(The following story by Dunstan McNichol appeared on the Newark Star-Ledger website on October 29.)
NEWARK, N.J. — Fallout from the global financial crisis continued to hit New Jersey in unexpected ways this week, as state and federal officials worked to head off a potential default that could cost NJ Transit $150 million.
“The timing couldn’t be any worse,” said state Transportation Commissioner Kris Kolluri. “It would add such a dramatic burden on the transit agency you would need drastic service cuts or the curtailing of the capital program.”
The root of the problem is deals made before 2003 in which agencies like NJ Transit turned buses, rail cars or stations over to for-profit banks, then leased them back in re turn for up-front payments.
Banks liked the deals because they profited from the lease payments and from the ability to reduce their tax bills by taking credit for the depreciation of the equipment and buildings. For public agencies, the deals meant extra funds and less expensive equipment.
But the Internal Revenue Service ruled in 2005 that the deals violated tax rules. It gave the banks and other investors until the end of this year to pay back most of the tax breaks or face penalties.
That made the long-term leases a bad bargain for the investors. But now the collapse of the financial markets has given them a way to get their cash back quickly.
Under terms of their deals with the transit agencies, banks had the right to demand payment of their leases in full if the insurance companies that guaranteed the lease payments were ever subject to significant downgrades in their credit rating.
For NJ Transit and at least 30 other transit agencies across the country, that provision kicked in earlier this year when the AIG Insurance Co., which had backed billions of dollars worth of the deals, veered toward bankruptcy and was downgraded.
U.S. Sen. Robert Menendez (D- N.J.) brought up the issue at a hearing on the financial crisis last week.
“The banks that are parties to these transactions are using AIG’s credit downgrading to terminate these transactions in terms favorable to them,” Menendez wrote in a letter to U.S. Treasury Secretary Henry Paulson last week. “As a re sult, the banks may have the opportunity to gain 100 percent of the tax benefits which have been disal lowed, and in turn devastate transit agencies.”
Nationwide, the American Public Transportation Association estimates banks could demand more than $2 billion in payments in short order.
NJ Transit has potential exposure of $150 million in payments among the 20 lease-back deals the agency signed on for between 1995 and 2003, said Transit spokeswoman Penny Bassett Hackett.
The association and federal lawmakers are seeking Treasury’s cooperation in guaranteeing the affected lease deals, so that the de fault provisions triggered by the AIG downgrade would no longer be in effect.
Yesterday, NJ Transit representatives and Treasury staffers discussed potential solutions in a conference call.
“Certainly this is a concern,” said Bassett Hackett. “Obviously, we’re working with our friends in Washington.”