Balancing demand for tax-exempt leases with concerns about non-appropriation
While tax-exempt leasing offers benefits for state and local governments in any economy, some municipalities are turning to it for cost savings during the pandemic. School technology for distance learning has been a particularly strong driver of recent demand.
The question is, how are finance companies balancing the risk of non-appropriation in these leases with the legitimate concern over decreased tax revenues facing eligible entities? While the rates of actual non-appropriation have historically been quite low, there is a real concern that risks may go up due to COVID-19’s impact on government budgets.
The answer? Essentiality. How essential is the asset to the basic functions of the entity? The more “essential” the asset, the more likely the equipment lease is to survive potential budget cuts.
KS StateBank has long offered tax-exempt leases through our state and local government financing arm, Baystone Government Finance, which often partners with independent leasing companies on these deals. We’ve had to get comfortable with non-appropriation clauses that give governments the right to terminate tax-exempt leases if the money is not appropriated in their annual budgets.
When reviewing potential deals, we have always considered the lessee’s finances and repayment history, of course. But in this era of uncertainty we are underwriting deals a bit differently based on the collateral we are willing to finance. Factors we consider include the following:
- How essential is the equipment in responding to the pandemic or to the basic functions of the entity;
- Is the equipment expendable if government budgets tighten due to decreased tax revenues and/or rising costs;
- What is the availability of cash at the time of procurement;
- What are the competing demands on capital resources, especially in responding to the pandemic;
- What affect will a COVID-19 vaccine, or lack thereof, have on demand for the equipment.
Good Bets
While every deal is different, tablets, laptop computers and software that enable distance learning have been good bets for tax-exempt leases in the current climate. Given the cost savings, we have seen an increased demand for lease purchase financing among K-12 schools and secondary institutions because of budgetary concerns and COVID-19 precautions. In general, we find this an attractive category for tax-exempt financing.
One of the largest tax-exempt leasing deals we financed this year, in partnership with an ELFA origination partner, involved a district-wide technology overhaul for a school district responsible for educating over 12,000 students. This transaction involved the placement of hundreds of tablets and laptops, and the accompanying software. While typically financed using a traditional lease product, the district found the tax-exempt lease product appealing in this instance given the substantial cost savings they could experience on such a large transaction.
In my opinion there are other asset classes that remain strong during the ongoing pandemic and economic uncertainty. These include emergency services equipment; hard collateral such as vehicles, fire trucks and yellow iron; energy management systems; and infrastructure improvements.
Unfortunately, we have also had to turn down tax-exempt leasing opportunities due to the risk posed by the ongoing pandemic. For example, office equipment presents unique risks given that many employees are working remotely and may continue to work remotely if operating models change in response to COVID-19. Another deal we declined to fund involved non-emergency municipal equipment in a locality where the local college’s remote learning had greatly reduced the need for the equipment in the first place.
Thinking Ahead
Many medical experts in the U.S. believe COVID-19 will be with us well into 2021 before a vaccine and treatments significantly improve management of the disease. Even then there will be longer-term economic impacts.
As finance companies, we are playing an important role helping governments acquire the equipment they need to serve their communities. Tax-exempt leases can be a win-win for governments and leasing companies alike if finance executives understand the right deals to consider for them.