How Does Lease-Purchase Financing Differ From True Leasing?

To a governmental lessee, the difference between lease-purchase financing and true leasing is the nature of the interest acquired in the asset. In the lease-purchase, the lessee acquires ownership of the asset. In a true lease, the lessee acquires only the right to use the asset for a period of time - it does not acquire ownership of the asset. The lease term of a true lease is usually much shorter than the asset’s useful life, while the lease term of a lease-purchase often approximates its useful life. The difference in term of lengths can be explained by what happens at the end of the term. With a true lease, the municipality typically relinquishes the asset but may purchase it at a price which reflects its residual or market value. With a lease-purchase, the municipality retains the asset without paying more than a nominal price in relation to the value of the asset, usually $1.00. Additionally, due to the ownership structure, lease-interest paid by the municipality to an investor is not taxed by the Federal and in some cases state government. In a true lease, rentals usually reflect interest at a taxable or commercial interest rate.

In some cases, true leasing may be the most cost-effective form of financing for an equipment project. An example of this instance may be if a city needs temporary space, such as a relocatable building for one year while city hall is being rehabbed. After the one year the city has the option to give back the building to the vendor, purchase it at the residual value or refinance it under a lease purchase agreement. True leasing may also be cost effective for technology purchases whereby the equipment becomes obsolete in a short period of time. The USLease program will determine whether true leasing makes sense on a case by case basis and make recommendations. USLease staff will evaluate each project and provide the alternatives available.

How Does Lease-Purchase Financing Differ From Bond Financing?

A lease-purchase financing is an exercise of a governmental entity’s authority to acquire or dispose of property. The issuance of bonds is an exercise of the authority to incur debt. Unlike a bond issue, a lease purchase financing is not considered to be debt for state law purposes, and no voter approvals are necessary to authorize the transaction. The underlying security for the two types of obligations is also different. With bond financing, the borrower commits a designated revenue source, such as property taxes or user charges, and obligates itself to raise revenues to the extent necessary to pay debt service. There is no such obligation supporting a lease-purchase agreement. The governmental entity covenants only to budget and appropriate lease payments from available revenues each year.

The financing mechanism for USLease is also different in structure than a traditional bond financing. Typically, funding for projects financed by bonds is obtained through the issuance of bonds in the public marketplace, also known as a public offering or underwriting. In this case, the debt issued by the public agency is sold to many investors with each investor receiving a proportionate interest in the principal and interest payments. Due to the cost associated with a public offering, including legal, trustee, printing costs, bond financing makes sense for larger, long term projects. Equipment financings, which tend to have shorter financing terms, generally are not financed through bonds unless larger projects are grouped together.

Funding as part of the USLease program is received through the private placement market. The private placement market provides municipal lessees with access to funding from large, sophisticated investors. Investors include institutions, banks and high net worth individuals. USLease bids each equipment project on behalf of the public agency to find the most cost-effective financing. Once the lowest bidder (funding source) is identified, USLease handles documentation and funding on behalf of the local agency. USLease documents have been pre-approved by multiple funding sources in the marketplace as well as numerous cities, counties, and special districts.

For more information about USLease and other financial programs offered through USCM, call Lilla Hammond or Justin O’Brien at 1-888-828-8763/ e-mail: info@uscmcitysavings.com  or Tracy McWilliams with USLease at 1-800-635-3993, extension14. For instant financing quotes, visit www.zipquote.com .

(Editor’s note: This is the second of three articles about lease purchase financing.)