CDFA Spotlight:
Lease/Appropriation-Backed Bonds

By Stan Provus

Preface

This month CDFA examines Lease/Appropriation-backed bonds, which include Lease Revenue Bonds and Certificates of Participation. Many states use these obligations to finance capital needs. They are an attractive alternative to general obligation bonds that require the approval of voters at a referendum.

Body

Lease Revenue Bonds and Certificates of Participation are both forms of lease/appropriation –backed bonds. States and local governments to avoid constitutional or other legal restrictions on the use of general obligation debt frequently use municipal leases. However, leases are still considered as a form of tax-secured debt. For these types of bonds, the timely payment of principal and interest depends on annual appropriations by the issuer (i.e. state legislature, city council, etc.). Because the lease payments must be appropriated annually, they are not binding on future legislatures or councils and, therefore, are not considered “debt” under many issuer’s technical and legal definitions—this also means these obligations are not subject to voter approval at referendums like many general obligation bonds.

However, the rating agencies will still consider lease/appropriation-backed bonds in an issuer’s (state, city, county, etc.) debt statement and debt ratios. Consequently, the failure to make an appropriation will result in a downgrade of both the appropriation-backed bonds and the general obligation of the issuer, as a reflection of the willingness of an entity to make good on its obligations, even though there is typically no legal requirement on future legislatures or councils to appropriate lease payments. At the end of the lease term, the issuer gets title to the property subject to lease/appropriation-backed bonds.

One of the factors the rating agencies will pay attention to with lease/appropriation backed bonds is the “essentiality” of the project financed with these obligations. That is, how essential if the property financed with these bonds to the issuer (state, city)? For example, a fire truck is more essential than office equipment and therefore, there is a stronger likelihood of obtaining future appropriations for lease payments.

Many different types of projects have been financed with lease/appropriation bonds including:

Office buildings, public administration buildings, courthouses, police and fire stations, civic center complexes, museums and convention centers
Elementary and high school buildings, relocatable school buildings and "land bank" programs for growing school districts
Telephone, telecommunications and data processing systems
College and university buildings and equipment, including laboratories, high technology educational facilities, libraries and instructional facilities
Prison, jail and other correctional facilities
Health care facilities
Cogeneration projects and other electric power facilities
Water system facilities
Wastewater treatment facilities
Aviation hangars and other airport facilities
Parking structures
Public golf course and recreational projects
Open space
Asbestos removal projects at schools
Unfunded pension liabilities
Land acquisition
Light rail transit
Equipment, buses, computers and other personal property
The leases or other agreements on which these financings were based have involved such features as:
Master lease arrangements
Leveraged leases
Transfer of tax benefits
Rent payable from a general fund, but limited to the amount of a particular tax or other revenue received by the lessee

This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.

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