S&P Global Ratings' review of its 10 ratings on federal lease bonds backed by lease rental payments from several U.S. agencies has yielded two negative rating actions, , one positive rating action, and seven affirmations. The outlook on all ratings is stable.

These rating actions reflect evolving credit factors and risks affecting this sector, including:

• The return-to-office dynamic,
• Technological advances that reduce requirements for large administrative office space, and
• Uncertain federal funding under the incoming presidential administration.

Rental payments through the Department of Defense (DOD), Department of Veteran Affairs (VA), or Department of Energy (DOE) support the federal lease bonds. These federal lease transactions provide access to the capital markets supporting the construction of the buildings or the refinancing of mortgages on same, with federal department cash flow funding debt service obligations.

We assign the ratings using our federal lease methodology, published June 18, 2007, and "U.S. Federal Future Flow Securitization (FFF)" methodology, published March 12, 2012. Each federal lease is different and faces specific credit risks, but common credit risks across this sector are the possibility of nonappropriation of funds by Congress and structural risks associated with the lease terms. Structural risks include the indirect relationship between the funding source and the projects, as federal lease bonds we rate are issued by private developers, not the U.S. federal government. Thus, these transactions are exposed to greater political and administrative risks in servicing the debt, as compared with a lease where the government is the director obligor.

What We're Watching

Technological advances continue reducing administrative office space requirements nationwide, even for highly essential assets. Markets' grappling with increasing vacancy rates for commercial office space (see our report "Global Credit Outlook 2025: Promise And Peril," published Dec. 4, 2024), coupled with uncertainty of federal spending cuts, could exacerbate the risk of vacated building space and lease nonrenewal. We will monitor any potential effects on credit quality related to the incoming administration's efficiency focus, its approach to maintaining federal office space, and trends in commercial real estate.

Our Rating Process And Review Highlights

We take a two-step approach to rate federal leases. First, we apply our FFF methodology, which considers specific factors of the federal entity and project to arrive at a rating that is linked to but typically notched below the U.S. sovereign rating. The methodology considers specific factors of the federal entity and the project. Second, we apply the federal lease criteria to address risks that are typical of leases, including appropriation, structural, cash flow, and construction. The final rating determined after application of the federal lease criteria can be the same or lower than that which the FFF criteria indicate.

Many federal leases we rate contain credit-supportive legal features such as debt payment priority in the flow of funds and lease term renewal options to extend to the life of the bonds, but our view of the more distant relationship between the project and source of pledged revenue adds a layer of structural and operational risk. Furthermore, our ratings consider credit risks beyond the one notch for the annual appropriation, resulting in at least two notches below the U.S. sovereign issuer credit rating (AA+/Stable/A-1+).

Our review led to changes in our analysis of three factors:

• Funding history of the federal entity,
• Project essentiality and geographic scope, and
• Renewal and reauthorization risk of the lease.

In assessing the first factor, we reviewed more than 30 years of appropriation funding history to underpin our long-term view of funding trends, with an emphasis on appropriations over the past decade. While the DOD and VA experienced annual increases in appropriations in most years, they also faced cuts greater than 3% as a result of sequestration effects, supporting a more moderate view of funding history. Comparatively, the DOE has benefited from greater stability in funding history.

Second, we focused on project essentiality and geographic scope. The FFF criteria determine essentiality by assessing the nature of the project's impact and whether that impact covers a large or small part of the U.S. population. In our review, we considered a project to have strong essentiality if it were to serve a major portion of the U.S. or a strategic national interest. Conversely, we determined a project's essentiality as weak if the project were to serve 15% or less of the national population or, more narrowly, a state or region. Our view of essentiality weakened for rated VA federal leases that have facility use agreements for office buildings tied to adjacent medical facilities that serve a small geographic region and are more vulnerable to funding disruption.

Finally, we reviewed the renewal and reauthorization risks related to each lease. While the terms and payment provisions differ for all our federal leases, most have renewal risk. Our analysis distinguished whether we believed the project exhibited significant importance to the basic function of the federal entity. In our view, that remains the case for our DOD and DOE leases. However, VA leases were for projects with a narrower or regional scope, serving an auxiliary function within the federal entity that introduces increased risks over the longer term.

For more information on the individual federal-lease-backed ratings discussed, see the following reports published Dec. 23, 2024:

• Chicago West Side Enhanced-Use Project
• Cleveland-Cuyahoga County Port Authority, Ohio
• Idaho Housing And Finance Assn.
• Illinois Development Finance Authority
• Keenan Fort Detrick Energy LLC, Md.
• Milwaukee Redevelopment Authority
• Oak Ridge Industrial Development Board, Tenn.
• Pacific Northwest National Lab
• Panhandle Economic Development Corp., Texas