Judge Tells Metro And Bank To Deal
Larger Financing Problem Remains

By Lena H. Sun
Washington Post Staff Writer
Thursday, November 13, 2008

A federal judge yesterday suggested a compromise to the Belgian bank seeking to collect $43 million from Metro that would give the bank some of the money without financially crippling the transit agency. The two sides were in talks last night and are scheduled to return to court today.

Even if KBC Group agrees to the compromise, Metro still has 14 similar financing deals that could be in jeopardy. If those deals go into default, the transit agency could be forced to pay more than $300 million to other banks in the next two months, wiping out half of its capital budget in the critical weeks before the Jan. 20 presidential inaugural.

"It could be devastating to that event," said Carol Kissal, Metro's chief financial officer. "It's the perfect storm that we had not anticipated."

If the bank agrees to the compromise outlined by U.S. District Judge Rosemary M. Collyer and accepts payment of $17 million, it would represent a victory for Metro and the more than two dozen other transit agencies that have been watching the case. Transit agencies across the country entered into similar financing deals years ago that are in jeopardy, an unintended consequence of the global credit crisis.

General managers of transit agencies in Los Angeles, Sacramento, Santa Clara, Calif., Atlanta and Chicago are coming to Washington next week to appeal to Congress for help. Transit industry lawyers estimate that 25 transit agencies in 18 states could face $2 billion to $4 billion in payments if the deals go into default, forcing the agencies to cut services.

Transit officials want Congress to pressure the U.S. Treasury and the Federal Reserve to step in as the guarantor for the deals, a move they say would cost the federal government little, certainly much less than the billions taxpayers have poured into bailing out insurance giant American International Group and that are being sought by the auto industry. They also want to be included in any new economic stimulus package.

KBC Group is demanding payment because its financing deal with Metro unraveled when the credit rating of AIG, which guaranteed the agreement, was downgraded. That downgrade put the deal in default and allowed the bank to seek payment.

Members of Congress, including House Speaker Nancy Pelosi and the Washington region's delegation, have been pressing Treasury and the Federal Reserve for the past two weeks.

Metro officials are hoping KBC will agree to the compromise; it's the same offer Metro made weeks ago. The $17 million that the bank would receive is money the agency had set aside for regularly scheduled payments, Metro spokeswoman Candace Smith said.

The financing deals were common practice from the late 1980s to 2003, not only among transit agencies but also at water and sewer authorities and other public entities. The public entities received much-needed cash for capital improvements; the private investors, such as banks, received a tax shelter.

Under the deals, known as lease-back transactions, transit agencies such as Metro sold their rail cars or other equipment to banks and then leased them back. Many of the deals were approved by the Federal Transit Administration. The banks received a tax break on the depreciation of the rail cars. The IRS ended the practice in 2004.

When AIG's credit rating was downgraded, the 2002 deal with KBC Group went into technical default. The judge's suggestion would allow the Belgian bank to reclaim about $17 million from a trust account that was set aside to make lease payments. The bank had been seeking an additional $25 million from Metro, and that would have forced cuts in the agency's $613 million capital budget.

The judge said that if the bank were to receive the full amount, it would be "an absolute windfall." She said that under an IRS ruling, banks are no longer entitled to the full tax benefits of the lease-back deals. Noting the potential harm to transit riders in the Washington region and elsewhere if other banks were to follow suit, she said that allowing KBC to prevail would "pull this stone wall down today."

Officials said they have tried to find other companies to replace AIG as guarantor, but few have the triple-A rating required, and in the case of one that does, a Berkshire-Hathaway subsidiary, the replacement would be expensive: It would cost Metro $50 million to $100 million to purchase additional insurance to replace AIG as guarantor in all of the deals.

Treasury officials are reluctant to step in because they would be bailing out a tax-avoidance strategy, sources familiar with Treasury's thinking have said.

The IRS has offered to settle these agreements with dozens of banks, allowing them to keep a portion of their tax benefits if they agree to settle by year's end. The judge suggested that KBC was motivated to collect payment from Metro as a way to recoup some of its tax breaks.

KBC has also suffered tremendous losses on its portfolio, records show, and a payment from Metro would cover some of those losses.

A financial adviser testifying for Metro yesterday said that the $43 million demanded by KBC would amount to an 11 percent annualized return on the bank's initial investment of $23 million six years ago.

Staff researcher Meg Smith contributed to this report.

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