
What is
"tax-exempt" municipal leasing?
(non-technical/non-legal
definition)
Or perhaps you've
heard of municipal leasing's "first financial cousin," the tax-exempt
municipal bond. Both are very low cost methods of financing the
acquisition of essential-use equipment, vehicles, hardware and software
exclusively for
state, county and municipal governments, special districts and
authorities. "Municipal leasing" is an umbrella term applicable to all
of the aforementioned entities. There are however some
very significant differences between leases and bonds that we'll cover below.
But let's
start with the "tax-exempt" piece first as it is sometimes
misunderstood. First and foremost, the I.R.S. created tax-exempt
municipal leasing (and bonds) as vehicles to provide state, county &
municipal entities--also referred to as state and political subdivisions, with access to the lowest cost of funds. The I.R.S. accomplished this by allowing
banks and investors to deduct the interest earnings and certain carrying costs
on these transactions from their federal income taxes--thereby
lowering the funding source's "cost of doing business" and allowing them
to lend at considerably more aggressive rates than would otherwise be
possible.
Hence the "tax exempt" nomenclature that we use to distinguish
this unique type of financing from commercial loans and leases. It is the funding source that is "exempt" from
their federal (and sometimes state and local) taxes. This I.R.S. tax exemption
should not be confused with sales (or other) taxes which most, but not
all
governments are exempt from on their
typical purchases.
What
are the
critical difference between
municipal leases and municipal bonds?
Both are
types of multi-year financing. Both reflect the
very attractive interest rates characteristic of their tax-exempt
pricing as described above. But there are some VERY IMPORTANT DIFFERENCES to
you, the borrower.
Bonds are based on
an unconditional pledge of the "full faith and credit" of the
municipal entity, including a pledge to levy property taxes on every
tax-payer in the jurisdiction, as necessary to cover the bond debt when
otherwise budgeted funds are insufficient to meet the obligation. This is
why most bonds require public consent in the form of complicated,
time-consuming and expensive voter referendums.
In direct
contrast to bonds,
our municipal leases ARE subject to the annual appropriation of funds
in all jurisdictions that require it--meaning that if funds are
not available to make the payments for any legal reason, in any budget
year, the government
entity would have the legal prerogative to terminate the lease after the
current budget period without legal penalty and to return the equipment/vehicles to us--the Lessor
(not your vendor). This
is one reason why a municipal lease, unlike a bond, does not create balance sheet debt on the books of the Lessee (municipal entity).
While the very
low interest rates on tax exempt municipal leases compares directly with
bonds, municipal lease issuance expenses are just a small fraction of the
those involved in the documentation and legal compliance required for bonds
(these expense should always be factored into your evaluation process)--making
bonds a much more expensive option
for all but
the very largest (8+ figure/15-30 year) transactions.
Lastly, municipal
lease rates are FIXED UP FRONT when quoted and the documents are
signed. On the other hand bond rates FLOAT until the
underwriter brings your issue "to market," where the final rates are
actually set by other traders and investors. You will not know
the final cost until the issue is sold to the public. And you may
or may not like the numbers--you may even find yourself back at "square
one."
For more
information on our new Municipal Leasing specialty site:
Municipal Leasing - Start Here
Municipal Lease Quotes
Municipal Leasing FAQ's
IMPORTANT NOTE: First Capital
Equipment Leasing Corp. (hereinafter "FCELC") acts for its own interest
only. FCELC does not act as a municipal advisor, municipal
financial consultant, fiduciary or agent to any person or entity
pursuant to Section 15B of the Securities Exchange Act of 1934 and the
municipal advisor rules of the SEC. FCELC is not recommending
that you take an action with respect to the information contained on
this page or this website. You should review and discuss anything
presented herein with such independent financial, tax, legal and other
advisors as you deem appropriate.