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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.

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