The Public Nonprofit Conduit Financing
Advantage
How Nonprofit Organizations Can Help Build, Manage and Own
Community Assets
The coming decade will continue to bring major cutbacks to governments at all levels.
Many cities, towns and states are struggling to maintain service levels while
contending with, in many cases, a declining or
stagnating tax base. Only a handful states in
2011 are without a budget deficit and those
lucky few have small populations and revenue
from a major resource -- oil, natural gas –
This kind of financing employs a
nonprofit organization to serve as
the borrower for projects financed
from revenue bonds issued by
government agencies.
allowing them for a time to avoid facing a mountain of debt.
Adding to the challenge for all municipalities is a heated and sometimes vicious
political and media climate in which critics constantly deplore government spending
and in some cases its legitimacy. The stratified electorate can turn routine meetings
into ugly clashes as middle, left and right face-off on spending and revenue issues.
It’s made traditional municipal financing more difficult than ever to achieve without
expensive referendums and often clangorous civic meetings. And it’s made managing
or building community assets – schools, swimming pools, sports and park centers,
administrative offices – increasingly hard and fiscally daunting.
There’s a financing innovation, however, that provides almost all the benefits of
municipal financing but allows for communities to potentially sidestep political fights,
referendums and other roadblocks. It’s called nonprofit conduit financing. This kind
of financing employs a nonprofit organization to serve as the borrower for projects
financed from revenue bonds issued by government agencies. The government is no
Nonprofit Conduit Financing 1
longer in the lead for paying back investors. The responsibility is transferred to the
nonprofit handling the conduit financing arrangements.
Nonprofit conduit financing – sometimes called conduit borrowing -- can be used to
transfer ownership of government buildings to free up capital and to construct new
community assets such as schools, university buildings, municipal structures, utility
facilities, ice arenas, recreation centers and maintenance garages. The cash flow
created by the rental to a single entity, most likely the government, is used to pay
back bond holders. It is a form of municipal financing quite common in several states,
among them New York, where 90 percent of all public financing is done through
conduit tax authorities using government bonds created by the state.
This white paper will first address traditional leaseback financing before describing in
detail the advantages of nonprofit conduit financing for state and local governments.
The two alternative approaches are similar and intertwined, although the cost of
nonprofit conduit financing can be significantly less than private company-financed
leasebacks. The paper will provide many points of differentiation between municipal,
leaseback and conduit financing, as well as detail the flexibility and greater public
oversight nonprofit conduit structures offer.
The solution of all the financial woes of communities cannot, and should not, be
solved by conduit financing but we believe it offers another tool to bring together
interested parties to build and complete projects.
In tight budgetary times and in a fragmented political climate, nonprofit conduit
financing can be a key tool for building community assets.
Leaseback Financing
Many forms of government issued debt exist to fund projects, among them tax
exempt general obligation bonds, revenue bonds, tax-exempt bonds defined by
geography (also known as tax increment financing) and taxable bonds. All have
somewhat fall into disfavor due to exacting requirements imposed by legislators, such
Nonprofit Conduit Financing 2
as the necessity of a referendum in many circumstances, or controversy surrounding
their use, as in arguments over TIF districts.
The question in every debate over buildings is who pays. The consensus has been
municipalities should use bonds since it is easier to pay for a facility over time than
all at once. Most communities use long term bonds to pay for projects, although fast
growing municipalities with good revenue flow can embark on a “pay-as-go” strategy
whereby they pay for projects out of current revenues.
The final equation comes down to what a municipality can afford based on their
growth, population, wealth and needs.
Considering the current climate and concern over
municipal debt, communities and states have began to
seriously consider leaseback arrangements to remove
debt from their books. Leasebacks have been part of
the municipal financing landscape for more than 30
years and have been employed to construct new
buildings and to move existing buildings to new
management while the government continues on as a
major tenant.
In a typical leaseback project a municipality or state is in a situation where they face
problems financing projects or confronting debilitating budget shortfalls. Leasebacks
have transferred ownership to a private entity or a nonprofit which in turn become
owners of office buildings, prisons, airports, police stations and parking facilities.
Many states have used leaseback arrangements to remove debt from their books.
Arizona has aggressively sought leaseback deals for many of its state office buildings
and even considered attempting to leaseback its own Capitol until public outcry
scotched the idea. California, a recent convert to the leaseback trend, recently sold
24 buildings worth $2.3 billion and then leased them back.
Nonprofit Conduit Financing 3
The buyers of buildings are investment banks, for the most part. They outsource
management, leasing, maintenance and other core commercial real estate activities
to other parties. In return for the purchase, the buyers often receive long term leases
from their primary tenant – the government. Private equity leaseback financing has a
myriad of pluses and minuses.
Leaseback Advantages
The costs and the liabilities of buildings are no longer the responsibility of the
government.
Frees capital for other uses.
Saves on management and maintenance fees.
Usually allows long term lease, guaranteeing agencies space over an extended
time period.
Leaseback Disadvantages
Government loses control of building.
Cost of lease frequently higher than total operations of building when under
government ownership.
No control over changes to the building.
If restricted to shorter term lease costs can increase.
Long term lease may be more expensive than government debt.
Contracts and attorney negotiation add costs.
Despite fears and misgivings of some politicians and community leaders the leaseback
process remains of great appeal, especially in states where huge deficits have brought
tremendous pressure to reduce budgets and debt. The practice also gives politicians
cover. After all, leasebacks require no voter approval through referendums, a huge
advantage over traditional municipal bonds. It’s unlikely the leaseback trend will
abate.
There are different methods of approaching leasebacks. The most popular method, by
far, is for a major investment institution or nonprofit to own or build a structure. In
Nonprofit Conduit Financing 4
this scenario the government body no longer owns the buildings but rather leases
them back from third parties. The government has no debt related to the property
because payback of the bonds will come from the building’s owners.
The Nonprofit Conduit Financing Advantage
Investment banks are currently managing most leaseback arrangements. First and
foremost is their fiduciary responsibility to stockholders to try to achieve the highest
share value, not to protect the public interest in their investments. That can make
leaseback projects done in collaboration with banks an expensive proposition.
A close cousin to leaseback financing is nonprofit conduit financing. The chief
difference is the leaseback is managed by a nonprofit 501(c)(3) charitable
organization. Some nonprofits exist for the purpose of managing development in
states and cities and can issue bonds if they have that authority from the state. Other
nonprofits, such as Community Facility Partners (CFP) in Minneapolis, are
independently created with a national scope. These nonprofits create separate
nonprofit limited liability companies for each project. Having nonprofits manage
financing keeps costs low compared to leaseback arrangements through financial
institutions.
How? Just as in leaseback arrangements,
ownership is transferred to a different entity
other than the government, in this case the
nonprofit, through a three-step process. Firstly, an agency of the government issues
revenue bonds to pay for a project. Secondly, a designated underwriter buys those
bonds and sells them to banks, financial institutions and individual investors. Thirdly,
the money the government collects from the sale of the bonds is lent to CFP to build
or buy (and often improve) a building. Revenue from the building, in turn, repays off
the bonds.
The nonprofit can use funding borrowed from a variety of government sources -cities, counties and states – to construct, acquire or renovate buildings. Revenue
Nonprofit Conduit Financing 5
flows guaranteed by government tenants and nonprofit tenants secures repayment of
the bond buyers. The projects can work either for construction of new buildings or
the purchase and leaseback of existing ones.
Lease contracts are written for terms of 20 and 30 years, much longer than traditional
bank-financed commercial real estate transactions. The ownership of the projects
reverts back to the original government tenants at the end of the bond financing. The
government, of course, always has the option of buying back buildings before lease
contracts end.
Generally, nonprofit conduit financing is a cheaper option for states and communities
than for-profit leaseback projects. Nonprofits have a greater vested interest in
serving the public and their tax-free status usually engenders greater oversight by the
Internal Revenue Service, state tax authorities and their own boards of directors. It’s
also easier to explain the advantages of conduit financing to legislatures, councils and
voters, who are likely leery of having their assets owned by for-profit entities with
high-priced executives whose greatest responsibility is not to the state or taxpayers.
Conclusion
Nonprofit conduit financing offers a
unique and compelling financial
Nonprofit conduit financing offers civic
leaders another tool in their tool box.
solution for communities facing difficult financial obligations and a public
uninterested in more debt. To continue to be competitive communities must maintain
their infrastructure and, on occasion, add new attractions to benefit residents and
draw attention from nearby communities.
These projects need not always force host communities to incur great financial
burdens. Innovative approaches such as nonprofit conduit financing allow for the use
of existing nonprofits, or the creation of new ones, to manage projects and protect
taxpayers and communities with a financial structure in accordance with the IRS
regulations. Nonprofits cannot seek to become rich off conduit financing because
their tax structures prohibit profit- taking by management or outside parties.
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Nonprofit conduit financing offers civic leaders another tool in their tool box. General
revenue obligation bonds are still the least expensive method for cities to raise money
for projects. But in a time of political strife and a lack of civic support for key
community assets the time for greater use of conduit financing has arrived.
(Community Facility Partners (CFP) is a nonprofit provider of conduit financing that
helps find ways to make difficult-to-finance projects “do-able” by partnering with
organizations -- municipalities, or a combination of municipalities, schools and
community groups –- to build projects. CFP also manages and coordinates leasebacks
of government buildings through the creation of affiliated LLCs. For more information
see http://www.cf-partners.org/index.php or call 612-801-0166.)
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