Municipal Tax What?

Municipal Tax-Exempt Lease Purchase Agreement

The school district currently has two loans out with the Bremer bank for the boiler project started back in 2016-2017.  These loans were done under a municipal/tax-exempt lease.  This is a lease that allows political subdivisions, such as school districts, to have lower interest rates by virtue of being tax-exempt. A Tax-Exempt Municipal Lease is a conditional sales contract done in the form of a lease.  Under this lease type, the interest earnings on the lease are exempt from Federal Taxes.  This helps you avoid the upfront bonding costs associated with these types of leases.  The tax-exempt status of these political entities is then used as leverage to obtain a better interest rate.  Our current rate for our two loans is 3.297% and 3.327%.

These types of leases are considered debt services, meaning there is a fee paid for third party financing.  This is factored into the interest rate.  Despite it being a debt service, it does not go against bonding capacity.  It also does not go against our capital.

Dollar with an electric cord attached

Dollar with an electric cord

In a guaranteed savings contract, the energy savings insured by the construction management company (in our case CTS) is used as leverage to obtain a lower interest rate.  The construction management company provides a guarantee that they will produce cost savings through the projects they undertake.  These savings are then put directly into paying the loan off.  This reduces the calculated risk and lowers the interest rate needed to take out the loan.  This is how CTS has skin in the game and why refinancing through this type of contract lowers interest rates. This type of lease has non-appropriation language and does not involve committing specific mils to the repayment.

In our specific situation the leasing company interested in the loan is Kinetic Leasing.  What Kinetic Leasing does is draw up the legal documents consisting of these leverage items to insure a low risk to the financial institution holding the loan.  It then sells that loan to a local bank so that the money remains local and that the local bank benefits from the loan.  What Kinetic Leasing is providing is the legal expertise to draw up a solid contract that the bank feels comfortable in acquiring.

This is how a municipal tax-exempt lease and a guaranteed savings contract work.  A combination of a political sub-division’s tax-exempt status and the guarantee of energy savings are used to insure to a loaning institution that payments will be received on the loan.  This allows for a lower interest rate because of the decreased risk to the financial institution.

A picture of a car on a calculator with money and a lock in the background.

Picture of a car, calculator, money, and a lock.

The difficulty in refinancing outside of the guaranteed savings contract is that insurance.  Presently a loaning institution would at best offer 3.75-4%.  This would not be a fixed rate and subject to changes 5 and 10 years out.  The rate offered by the guaranteed savings contract is fixed and so are the annual payments. This makes budgeting for such expenses easy, because they are fixed.  This is unlike a bond where rates can fluctuate. The boiler loan itself is difficult to refinance because in the event of payments not being made, the financial institution is not going to repossess just a boiler.  For one it is attached to the school and for the second it would incapacitate the school.  This sort of equipment is unappealing for banks to take loans out on for more than 5 or 10 years.  The guaranteed savings contract is also callable, meaning that there is no penalty for buying out the loan.  Often loans or leases have penalties for paying off the debt early because this cuts into the financial institutions’ profits.

Dollar signs on a seesaw

Dollar signs on a seesaw

Refinancing the school’s boiler without some sort of financial leverage or guarantee would result in a higher interest rate and most likely one that is not fixed.  The only other way to gain extra financial leverage or guarantee would be to enter into contract where a certain number of mills would go directly to the financial institution holding the loan (certificate of indebtedness).  The money left after this deduction would be what the school would have to work with for its financial budgets regarding that levy. In this situation the number of mills committed is fixed and subject to fluctuations in valuations.

This is how these types of leases and loans work.  These are the factors that play into the interest rates and other factors.  To summarize, leases and loans operate on the calculation of risk.  The lower the risk, the better the interest rate is.   The more you can do to lower risk, the better rates you can acquire.

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