Reading the dollar signs
E-mail inboxes of city and county managers and finance directors can fill quickly with requests from department heads for funds to purchase equipment. The fire chief might send a reminder that the department is still under a mandate to upgrade the emergency communications systems by year end; the public works director sends a message that he needs new equipment to pave and plow the streets; and it is well-known that the parks and recreation department has not purchased new mowers since Reagan asked Gorbachev to tear down the Berlin Wall.
Traditionally, city, county and school district officials have used large publicly offered bonds to address those and other countless capital needs. But, facing pressure to reduce bonded indebtedness, coupled with voters’ growing reluctance to approve bond issues and even less support for tax increases, government officials are looking for alternatives.
The private option
Some local officials are turning to direct-purchase, private placement financing to acquire essential personal property and facilities. In particular, municipal lease/purchase agreements, often called municipal leases, are becoming common methods for obtaining equipment.
In general, “private placement” refers to the sale of a transaction to a financial institution, which does not involve a public offering. Most financial instruments — such as notes, leases, revenue bonds and certificates — can be sold as private placements.
To qualify for a tax-exempt municipal lease, the lessee must be a city, county, state or political agency that can exercise at least one of the following sovereign powers: taxation, eminent domain or police power. Municipal leases are structured as conditional sales contracts whereby the lessee must have the intent to purchase the leased asset and therefore can be considered the owner of the equipment for federal income tax purposes.
Funds for municipal leases often must be appropriated to make the lease payments and to avoid being characterized as debt, either for constitutional or statutory reasons. Additionally, a portion of each payment must be designated as interest, and purchase options must be at a nominal or bargain price. Therefore, most municipal leases fully amortize to a dollar. The transaction must meet certain private activity tests regarding the assets’ general use and who pays for them, because assets used or paid for by private or federal entities often are ineligible for tax-exempt financing.
Simplifying the process
There are four primary benefits of municipal leases:
They spread the cost of acquiring property and facilities over their expected useful life.
Assets such as police cruisers, communications systems, heavy trucks, computers and lawn maintenance equipment have a lifecycle that is considerably shorter than the 30-year, publicly offered bond. A 30-year bond can outlive an asset by as much as 15 years, and the local government would be paying for those assets through the bond’s maturity. By spreading the asset’s cost over a number of years equal to the asset’s life span, governments are better able to manage fund balances. In addition, when investment returns increase, they can leave unrestricted fund balances invested and borrow on a tax-exempt basis, rather than draw those funds down.
Municipal leases are less complex, cost less and close more quickly than bonds.
Most publicly sold obligations are far more complex and costly than direct-purchase private placements, including the need for credit enhancement, a rating, trustee, and a disclosure document, which increase the cost and size of the financing. Municipal leases can be originated, signed and funded in two weeks, and any expenses incurred in closing a municipal lease can be included in the financing, eliminating out-of-pocket expenses.
The Littleton, Colo., Public School system uses a master lease agreement to purchase technology assets for its 15 elementary schools, four middle schools and three high schools. There, the master lease agreement keeps all financings under one document and is managed through one point of contact. The lease terms also are matched to anticipated useful life of the assets being acquired.Leasing has simplified the school system’s relationships with vendors because it now is only negotiating purchase price and not other terms of the sale.
The terms and payment plans are flexible.
Municipal leases can range from $5,000 to $40 million, with terms from two to 20 years, averaging five to 10 years. Payment structures can be designed to allow government agencies to coordinate lease payments with budgetary cash receipts.
An option to purchase the equipment during the lease term is part of municipal leases. Called a “purchase option,” the lease agreement includes a pre-payment schedule of the amounts due if the government lessee wants to buy out the rest of the lease. Bonds, in contrast, have call protection, which requires that the bond be held for a certain amount of time before it can be redeemed prior to its maturity.
Municipal leases can be used to finance new construction.
Municipal leases can be used to construct new buildings. In project leases, the documents often create an interest-bearing escrow account until the contractors are paid. The government agency receives the interest on the invested funds in escrow. As security, project leases may include a ground lease of the land, with a right of entry and operation for the investor in the event of default or non-appropriation.
A city in Northern California’s Bay Area has used a master lease to finance equipment for its cable television and Internet system operations. Additionally, it used a master lease to buy equipment to help retrofit buildings and upgrade other assets, such as traffic signals. The master lease also was used to renovate city hall.
As funding requests roll in and the funds to pay for necessary equipment become more scarce, government officials might want to consider alternatives to purchasing outright or financing with bonds. A third option — municipal leases — could be a viable alternative to satisfy a community’s needs.
— David Jackman is a business development manager for Danbury, Conn.-based GE Capital Public Finance.