The National Association of Insurance Commissioners (the “NAIC”) recently approved new rules with respect to ground lease financing transactions (each a “GLFT”). GLFTs are generally those that have the following characteristics:
(i) a long term ground lease (typically 99 years);
(ii) one or more subtenants in an existing or to be construction building;
(iii) both the owner of the land and the owner of the leasehold separately finance their respective interests;
(iv) the financing on the fee interest typically includes the issuance of debt-like certificates or notes (and this is the portion of the transaction that would involve the NAIC) and the financing on the leasehold interest is typically a more traditional mortgage loan;
(v) in most cases, neither the fee owner nor the ground lessee are entities that are rated by a recognized rating agency, but are generally both special purpose entities; and
(vi) the ground lease will contain typical “hell or high water” provisions with no landlord obligations and a reversion of the ownership interest in the improvements built on the land to the owner of the fee estate if the ground lease terminates.
The recently approved approach to GLFTs by the NAIC clarifies that GLFTs are ineligible for filing exemption and each GLFT must be submitted to the Securities Valuation Office (the “SVO”) for review.
The SVO review of GLFT includes the following review steps:
(i) The SVO reviews the ground lease to determine if the ground lease meets CTL criteria for a Bond Lease Based or Credit Lease Based CTL (other than the presence of a tenant with a credit rating). If the ground lease does not meet the criteria, then the GLFT is not eligible for Schedule D reporting.
(ii) If the ground lease meets CTL criteria and there are a limited number of subtenants (three or fewer) that comprise 90% or more of the space in the improvements and each of such subtenants is rated by a recognized rating agency or the credit of the subtenants may be evaluated by the SVO, then the SVO will evaluate the leases of the subtenants to determine if the leases satisfy CTL criteria and if the SVO determines that the leases meet CTL criteria then the SVO can analyze the GLFT as a CTL
(iii) If the ground lease meets the Bond Lease Based or Credit Lease Based CTL criteria and there are four or more subtenants or the SVO is not able to evaluate the credit of the subtenants, the SVO will cause the leases of the subtenants to be financially modeled by the Structured Securities Group (the “SSG”) to determine whether the leases will provide sufficient cash flow to pay the rent due under the ground lease and any other costs that the ground lessee is obligated to pay pursuant to the terms of the ground lease.
(iv) If the SSG determines that it cannot model the subleases or the cash flows, and if the transaction has been assigned a rating by a recognized rating agency, the SVO will proceed with an independent analysis of the transaction but guided by the analysis contained in the rating letter. The SVO is not required to accept the rating provided by the recognized rating agency and reserves the right to assign a different rating or to not rate the GLFT.
(v) If the SVO or the SSG, as the case may be, determine that they cannot provide an NAIC designation to the GLFT, then the GLFT would be ineligible for Schedule D treatment.
Market participants that are considering a GLFT with the expectation that the issue be reported on Schedule D should review the proposed structure and leases to identify the likely pathway to NAIC designation prior entering into a particular GLFT. As the rules with respect GLFTs are new, we expect that it will take a reasonable period or time for all parties involved in GLFTs to understand the implementation of the rules as written and sufficient time should be allotted for NAIC analysis. Over time we expect the efficiency of the process to improve.
Contributed by Philip M. J. Edison (Chapman and Cutler LLP)