What is a tax-exempt governmental lease-purchase?
It is an installment-type obligation, specifically for governments and political subdivisions that offers tax-exempt interest rates (as municipal bonds do), flexible terms, and ease of implementation.
Why lease-purchase with SCB Public Finance?
Sargent County Bank has actively underwritten municipal debt, including bonds and lease-purchases (also known as “municipal leases”) for over 60 years. As a division of Sargent County Bank, SCB Public Finance specializes in providing all types of tax-exempt financing to the governmental sector.
Governmental entities and state political subdivisions, including cities, towns, counties, school districts, state colleges and universities, state government, fire districts, and other special districts. The entity must have the power to police, levy taxes, and have eminent domain.
What can tax-exempt lease-purchasing do for our entity?
Attractive, tax-exempt interest rates are only available to governmental units and the obligation takes the form of debt. Benefits of equipment/property ownership remaining with the customer with the leased property simply provides “collateral” until the lease-purchase is fully paid. Compared to municipal bonds, a lease-purchase is easy to implement, is very flexible as to payment terms and types of equipment/property that can be financed, and the completion time is typically 3 to 5 weeks.
Compared to the cash alternative, a lease-purchase provides for immediate purchase, with installment payments coming out of an annual budget. Equipment selection, the equipment vendor, and lease payment terms are decided by the customer.
What is difference between lease-purchase and commercial lease?
Commercial and consumer leases have “taxable” rates, not the lower tax-exempt rates reserved for governmental entities. They are typically structured as “operating leases” which are basically rental agreements in which equipment ownership remains with the leasing company and the customer may be given options to purchase the equipment at various times.
What is the difference between a OEM residual lease and a lease-purchase with SCB?
A residual lease from a OEM for heavy equipment will always charge a higher interest rate. Typically 2-3% higher than SCB Public Finances rates and the interest is compounded monthly costing more money.
Some vendors offer a guarantied trade in value and even say the equipment could appreciate over time. It is very rare for equipment to appreciate over time and when is the last time your car has appreciated after 5 years in value. The value guarantied by the OEM is very low value allowing for them to make extra money on the re sale of it.
By entering into a residual lease you are basically renting the equipment and never building any equity in the equipment. It forces the entity to have to be constantly making payments for the equipment every year. The payments will not decrease over time, but increase due to inflation and rising equipment costs. It also makes it more difficult to try different vendors or price shop. For example if a entity owns a loader for 15 years at a time. This could be typically paid for within 5 to 10 years with a level payment. If this was through the OEM payments would continue to rise every time a new machine is received and no equity is built.
The government entity will receive the best deal by paying cash up front and not financing it through an OEM.
Why not just borrow the money or issue bonds?
Governmental entities are limited by state statute as to when and how they borrow money, including the use of loans, bonds, leases and lease-purchases. Voter approval/referendum is commonly required for the issuance of any long-term debt (greater than one year in maturity) like bonds. A lease-purchase is not considered statutory long-term debt because the payments due each year are appropriated for on an annual basis and the customer can legally cancel the lease-purchase if funds cannot be appropriated in a given year’s operating budget for upcoming payments.
Bonds are usually reserved for long-term financing needs (12 years or longer) and for large capital needs for which money has to be raised through taxation or assessment to make bond payments.
Who owns the equipment/property during the lease-purchase and who is responsible for insurance and maintenance?
In most situations, the customer (“lessee”) retains ownership with the finance source (“lessor”) keeping a security interest (lien) in the equipment/property until the obligation is paid off. The responsibilities of ownership also rest with the customer, including insurance, maintenance, and any applicable taxes.
What is the approval, application, and credit process?
After the potential customer and SCB Public Finance discuss the customer’s financing need, financing options, the desired equipment/property, and timing, a proposal is provided by SCB Public Finance. If the proposal is satisfactory to the customer, it is signed and returned to SCB Public Finance along with specified financial statements and/or audits and current year budgets. SCB Public Finance then performs its due diligence and makes a credit decision approving the transaction or a modified version of it.
What is the documentation process?
Following approval by SCB Public Finance, a document package is prepared by SCB Public Finance for execution by the customer, typically with the assistance of the customer’s legal counsel. The transaction can be closed, and SCB Public Finance makes payment to the vendor, once all documentation is complete and the equipment/property is delivered to and accepted by the customer.
What are typical terms and rates?
Most municipal leases run from 3 to 20 years, and they have equal, regular payments of principal and interest (like a car loan). The customer usually decides on the frequency of payments, the payment due date, and when payments start. Interest rates, which are fixed for the term, vary according to the length of the obligation, the type of equipment/property, and the credit strength of the customer. Interest rates are fixed throughout the term and can range anywhere from 2% to 4% as of February 2017.
Do 501 (c)(3) non-profit organizations qualify for tax-exempt financing?
Yes, but the lease-purchase instrument is not used for non-governmental entities. Instead, a tax-exempt note (conventional debt) is used since the borrower is generally not subject to state statutes restricting how a non-profit incurs debt. A non-profit has no taxpayers that require “protection” by statutes.
A tax-exempt note is very similar to a lease-purchase as to how it is structured but the note payments are unconditional and not subject to an annual appropriation condition as in lease-purchases. Federal tax rules require that a non-profit obtain the assistance of a local city or county that will “issue” the debt on behalf of the non-profit in order for the transaction to enjoy a tax-exempt interest rate. The issuing entity has absolutely no obligation or responsibility in the transaction and, after the transaction closes, it becomes inactive and serves no function.