An effort by the San Francisco Municipal Transportation Agency to earn money nearly a decade ago through “creative solutions” could end up as a financial debacle that costs the city $68 million or more, a delayed effect of the nationwide subprime mortgage crisis, financial analysts and legal experts said.
The financing deals created in 2002 and 2003 — in which 139 San Francisco light-rail cars were leased to Wells Fargo and three other banks, and then leased back to the city — had clauses requiring the city’s lease payments to be insured by a company with a high credit rating.
According to documents describing the deals, if the insurer’s credit rating dropped below a certain threshold, and San Francisco could not get new coverage, the city would fall into default and be liable for penalties of up to $126 million. (The most recent liquidation value estimate is $68 million.)
The company chosen to insure the lease payments, Assured Guaranty Ltd., is now “on the cusp of falling below the thresholds under the lease,” according to a memo this summer by Debra Johnson, the acting executive director of the transit agency. And in late September Standard & Poor’s gave Assured a “negative outlook,” suggesting that it might be headed for a downgrade.
“This is actually a potential bomb,” said Jesse Markham Jr., a University of San Francisco law professor who reviewed documents related to the transaction for The Bay Citizen.
According to Lee Sheppard, a tax lawyer and a contributing editor for the publication Tax Notes, “San Francisco is looking down the barrel of a horrifying termination payment because that’s what they signed up for.”
San Francisco’s transit agency was among many that seized on an early-2000s boom in public-infrastructure tax shelters, in which banks and other investors gave millions of dollars in cash up front to the agencies in return for the right to claim tax breaks in subsequent years for wear-and-tear on the equipment.
In San Francisco’s case, Michael Burns, then the general manager of the transit agency, announced deals that allowed the 139 light-rail cars to become rolling tax shelters for the banks. An aide said Burns declined to be interviewed for this article.
In 2004, the Internal Revenue Service declared such transactions to be sham tax shelters and outlawed most of the tax write-offs. Public agencies were not harmed because the contracts did not hold them responsible for the validity of the tax shelters.
The deals received another blow in 2008 with the nationwide mortgage meltdown. Bond insurers including American International Group and the now-bankrupt Ambac were downgraded as their portfolios were hit by the subprime mortgage crisis. This time, ripple effects rocked public infrastructure tax shelters.
The Metropolitan Area Transit Authority in Washington, for example, had entered into a tax-shelter deal with KBC Bank of Belgium, with A.I.G. as insurer. The A.I.G. downgrade meant KBC was entitled to a $43 million termination payment from the transit agency, which eventually reached an undisclosed settlement.
The John Hancock Life Insurance Company entered a lease agreement with the Hoosier Energy Rural Electric Cooperative, an electricity-generating plant in southern Indiana. Rather than pay a $120 million termination fee after Ambac’s downgrade, the cooperative took John Hancock to court, but eventually settled for an undisclosed amount.
Sonali Bose, chief financial officer for the San Francisco transportation agency, said two of the banks that entered tax-shelter deals with the agency had agreed to enter negotiations to possibly end the deals in a way that would not require a termination fee. The others have declined, Bose said. She would not say which banks were at the table.
Elise Wilkinson, the Wells Fargo spokeswoman, said the bank might be open to discussing a possible lease termination. Comerica, another light-rail-car lessee, declined to comment. The two other lessees, CIBC Capital and Australia New Zealand Banking, did not respond to requests for comment.
This article also appears in the Bay Area edition of The New York Times.