Lease securitization continues to be a viable financing structure, supplying cash to the issuer to fund retirement of existing debt or ongoing operations. The structure can be developed to serve as a standalone transaction or as an ongoing funding source, with features that remain constant in successive issues.
There are several intricacies that contribute to the variety of lease securitizations. The distinctions between "true" leases, "finance" leases and the taxable or tax-exempt nature of the lease stream are essential considerations for legal and investment purposes.
Of importance to some issuers is the method, rather than a sale to the security holders, to avoid taxation. For other issuers, a sale as opposed to debt treatment may not be significant.
State tax considerations and federally regulated equipment that is leased may also be determinants for particular financing structure. Accounting considerations to achieve either off-balance-sheet treatment or liquidity and cash flow are a priority.
The investment community remains favorable to lease-backed securities, in particular, municipal tax-exempt securitizations. The historical performance of these kinds of contracts, coupled with the general nonterminable characteristic of the leases (other than an a failure of a governmental agency to appropriate sufficient funds) and the underlying credit quality of the governmental,entities are attractive elements.
Overall municipal debt volume for the years 1989 to the present total some $543 billion representing over 35,000 issues. Of this, $38.8 billion are municipal lease securities representing over 2,400 issues.
The market is expanding and as municipalities continue to utilize lease financing these assets become an attractive securitization resource.
A Recent Illustration
As we continue to contemplate the vast array of office equipment, transportation vehicles, public-safety merchandise, teaching and administration supplies, and communication systems that are acquired by lease contract, perhaps the most recent illustration of financial engineering in this field serves to educate us:
GECPF-2 Tax Exempt Grantor Trusts, Series A-D $115.3 million municipal lease-backed certificates issued via grantor trusts. The seller, GE Capital Public Finance Inc. is a wholly owned indirect subsidiary of General Electric Capital Corp. The certificate carry a 10% limited guarantee provided by GECC.
The four series represent fractional interests in the grantor trust. Each series was established by selling and assigning the lease obligations for each trust to the trustee, without recourse in exchange for the rated pass-through certificates.
Series A and B comprise lease obligations entered into by state and local government entities and institutions in California and Connecticut. Series C and D comprise lease obligations of governmental entities geographically dispersed throughout 38 other states.
Protection for Investors
GECPF is not a bankruptcy-remote entity; therefore, the transaction structure must protect investors from a potential seller insolvency. The transfer of leases from GECPF to the grantor trusts could be characterized as a collateral pledge, rather than an asset sale by a bankruptcy court, causing a determination that the leases should be included in the assets of the insolvent company.
The cash flow from the leases would be subject to the direction of the court and might not be available to service the certificates. In this transaction, GECC provided a limited guarantee agreement providing for payment to the trustee of any amounts held by the servicer or trustee that cannot be distributed to certificate holders due to insolvency proceedings.
Any payments under this provision of the guarantee agreement do not reduce the guarantee amount available to cover defaults or nonappropriation by the lease obligor.
Upon either scenario, the trustee agrees to assign all rights, title, and interest to the collateral to GECC in exchange for the principal outstanding and accrued interest due on the lease. Only one limited guarantee is issued to secure all four trusts. The amount available for claims will decline as payments are made to any of the four trusts.
The lease obligations assigned to the trusts number 510. involving more that 290 obligors mostly comprising either state governments, 24%; city governments, 10%; hospitals, 69%; counties, 5%; school districts, 39%; or universities, 2%.
The leases have primarily financed the purchase of computer equipment, 51 %; trucks, buses, and fire equipment, 13%; medical equipment, 10%; and automobiles for municipal use and police cars, 7%. They have also been used for telecommunications equipment, 5%, and real property, 1%.
The leases are nonterminable by the obligor for any reason other than a failure of the government agency to appropriate sufficient funds to pay the lease obligation.
An interesting caveat involves the concept of security interest in the collateral. GECPFS standard equipment lease purchase documentation constitutes a personal property security agreement and includes the grant of a security interest in the equipment to GECPF.
In most states, no provisions of law govern the perfection of security interests in equipment financed for the benefit of state and municipal governments. The Uniform Commercial Code, as adopted in most states, may not apply to security interests created by a government or government agency.
GECPF filed UCC financing statements applicable to transactions between private parties as the best method of attempting to assume its lien position. Perfection of the assignment of the security interest will occur upon an event of default under a lease and request by the trustee or GECC.
Cash Flow Structure
The cash flow and transaction payment structure is as follows:
Each month the servicer transfers to the trustee all scheduled payments made by the obligors plus any advances required from GECC as servicer, to pay the scheduled principal due and the interest payable at the pass-through rate for each respective certificate. Principal and interest due will be calculated monthly based on the valuation balances for each trust in the preceding month.
Investors will receive distribution in the month following the date on which lease payments are due. Scheduled interest accrues until payment is made to the servicer.
Prepayments, equipment insurance proceeds, repurchases, and claims paid under the limited guarantee are also distributed to investors on the appropriate date. The calculated interest on such payments will accrue up to the time of receipt by the servicer of the payment and not the full interest due under the original life of the contract.
The experience of a trustee in both municipal financing and asset securitization enhances the efficiency and operating viability of structures such as the GECPF grantor trust.
Familiarity with government operations and finance law, revenue streams, asset generation, and servicing and credit risk are all integral. Additionally, thorough administrative experience in securitization with various asset pools only serves to strengthen the transaction.
As financial engineers continue to develop variations in municipal lease securities, opportunities will develop for product origination which will benefit local governments and ultimately, the taxpayer.
As Jim Lebenthal, chairman of Lebenthal & Co. and industry spokesman, would say, "Buy Municipal Bonds!" - they're good for America, we, too, can begin to say Buy Municipal - it's good for America!
Some material in this article was extracted from research reports by Moody's Investors Service Inc. and Standard & Poor's Corp.Overall Municipal Volume: January 1989 - June 1992Date Range $ Amount (mil.) % of Total No. of Issues 1989 125,566.1 100 9,374 1990 128,765.3 100 8,862 1991 125,579.4 100 11,125 1992 113,983.8 100 5,999Lease Revenue Bonds: January 1989 - June 1992Date Range $ Amount (mil.) % of Total No. of Issues 1989 8,778.8 7.0 506 1990 10,071.6 7.8 665 1991 14,795.5 11.8 925 1992 6,205.0 5.4 372
DEBORAH L. MCDONALD Vice President M&T Bank
Deborah L. McDonald is a vice president f or corporate trust business development at M&T Bank, a unit of First Empire State Corp., Buffalo.
Ms. McDonald is responsible for expanding regional and national markets for corporate trust services. This includes analysis and definition of market potential with regard to issuing trends, and customer needs.
Before joining M&T, Ms. McDonald was vice president of Marine Midland Bank's public finance department. There, she co-managed the bank's $250 million tax-exempt loan portfolio and $800 million of municipal deposit business. Prior to Marine, she was with Chase Manhattan Bank for eight years.
Ms. McDonald received a bachelor of arts degree from Boston University and is currently pursuing a master of science degree in public policy and administration f rom the State University of New York at Buffalo. She has successfully completed the requirements for the certificate of institutional market sales from Cannon Financial institute and is a certified corporate trust specialist.
In addition to being a board member of the Government Finance Officers Association, she is a member of Financial Women international and Corporate Trust Associates, and is past president of the Western New York Veterans Housing Coalition.