A municipal lease-purchase obligation is a tax-exempt loan which even some seasoned investors are unaware of. It is a private placement with a maturity span of generally two to five years that offers a premium rate of return higher than comparable municipal bonds. Payments include both principal and interest and the amounts range from $5,000 to several million dollars.
What Is a Municipal Lease?
A state or local government seeking lease-purchase financing may go to one of several leasing companies that specialize in municipal funding. When documentation has been agreed upon and signed, a lease-purchase obligation has been created. The leasing company agrees to pay for the equipment being acquired by the municipal government, and the municipality agrees to repay the equipment cost plus interest in installments.
The leasing company will then locate an investor who can benefit from the tax exempt income generated by the municipality's payments. These investors include banks, trust departments, insurance companies, and individuals.
Documenting the Lease
The investor receives a booklet of documents which establishes that person's right to all payments and protections originally given by the municipality to the leasing company. The papers include a copy of the lease-purchase agreement, payment schedules, legal opinions, and papers naming the investor as the owner or assignee of the contract.
Municipal lease-purchase obligations are multi-year agreements which are funded by the municipality on an annual basis. The investor is protected against a failure to appropriate by the municipality's pledge to use its best efforts to set aside monies to continue the lease-purchase contract for the full term of the agreement. In addition, there is a pledge that if the municipality fails to appropriate for the equipment being financed, no substitute equipment may be used for at least one year. Finally, the state or local government is required to surrender the equipment, which then becomes the property of the investor.
Lease-Purchase Obligation Advantages
The short-term length of municipal lease-purchase obligations is just one of the many benefits that they provide. Other advantages include the fact that the repayment of principal is carried out with installment payments made on a regular schedule, usually monthly. Also, the rate of return is substantially greater than that available on comparable municipal bonds.
12 Questions Investors Ask about Municipal Lease-Purchase Obligations
1. What kinds of state and local governments use this type of financing?
Lease-purchase financing is used by almost all types of taxing bodies. These include state governments and city, county, school, park, forest preserve, and other municipal districts throughout the country.
2. Who are the investors in these financings?
These securities have been sold to bank investment and loan portfolios, trust departments, insurance companies, and individual investors.
3. What kind of equipment is usually financed?
Equipment most often financed includes computers, fire trucks, photocopiers, and telephone systems. Occasional financings can be made for anything from water towers to water meters. In addition, many real estate financings have been handled in this manner.
4. How are the payment schedules determined?
The municipality and the leasing company select a mutually satisfactory repayment schedule. The municipality has the option of paying monthly, quarterly, semi-annually, or annually. The repayment period can be from two to seven years. In most cases, the frequency of payment is monthly and the total life of the obligation is two to five years. …