Jack O. Yost has seen tax-exempt leasing growing to a flourishing business in the 18 years since he did his first municipal lease finance deal.
As one of the original members of the Association for Govenmental Leasing & finance, founded in 1981, he has been the association grow from "just a handful of us to 175 or 185 members."
Yost, who is with Dougherty, Dawkins, Stand & Bigelow Inc. in Minneapolis, has served on the board of directors of the leasing group for the last eaighe yeas and will conclude a one-year term a its chairman in November.
Yost has watched the association bringing together people from all sides of the municipal lease business, as well as the steady growth in lease issues.
"We used to do $200 million a year; now we're doing $10 to $12 billion. So [leasing has] become quite a lady." Yost said.
The association's primary missin has been to educate its members and instill a code of ethics and behavior for the players in the municipal lease industry. It has also tried to provide a network of contacts for the members, he said.
"In all of those cases it's worked very, very well," Yost said.
From his first municipal lease financing, Yost has tried to encourage those in the business to talk to each other, to talk to everybody about municipal leases. It pays to educate, he said.
"I harpe at them to meet, I harp at them even to share who their customers are. A lot of them fight me on that.
"Ten years ago in Phoenix, I was talking about who the buyers were of these deals, and I was talking about the insurance industry. I had people come up to me later and say, 'What are you telling them that for? They'll go after my customers.'
"Hell, none of us are going to get 100% of anyone's business," he said.
There is a lot of money out there to be invested, and if people know about the municipal ease, the number of investors wanting to buy it will continue to expand, Yost said.
"That's what the whole organization is about--to help each other become successful and to help the industry become successfu," he said. When the municipal lease was a "strange and unique financiing," they were very expensive, he said. Now "they're just as skinny as regular old municipal bonds."
The municipal lease industry received some negative attention over the last couple of years because of two highly publicized cases, one in California and one in Florida, where the municipalities involved almost defaulted on the lease. Yost shared his insights into the municipal lease industry and projections for its future in light of the controversies in a recent interview with staff reporter Heather Ann Hope.
Q: What is the condition of the municipal lease-purchase industry? Is the industry still healthy in light of the two widely publicized controversies last year?
A: The health of the industry is good. The original use of municipal lease-purchase financing as a method for acquiring necessary assets and equipment for municipalities is still in place. It was originally put in place to acquire fire trucks, garbage trucks -- things that a municipality has to have to provide services. As a tool for municipalities it's excellent and is still very viable and will continue to be very viable for years to come.
The Brevard [County, Fla.] thing, where you're talking about a huge county office building, was a totally different usage of municipal lease financing. A type that has been criticized. If there is going to be or them has been criticism, it's going to be for those kinds of projects where it has been felt by some of the elected officials it was a means of bypassing the voter, bypassing referendum. You can really get into some fistfights when it comes to that side of the business. But the general municipal lease-purchase technique for acquiring things is excellent.
Q: So the Brevard County deal was really outside the purview of the original use for lease-purchase deals ?
A: I think most of the industry feels that way about a building. If you're going to do a school, you typically would go to referendum. If you need streets or water, that's typically a referendum or you have it within the budget to do that type of thing.
Q: During an association meeting last year, some people were quoted as saying the Brevard County fiasco had little permanent, negative impact on the lease financing industry. Is that still the case?
A: If you were a municipal leader and you had a proposal laid on your desk to do a facility like they did in Brevard County, because of all the publicity Breyard County got you'd think twice before you'd go to municipal lease. You'd jump through a whole bunch of hoops to make sure you were backstopped right to the top rung. You would in no way want to hang yourself out like they did in Brevard County.
What it's done across the country is given municipal leaders something to think about. But as far as its effect on them using the municipal lease as a tool for the normal everyday things that it was designed for, no, it hasn't affected that at all.
Q: Is there an image problem with leases?
A: Anytime it's been used for the obviously questionable, Brevard-type financing there's been negative thought by people that just don't think it should be used that way. But as far as the industry goes, or municipality goes, I don't think there's any negative thought when it's used as it should be.
I've put on two seminars and in both instances we just talked to these people about lease-purchase financing and where it's going. We were in a position to ask these [state and local treasurers] questions. We asked if they have ever done, or think of doing a lease-purchase agreement, and probably 75% of the hands in the room would go up. Then the question was why.
Well, it's obvious it's a very viable method for municipalities to use to acquire equipment. If you go to referendum for something two or three thousand dollars or upwards of $1 million, it's going to cost you more to acquire it that way. You may get a little better interest rate, but you're going to end up paying the costs of just getting that voter out to vote.
It's an awful lot easier to pick up the phone... first of all you go through the process of identifying what you need -- let's say it's a fire track or a new computer -- and you jump through a lot of hoops as a municipal counsel to have vendors come in and bid. Now you pick the piece of equipment you want, and now you're going to go out for a financing bid. Are you going to use a referendum or is it easier to send out a request for proposal to 15 or 20 different brokerage or leasing firms to give you a financing bid. I mean that's something like going to a public vote fight there. You're going out for bids and looking for the lowest cost.
We in the industry sharpen our pencil. We want to buy that thing. We know it's going to take the lowest rate to do that, and we know we're not the only kid on the block bidding. That way you get the absolute lowest bid and the lowest cost. It's amazing how sharp pencils get. Right now it is extremely competitive and being won at extremely low interest rates. Municipalities are really getting a good deal.
Q: What has made lease-purchase financing so competitive? And has the non-appropriations language made investors shy away ?
A: It's become a lady as a method of financing. It's become a highly recognized investment for banks and insurance companies and mutual funds.
If I buy a deal, say it's a $500,000 deal for fire trucks, where am I going to put that? I'm an investment banker; my job is to do the deals and place that financing with the ultimate investor. Go back 17 years and nobody had heard of these things, so to take a municipal lease financing to a bank or an insurance company and have them read the language in there, they'd say, "Well, gee, what if they don't appropriate? My only recourse is to go repossess that piece of equipment. What am I going to do with a garbage truck or a computer?"
We had to overcome that objection and it's now an established fact that municipalities don't default, they don't nonappropriate. There have been a couple, sure. But they're so few and far between. In fact, we're asked that question by the state treasurers at meetings.
Several years ago, someone came to us and wanted to sell their $48 million portfolio that they had spent 12 years building. They had leased a lot of equipment to municipalities. In 12 years on a $48 million portfolio -- only a $25,000 write-off. That's nothing. I know two who have portfolios in excess of $1 billion that have not had $100,000 in losses, in write-offs.
In other words, municipal lease financing, even though it has that non-appropriation clause language in there, is extremely secure. Your municipal leaders don't enter into these things by the seat of their pants. Those municipal leaders have jumped through a lot of hoops to get the financing and they're not doing it very lightly. Their intent is to acquire the piece of equipment at the lowest possible cost.
They build into the lease document that they can non-appropriate, but they have to do that because the law says that one administration cannot obligate a future administration without going to referendum. The municipal lease deal was blessed by the IRS as long as you have a lease payment that's broken down into a principal component and an interest component with a buyout provision. This is only available to municipalities to allow them to get a piece of equipment on installment.
But they don't non-appropriate. Those that have and do and the people that are in our industry that have experienced defaults, non-appropriations, typically are for pieces of equipment that are nonessential -- other things like copy machines or fax machines or a vending machine in the lunch room.
Q: Any controversies looming on the horizon?
A: No. I don't know of anything that's in the wind. There are no bombshells that I'm aware of.
One of the reasons we formed the association was to unify people that were starting to do business with municipalities. So what we've brought is kind of a common mind, if you will. Everybody wants it to be a very clean, honest busihess just like the regular municipal bond business is. We use it here interchangeably within our firm. There are numerous things we'll do as a municipal lease almost second nature as we would with municipal bonds.
When we first started the firm it was a bond firm, but because I had done some municipal lease financings I then had to educate our bond people to be on the lookout for lease financings; the firm would normally say we don't even want to look at a deal unless its $1 million or $2 million. I had a ready client base developed that just loved [leases].
[If an issuer] was an A-rated town and they were to come with an A-rated bond at 5%, a municipal lease would be at 6%. It would cost him 100 basis points more, but now that's down by 50 to 60 to maybe 75 basis points. But a lot of the time if you use certificates of participation, they get down between 15 and 25 basis points.
Q: What is the difference between a COP and a lease-purchase ?
A: They're the same, but when you use a COP you certificate each payment. With a five-year deal with semiannual payments, there are 10 payments. Each of those payments is made up of principal and interest. If a single investor would buy it, he would have just those 10 payments. If you issue a COP, you certificate each payment, like a bond payment, and you could have 10 different investors. There would be a little different interest rate on each one of those payments.
Q: What is the benefit of a COP?
A: You will get a little better interest rate usually for the municipality because you are now making it look exactly like a municipal bond. If you were to take a $1 million or $500,000 COP, it's not uncommon to see those interest rates down to only 25 basis points higher in yield than a regular municipal bond.
You'll hear on the Street, "Well, why do a municipal lease when you'll pay a substantially higher interest rate?" It's not really the case anymore. There are more bankers out there that use them. Right now you can sell it in three seconds. The insurance companies use them very effectively, in fact some of the mutual funds use them as part of their portfolio mix. You can get them rated now by Moody's Investors Service and Standard & Poor's Corp. You can insure them by AMBAC Indemnity Corp., by Municipal Bond Investors Assurance Corp. -- all of the insurers will insure them.
Q: During the association's May meeting, several speakers were quoted as saying that a lease structured as a COP looks like a municipal bond and sells better. Why is that?
A: It gives you a very broad market and as a result you can get a lower interest rate.
I'll give you an example. I'm going to do a deal. Let's take a $500,000 deal. There are a lot of big portfolios out there that will buy that deal as a single-shot private placement. They'll probably be as much as 100 basis points higher than if I took it public, as a COP. So if the origination guys in my firm here get hired to do a deal, we can go two ways with it. I can privately place it or I can take it public and offer it in $5,000 denominations to every little old lady or bank or whatever in the country.
I'm going to get the lowest interest rate for the town if I do it as a public issue, break it up into smaller denominations, and diversify it, than if I take it to one single investor. [A private placement is] a slam dunk. It doesn't cost them for all the printing and all that extra legal stuff. Some of the big guys will say, "even though we charge you more, we're saving you all the printing costs. We're saving you all the extra legal bills and so our interest rate really ends up just the same and it's a lot easier to pick up the phone call and say here's the check."
Q: Does it really work out that way?
A: I can go either way as a salesman. I can place it either publicly with a lot of individuals or privately with one of the big guys.
Investment bankers that go out and get hired by those towns to do the financings get hired on the basis of getting that town the money at the lowest cost and with the Least amount of hassle. They bring the deal in to me and see what I can get. Right next to me they can sit down with the guy who heads up the public issue desk who would broadly diversify it. Invariably, he'll beat the socks off me on rates. The originations people are going to immediately take his rate.
If they don't, over across the street here they've got a lot of investment bankers at that town trying to get hired to do the job. There's probably half a dozen firms that are calling on that town trying to get hired to do that financing and every one is saying "Hire me because I can do it cheaper than anybody else."
So if we as a firm can't get it done at the lowest price, or I do it privately at the higher price, the other firms are going to go right to that town and say, "they screwed you." We can't afford to have our reputation besmirched by that kind of critique, so we're going to do it at the lowest possible price. That's what controls the competitiveness is this business.
Q: What is a municipal lease rating based on?
A: Usually they will take the city's rating and downgrade. In other words if it was a triple-A-rated town and they wanted to do a municipal lease, it would probably be rated triple-B-plus or A-minus.
Q: What kind of future do you see for lease financings ?
A: I'm very, very comfortable with the industry. It's a very positive tool for the municipality to use. You take a small little town or a fire district and they need a $5,000 jaws of life tool -- you know that's what they use to cut people out of cars -- and it's not in their budget. It's a very effective way for them to get that tool. And there are people out there who will loan them that $5,000 over three years or five years to get the piece of equipment.