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.