters in 2000 and 2005, respectively.

The IRS offered in August to settle with corporate taxpayers who held LILO and SILO contracts. The settlement, entered into by 30 companies of the 45 to which it was offered, required the investors to return 80% of the tax savings they realized under the leaseback transactions.

Companies were given a deadline of the end of 2008 to decide to settle with the IRS. Some market participants believe the credit-rating downgrades gave companies an excuse to get out of these deals, which would no longer provide them with significant tax breaks.

The top 10 transit issuers who pursued the most SILO/LILO deals are now beholden to leases held by at least 23 foreign and domestic banks, and at least one private company. WMATA was the first agency whose leaseback deal went into technical default because of the AIG downgrade.

Candace Smith, a spokeswoman for WMATA, said officials are continuing to meet with lawmakers and their staffs on Capitol Hill, "trying to solicit any action" to help it.

Smith said after meeting with staff members of the Senate Finance Committee, that they seemed to be "understanding of our situation," but that no action has been taken. Congress is in recess until Nov. 17 when lawmakers are expected to return for a lame duck session.

"For all practical purposes, we have two days here," today and Monday, Smith said, because WMATA will return to U.S. District Court for the District of Columbia on Wednesday for a hearing to decide whether KBC Bank should be barred from collecting the $43 million termination payment. U.S. District Judge Rosemary M. Collyer ordered the bank to wait 10 business days before forcing the transit agency to pay.

WMATA has 14 other financing deals with banks that could go into default, and Carol Kissal, the chief financial officer of WMATA, said it would cost $50 million to $100 million to purchase the additional insurance to replace AIG as guarantor.

Kissal is urging support from the Treasury Department to take over as guarantor, which would restore the triple-A rating to the deals and negate the defaults.

Lynne Funk contributed to this story.


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