appropriations by the issuer. Because lease or service
contract payments are not binding on future legisla-
tures or councils, appropriation-backed obligations
are generally not considered “debt” under issuers’
technical and legal definitions. As a result of the
appropriation risk those appropriation-backed obli-
gations that meet Standard & Poor’s Ratings
Services criteria are rated one notch off the GO rat-
ings, as a reflection that appropriation-backed obli-
gations are not legally debt and do not bear the
same legal protections as GO bonds.
However, analytically, these instruments are con-
sidered obligations of the entity and are fully
reflected in the debt statement and ratios. As a
result, failure to make an appropriation will result
in a downgrade of both the appropriation-backed
obligation and the general obligation of the entity,
as a reflection of the willingness of an entity to
make good on its obligations.
Standard & Poor’s does not consider the essen-
tiality of a particular project in the evaluation of an
appropriation-backed obligation. Instead, the will-
ingness to pay for that project is a part of the
analysis performed in the assessment of the general
creditworthiness of the issuing government.
Additionally, the necessity of a security interest
being granted in the leased property is not required.
A security interest is a common feature in which
the governmental obligor grants the lessor, or the
trustee, as assignee of the lessor—title or a first lien
on the leased property for the life of the bonds. In
the event the government obligor chooses to exer-
cise its right of nonappropriation, the lessor, or its
assignee, has the right to take possession of the
leased asset. For many projects, even if a security
interest is granted, it is questionable as to whether
the lessor or its assignee can effectively take posses-
sion of the projects, as in the case of a prison, a
government center, a school or any other facility
that serves the basic functions of that government.Government Obligor’s General Creditworthiness
The government obligor’s general creditworthiness
evaluation is based on traditional GO analysis, and
includes factors such as:
■Overall debt structure and burden;
■Economic and tax-base factors;
■Financial flexibility, performance, and position; and
■Administrative and management factors.
If the government obligor were a utility district,
university, hospital, or other not-for-profit entity,
the relevant rating criteria used in assessing credit
quality for those types of entities would be applied.Appropriation And Term Features
For master leases or service contracts, where
numerous operating departments may be involved,a centralized appropriations process helps to ensure
the timely payment of obligations.
The following appropriation features are impor-
tant to the evaluation of the transaction’s structure:
■The useful life of the financed property or project
matches or exceeds the term of the contract.
■The term of the contract matches the term of the
bond issue or certificates of participation, avoid-
ing exposure on renegotiation; if state law pro-
hibits long-term appropriation-backed
obligations, term renewal should be automatic.
■The lease or contract payments represent install-
ments toward an equity buildup in the financed
property. At the end of the financing term, own-
ership of the asset should transfer to the govern-
ment obligor automatically or for a nominal fee.
■The government obligor agrees to request appro-
priations for lease or contract payments in its
annual budget.
The government obligor unconditionally agrees
to make rental or purchase option payments as
agreed. Such payments should not be subject to
counterclaim or offset because of a disagreement
over any aspect of the transaction. A clear state-
ment that “notwithstanding any other provisions to
the contrary, appropriation-backed obligation
rental payments are triple-net not subject to coun-
terclaim or offset” is preferable and should be
included in the contract. However, language that
indicates that those payments are absolute and
unconditional and can’t be reduced for any reason
is allowable A triple net appropriation-backed obli-
gation is one that designates the government oblig-
or as a tenant being solely responsible for all of the
costs relating to the asset being leased. The costs
could include any upgrades, utilities, repairs, taxes
or insurance requirements.
For California lessees, while the lessee covenants
to appropriate lease payments, those payments are
subject to abatement in the event the leased proper-
ty is not available for use. As such, Standard &
Poor’s requires that, as it does with all abatement
and non-date certain appropriation-backed obliga-
tions, both a review of the construction risk associ-
ated with the project and the presence of business
interruption insurance.
Underlying revenues in support of
appropriation-backed securities
In certain circumstances, a government may legally
pledge specific tax revenues to meet its appropria-
tion-backed obligation payment. If the pledged rev-
enues are not available for any purpose other than
those consistent with the appropriation project,
such as economic development or a convention cen-
ter, the appropriation risk is significantly mitigatedTax-Secured Debt104 Standard & Poor’s Public Finance Criteria 2007