omontgomery-leasing-advantages-of-leasing

Advantages To The Lessee

Municipal Lease/Purchase financing is designed to compliment, rather than replace bond
financing. As governmental units have become cognizant of the advantages of Municipal
Lease/Purchase Agreements over bonds, they have increased their utilization of this
unique financing vehicle to satisfy many of their equipment and facility financing needs.
The advantages of Municipal Lease/Purchase Agreements are as follows:

A) No Cash Down Payment – These financings may provide for 100% of the
equipment purchase price or facility construction cost plus related expenses. The
governmental lessee only makes periodic lease payments. Substantial down
payments may reduce interest rates charged.

B) Tax-Exempt Interest – Properly structured, these transactions result in each
payment representing some principal and some interest. The Internal Revenue
Service has determined that interest paid in this manner is exempt from federal
income tax. The interest may also be exempt from state and local income tax.
Charter schools do not directly qualify for tax exempt financing.

C) No Public Debt Created – Since the lease payments due in the transaction are
subject to annual appropriation, the obligation created by the lease is not subject
to constitutional or statutory debt limitations in most states. Since public debt
is not created, voter approval for a Municipal Lease/Purchase transaction is not
usually required.

D) Matching Cost with Revenue – Payment obligations correspond more closely
to the useful life of the asset(s) financed by the lessee. A full cash purchase
charges one year’s operating budget with the cost of an asset, which will be in use
for several years. Lease/Purchase transactions can and should be designed to
match the finance terms with the expected useful life of the asset, thereby
spreading the cost over the budgets for all the years benefiting from the use of the
asset. Amortization can be designed on a monthly, quarterly, semi-annual, or
annual basis or even on a SKIP payment basis.

E) Flexibility – Shorter lead time to arrange a financing, as the procedural aspects
of traditional bond financing may be complicated by rigid constitutional
requirements which serve capital project financing control, but are inflexible for
asset acquisitions and future refinancings.

montgomery-leasing-what-is-municipal-leasing

What Are Municipal Leases?

Municipal Leases are agreements entered into by state, county, city, town, and other local governments to acquire essential equipment by paying for it over time. The payments include both principal and interest. For investors, the most distinctive feature of municipal leases is that the interest received is exempt from federal income taxes.

Municipal Leases can take several forms depending on state and local laws. They come in widely varying amounts, from a few thousand dollars to several million. And they are usually short term, from three to eight years.

From a strict legal standpoint, a municipal lease is not really a “lease”. The equipment is not rented and used for a time and then returned to the owner, but actually is bought by the municipality and paid for over time. The municipality owns the equipment, subject to a lien. The municipality only borrows the money used to acquire it.
The principal and the tax-free interest on the remaining balance are then repaid periodically, usually in equal amounts over a fixed period of time. Payments are made in advance or arrears, often on a monthly basis, but sometimes quarterly, semi-annually or annually.

State and local governments use municipal leases to acquire everything from cars, trucks and emergency vehicles to computers, other office equipment and even buildings. Virtually any piece of equipment that is needed by a municipality can be purchased using a municipal lease.

TYPES OF MUNICIPAL LEASES

Municipal Leases are usually written as installment purchase contracts, conditional sales contracts, or lease purchase agreements. The municipality takes immediate possession of the equipment and either acquires title with a lien (installment purchase), or takes title at the end of the lease period (conditional sale, or has the right to
purchase the equipment at the end of the lease period for a nominal sum, usually $1.00 (lease-purchase).

A “Certificate of Participation” is a specific type of municipal lease in which public or private investors are invited to purchase shares in a single lease, usually a large and fairly long-term one, which is offered to investors directly by the municipality. The term also is used for the sale of partial interests in a lease to a number of  investors by the lessor.

“Master Leases” are written to allow the addition of more equipment or property to a lease agreement in the future under the same terms and conditions.

WHO LEASES? A VARIETY OF U.S. MUNICIPALITIES  NOW USE LEASING

There are more than 88,000 state and local municipal governments in the United States. In addition to states, counties, and cities, municipal leases may be used by a wide range of other local government agencies, including:

• School districts
• Airport and port authorities
• Fire districts
• Sanitation and water districts
• Housing authorities
• Municipal hospitals
• Cities
• Counties
• States
• 501(c) 3 Organizationa
• Native American Tribes

montgomery-leasing-brief-course-public-finance

A Brief Course In Public Finance

Purpose: To acquaint the reader with the most commonly used methods of financing utilized by municipal governments and when Leasing is the best option.

Public agencies have numerous available options to acquire needed resources – equipment and/or project financing. Of course, paying cash is the most preferable method. This being said, cash may not be the best use of funds because agencies often have multiple simultaneous needs and a finite amount of available cash in their current or, possibly, future budget years to accomplish their goals.

Financing Options: Most common methods of financing are:
1. General Obligation Bonds.
2. Revenue Bonds.
3. Certificates of Participation
4. Lease/Purchase

What is a bond? In public finance, a bond is a piece of paper worth exactly $5,000.00 (not including interest). Bond issues are divisible into $5,000.00 units. A single $5,000,000.00 bond issue has 1000 bonds ($5,000,000.00 divided by $5,000.00 = 1000 bonds) and permits the underwriter to sell the issue in parts to multiple investors. Placing a $50,000,000.00 issue with just one single investor could be a real challenge.

Bonds have liquidity, which means they can be sold back to the underwriter by the original bondholder for an amount below their current par value, thus creating what’s called a “secondary market.” In other words, bonds are securities just like stocks and are subject to regulation by the SEC and NASD (National Association of Securities Dealers).

Securities require full disclosure to prospective investors in the form of an Official Statement (“OS”) prepared under the supervision of an attorney called “Disclosure
Counsel.” In addition a “Bond Counsel” is responsible for the authenticity and tax issues related the bond documents. Other underwriting costs include: paying agent (collects and disburses payments), printing costs of the OS and fees associated with the sale of the bonds. Bonds are ”priced-to-market” the day the bonds are sold, meaning they are sold to investors at the prevailing interest rate on that particular day. Payments are due to
bondholders every 6 months.

General Obligation, or “GO” Bonds, are exactly as the name implies – a general obligation of the city, county or state whose taxpayers approve the bond sale at the voting booth. All GO Bonds require voter approval. GO Bonds average 20 years in length. Bond proceeds are generally issued to finance larger capital projects. Bond issue rated A1 or AA by rating agencies are considered a conservative investment opportunities. Investment grade bonds are those with a rating of BBB or higher. Conversely, those rated lower than BBB carry higher risk but pay higher interest rates to offset the potential risk of default.

GO Bonds are not spontaneously conceived due to the time it takes to originate, sell the idea to the voters and hold an election – all of which is accomplished with public
scrutiny. The process could take a year or more to complete and may or may not pass in the referendum.

Revenue Bonds
Revenue Bonds have the same characteristics as a GO Bond with two exceptions: a) they do not require voter approval and, b) repayment is based on a defined source of revenue from the project being financed. Revenue bonds are approved by the board of the agency needing the funds after numerous meetings open to the public. Although the bonds are “revenue neutral” to the taxpayers, local input is encouraged for political and legal reasons.

Streets and sewers for a new housing development would be financed with revenue bonds since the debt service comes from user fees charged to the those directly impacted by project being financed. There are over 90,000 separate political sub-divisions in the US. Of this total, many are sewer and water / wastewater related.

To mitigate possible investor risk, underwriters will often arrange for bonds insurance against default. An insured bond issue are rated A+ or AA, making them a safe,
conservative investment. The added cost of insurance is worth every penny to the borrowing agency because it lowers their overall borrowing cost.

By the same token, uninsured municipal bonds (not quite junk bonds) are sold at higher interest rates to entice more aggressive investors willing to take some risk for a higher yield on their money. These bonds can be very attractive to sophisticated investors who know what they are doing.

MUNICIPAL TAX-EXEMPT LEASES

“Tax-exempt” in this context means the interest portion of each lease payment is not subject to federal and state income taxes to the Lessor, or their assignee. The issue has
nothing to do with sales, use or property taxes.

Only agencies with taxing authority can issue a tax-exempt lease. A non-profit corporations tax-exempt status does not qualify them since they don’t have the taxing
authority reserved solely for public agencies.

Tax-exempt leases are, in most cases, installment sales containing “non-appropriation” language (also called “funding-out clause”) and enabling the lessee to terminate the lease at the end of the current fiscal year, without further obligation, should the lessee be unable to obtain funding for the next fiscal year and beyond. Technically the lease is structured as a series of one-year renewable obligations subject to the lessee’s ability to appropriate the money for payments due in future years. Cancellation for convenience is not implied by this provision.

Non-appropriation language permits the lessee to amortize the loan over a multiple year period. Without it included, leases would have to be fully amortized during the current fiscal year.

As a result, the payment constitutes a current expense of the lessee and is the reason it is called a “Lease/Purchase” rather than a “Loan.” In the sole event that sufficient funds are not available next fiscal year, the lease is terminated at the end of the current fiscal year and the equipment is delivered to the Lessor with 90 days prior written notice. A current expense item is not considered debt; therefore tax-exempt leases do not require voter approval, nor do they count against the lessee’s debt ceiling, or borrowing limit. Being an installment sale, title to the equipment vests with the lessee during the lease term, and the lease will fully amortize to $0.00 with the final lease payment.

The two most common forms of a Tax-Exempt Lease are:
1. Certificates of Participation (a.k.a. “COP”) and,
2. Lease/Purchase Agreement

COP’s are structured much like revenue bonds. They a) are sold to multiple investors in $5,000.00 each certificates, meaning they are “securitized” and require full disclosure in the form of an Official Statement (OS), b) payments are made semi-annually and, c) they require a Paying Agent, or Trustee. The main difference between the two is that COP lease payments may be tied to a lessee’s General Operating Fund rather than to a specific revenue source such as monthly utility fees. COP’s may extend out 20 years, or longer, and are of sufficient $dollar size to warrant certificating them. Hence the name: “Certificates of Participation.”

Municipal Lease/Purchase Agreements transactions are placed with single investors, such as: banks, mutual funds, or large corporations interested in debt instruments that are not federally taxable. Being single investor transactions, they are not “securitized” – meaning they are not considered securities and therefore not subject to the same stringent disclosure, legal and reporting requirements or significant underwriting costs associated with Bonds and COP’s. Lease/purchase agreements offer some distinct advantages:

1. Capitalized cost as low as $10,000.00.
2. 100% financing including: delivery, installation and sales tax (where applicable).
3. No up-front Lessor underwriting costs.
4. No voter approval requirements.
5. Equipment and Real Property may be financed on a Lease/Purchase Agreement.
6. Flexible payments: Monthly, Quarterly, Semi-annual, annual or delayed pmts.
7. No Reserve Account required.
8. Uncomplicated documentation.

montgomery-leasing-leasing-to-federal-government

Leasing To The Federal Government

OVERVIEW

The Federal Government may acquire equipment by purchasing it outright, renting it or through lease financing.
Their decision to lease is based on budgetary restrictions and the planned use of the equipment. When they
decide to lease, the responsible contracting officer will receive vendor proposals, which upon request by the
government, will include finance Terms & Conditions (T’&C). Upon award the vendor is called a Contractor.
The Contractor provides the equipment per the terms of the award and will be the party to whom the
government issues it’s Purchase Order (P.O.) with all the T&C inside. The Contractor, working with a 3rd Party
funding source such as Leasource Financial Services (Assignee), assigns it’s interest in the stream of payments
to the assignee and is able to book a cash sale.

Reciprocal Immunity Agreement. Sixty years ago, the FED and the States agreed to exempt each other’s debt
instruments from any applicable income tax liability. Municipal debt instruments, including leases, are exempt
from both federal and state income tax. Although federal leases are exempt from state income tax per the
Agreement, they are federally taxable the same as Treasury Notes and bonds and other federal debt instruments.
Federal lease finance rates are substantially higher than municipal rates because they are federally taxable.
They also bear a greater default risk.

Assignment of Claims Act. The participation of financial institutions in federal leases is allowed under the
Assignment of Claims Act of 1940. Under the Act, payments due from the Government to a vendor
(Contractor) for an equipment lease may be assigned out of the original government purchase order while
leaving warranties and other issues with the Contractor.

Federal Acquisition Regulations (FAR). Federal procurement is highly regulated. The FAR that determines
individual agency policy & procedures.

TYPES OF LEASES

A. Lease To Ownership Plan (LTOP)
Under the LTOP, the Government intends to own the equipment. The Government’s equity in the equipment
increases with each payment and fully amortizes over the term of the lease with no balloon payments due at the
end.

B. Lease with Option to Purchase (LWOP)
Under the LWOP, the Government has the option to purchase the equipment at specified times throughout the
lease and at the end of the lease term for a predetermined price. As each payment is made, credits accrue to the
Government, and the purchase option price is the cost of the equipment less any accrued credits. At the end of
the lease term, the Government may purchase the equipment for a previously agreed upon price, return it to the
Lessor or negotiate a new lease.

C. Straight Lease (Rental)
When using a Straight Lease or Rental, the Government does not have the intent to own the equipment, and
does not accrue any equity in the equipment. Payments are made over the term of the lease. At the end of the
original term, the equipment is returned to the Lessor or a new lease is negotiated.

RIGHTS OF TERMINATION

Pursuant to the FAR, the Government enjoys the right to terminate contracts for a variety of reasons. These
rights typically pass through to the Government’s contractor.

Termination for Default
Under the FAR, the Government may, at its sole discretion, terminate a contract for any default of the
contractor (FAR 52.249-8). This clause is mandatory in all federal contracts. Default includes, but not limited
to, non-performance of either the equipment or the Contractor. By exercising this right, the Government is not
obligated to make any additional payments to the contractor or its Assignee/Lessor. The defaulted contractor
may also be liable to the Government for any costs incurred by the Government in acquiring the defaulted
products from a more expensive source.

Financing between the Contractor and Assignee/Lessor is usually on a non-recourse basis. Assignment
documents between the Contractor and Assignee/Lessor contains language which clearly indemnifies the
assignee against any loss due to performance deficiencies. In this event, the Contractor is obligated to make the
Assignee/Lessor whole, including payment for loss profits. The Contractor is then free to pursue further
negotiations with the Government.

Termination for Convenience
Under FAR 52-249-2, Termination for Convenience (T for C) is mandatory in all fixed-price contracts over
$100,000.00. Unlike Termination for Default, it is customary for the leasing company to assume the risk of
Termination for Convenience. Under this termination right, the Government has the right to terminate the lease
at any time it is determined to be in the best interest of the Government. They may not, however, exercise this
right in order to avoid contractual obligations. In the event of a T for C, the Contractor is required to assist the
Assignee/Lessor in re-marketing the returned equipment.

The best protection for all parties is to insure that the equipment is essential and that its useful life exceeds the
lease term.

Termination for Non-appropriation.
As with municipal leases, most leases to the Government are subject to annual appropriations. The Government
may terminate the lease without liability at the end of each year if funds are non-appropriated.
Non-appropriation is a risk that is assumed by the Assignee/Lessor.

montgomery-leasing-mom-never-told-you2

Things Your Mother Never Told You About Federal Government Leasing

The United States federal government leases an enormous amount of equipment every year – and
it’s appetite for leasing continues to grow. Over the past decade, hundreds of federal agencies and
departments have discovered and embraced leasing as a way to acquire needed equipment.

Under the Assignment of Claims Act of 1940, as amended, 41 U.S.C. 15, 31 UI.S.C. 3727, as
implemented by the Federal Acquisition Regulations (FAR), 48 C.F.R. subpart 32.8., a
government contractor may release their interest in lease (LTOP or LWOP) payments to a 3rd
party by executing an Instrument of Assignment of Claims. The 3rd party assignee forwards this
with a Notice of Assignment to the government and is entitled to receive all future lease
payments due under the contract or government purchase order. Payment made by the
government and/or the contractor will not discharge their mutual obligations under the contract.

Federal contracting officers don’t normally sign a lease. They incorporate terms & conditions of
the Federal Acquisition Requirements (“FAR”), inside the purchase order issued to the contractor
for goods and services. The Contractor, in turn, executes a Federal Lease Financing Agreement
with a Lessor/Assignee that permit the assignment of payments, but none of the other
obligations, to a 3rd party under the Assignment of Claims Act of 1940, and is paid the full
invoice price at the time the government accepts the equipment. By accepting a Purchase Order,
the contractor acknowledges responsibility for understanding what all the little numbers mean –
numbers that take on significant meaning if certain events take place, such as:

Cancellation for Non-Appropriation. The Government may cancel a contract if funds for
subsequent years are not approved. They actually issue a new purchase order every year for the
payments due in that fiscal year (October 1 thru September 30) no matter the term of an
installment agreement. If a Prime Contract is terminated early, for example, the Government
would simply not issue a new Purchase Order for next year’s payments and the installment
agreement ends on September 30 of the current year irrespective of the remaining number of
payments.

Cancellation for Convenience (FAR 52-249.2). Under this FAR, the Government has the right
to terminate the Order at any time it determines to be in the best interest of the Government. They
may not, however, do so to avoid contractual obligations.

Cancellation For Default (FAR 52.249.8). The Government may, at its sole discretion, terminate
a contract for any default of the contractor including, but not limited to, non-performance of the
equipment or by the contractor – even if the contractor is not the original manufacturer.

Cancellation for Non-Appropriations and Cancellation for Convenience are investor risks.
Cancellation for Default is a different matter. In the event of a performance or equipment related
default the Lessor has the right to be made whole under terms of the Federal Lease Financing
Agreement. It always remains the obligation of the contractor to perform during the contract
period. Again, the contractor is merely selling the payment stream due under the government P.O.
but none of the other obligations, thus making him responsible over the full term of the lease.
Normally the three parties work together to best resolve issues well before an actual default takes
place and there are certain limitations placed on the government in this context.

Who buys Federal leases?
Federal leases have a thin investor pool due to inherent risks already discussed. Although
government financial statements are not normally an issue, a perspective Lessor will, at a
minimum, want to know the following information prior to purchasing:
- Name of Agency
- Collateral description and cost
- Lease term
- Why the equipment is essential.
- What the equipment is replacing (if any) and how old is the equipment being replaced.
- Source of funds to make the payments.
- Copy of the completed government P.O.

Red Flags!
a) Prime Contract whose termination date is shorter than the desired term of a new lease.
b) Non-essential equipment

Paper Flow
1) Contractor/Vendor solicits payment terms from Broker subject to credit.
2) Contractor responds to government Bid including a lease payment quote.
3) Government makes award to Contractor and issues them a P.O.
4) Contractor provides Lessor a copy of the Government P.O.
5) Lessor prepares the necessary documentation for signature.
6) Executed documents are returned to Lessor.
7) Transaction is funded upon final Acceptance. Funds are wired to the Contractor.