NEW YORK-With hip-hop pulsing in its stylishly dim lobby and a bar known more for fashionistas than financiers, W New York - The Court seemed an unusual venue at first for the Institute for International Research-sponsored Synthetic Lease Structures & Credit Tenant Leases conference.

However, in light of the looming Financial Accounting Standards Board (FASB) decisions that one panelist described as having paralyzed the market, speakers and delegates at the event held at the hotel last week were as determined to see and be seen as the SoHo types downstairs.

In it's well-intended crusade against future criminal abuse of off-balance-sheet financings and corporate disclosure practices, the FASB has inadvertently driven a wedge into the leasing community, with the synthetic lease and credit tenant lease (CTL) camps each vehemently defending the historical and ongoing legality and validity of their respective instruments - often at the expense of each other.

The lone gun on the opening synthetic lease market overview panel was Todd Shutley, managing director in the synthetic leasing group at SunTrust Robinson Humphrey.

Shutley, who works with CTLs, sale/leaseback transactions and other forms of leasing in addition to synthetics, was quick to assert - and to reiterate during his presentation - that "synthetics are simply not going away."

While no one denies that both synthetic leases and CTLs will no doubt undergo some degree of respective change as a result of the pending FASB decisions, Shutley, echoing the argument of the entire synthetic arena, maintained that such changes - whatever form they may take - will not fundamentally change the way that market players (as opposed to politicians and the media) view the validity of the structure.

Reacting to what the synthetic camp views as uninformed, overblown and, in some cases, arguably biased scrutiny placed on synthetics by politicians and a news media eager to "out" corporate and accounting malfeasance in the wake of Enron Corp. and WorldCom, Shutley said flatly that far from the shady, ace-in-the-hole stigma that has been applied to them, synthetic leases are "fairly immaterial" to the Fortune 500 companies that use them.

In the last five years, Shutley said, almost every synthetic lease has been counted as debt. "They're not on balance sheet," he continued, "But the lenders know all about it; it's not going to bust the balance sheet."

According to Shutley's figures, synthetic leases have been used by over 2000 companies, and less than 5% have been brought on balance sheet or refinanced to date.

Don't call us Enron

More than one synthetic lease pro noted that far too much attention has been heaped on the refinancing risk involved in the instrument. With a typical tenor of three to ten years, concerns have been raised as to the "shock to investors" that such risk ostensibly poses, particularly in situations where the lessee's credit has deteriorated since the inception of the original lease.

As Shutley pointed out, however, the correlation of asset/liability tenor in this situation is not necessarily a simple one-to-one relationship, particularly when the scope of the typical synthetic lessee's balance sheet is taken into consideration.

As one panelist commented, "It's unlikely that the refi or consolidation of a synthetic is going to bilk grandma out of her pension."

"Enron was a case of fraud," Shutley said. "It involved self-dealing, the hiding of significant money-losing entities and a management that was personally profiting from the situation - perhaps increased jail time would be a better deterrent (than the FASB measures)."

The argument for synthetic leases is fairly simple: when used properly, they often provide the cheapest method of monetizing real estate and other corporate assets, providing significant lease-related tax benefits to the client while maintaining control over the asset and other upsides associated with ownership - all off balance sheet. One area that even the synthetic crowd admits could be a breaking point for the instrument, however, is the residual value guarantee that synthetic leases carry.

Again under the auspices of full disclosure and the pre-emption of fraud, the FASB's exposure draft on guarantor's accounting and disclosure requirements for guarantees suggests that a guarantor, i.e. the lessee in a synthetic lease, record the potential liability of the guarantee on balance sheet at "fair value." Just what constitutes fair value, however, is open to broad interpretation, and in line with its principals-based approach, the FASB isn't providing much help on the brass-tacks level.

Either way, according to David Mayer, a partner at Patton Boggs LLP, the FASB guarantee project could be what he called "the stealth killer" of synthetic leases. While players in the synthetic arena certainly acknowledge the potentially drastic and now seemingly inevitable changes to their business, they're not ready to fold just yet. As the Mark Twain quote that marked the end of Shutley's presentation succinctly put it, "The reports of my death have been greatly exaggerated."

CTL Stance

From the credit tenant lease perspective, the FASB prognosis isn't quite as severe as that facing the synthetic community, but the uncertainty and Rube-Goldberg atmosphere that has defined the entire process nonetheless remains a thorn in the side for CTL industry professionals.

The admittedly accidental standard-bearer for the CTL camp is Kyle Gore, a principal at the pre-eminent CTL shop Legg Mason Wood Walker. Given that CTL's typically involve true arms-length operating leases - with no covenants, no debt guarantees, no downgrade triggers, no residual value guarantees and no equity role by the tenant - Gore's primary argument is that they should not be subject to the proposed consolidation guidelines at all.

He made his case directly to the FASB during its Sept. 30 roundtable for industry comment concerning the consolidation project, and while it seems that the Board isn't willing to exempt any "entity" at this point - special purpose, substantive operating or otherwise - the argument didn't fall on deaf ears.

In fact, one FASB member at the roundtable, which was reportedly dominated by professional lobbyists from the corporate paper and CDO arenas, responded to Gore's position with the statement "Finally, someone with whom we agree."

But CTLs are by no means out of the woods yet. Gore's secondary mission was to demonstrate to the Board that the proposed 10% outside equity requirement for unconsolidated SPEs - up from 3% - should not apply to CTLs or any other situation where it can be actuarially demonstrated that less equity is sufficient.

"The nice thing about CTLs - particularly investment-grade CTLs - is that there is abundant data on default rates published by Moody's Investors Service and Standard & Poor's. If you take that data and multiply it by the probable loss of the default - the difference between the loan amount and the underlying go-dark value of the real estate - you come to the conclusion that one or two percent equity is sufficient."

According to Daniel Rubock, vice president/senior analyst at Moody's, the rating agency already uses such a variable interest, expected loss model in rating CMBS transactions. "We focus on the dirt as well as the credit," Rubock said. Case in point: a CTL involving, you guessed it, a W Hotel. The deal was rated Baa1 by Moody's - one notch higher than W Hotel's parent, Starwood Hotels & Resorts Worldwide, Inc.

The rational was that the real estate was good, but the go-dark loan-to-value ratio was excellent, regardless of the level of equity interest.

At the end of the day, the only concrete effect of the ongoing FASB debate seems to be the paralysis and bifurcation of the leasing world, and a general sense of frustration - bordering on anger - over the contagious black eye the business has caught in the wake of everything Enron. Acknowledging the air of contention between the synthetic and CTL camps, one panelist nonetheless remarked "We have a lot more in common than not, and I applaud this effort to come together."

Thomas R. Cox III, executive vice president and one of the founders of R.V.I Services Co., Inc., in fact challenged the attendees to move even further toward a cohesive cause in order to preserve their business.

Following one panelist's remark that if the leasing industry goes down, it'll go down swinging, Cox added "We haven't even begun to fight, because this is just beyond common sense."

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