COP finance, or Certificate of Participation finance, is a method where an investor purchases a share of the lease revenues from a program, rather than the program being secured by traditional bonds. In essence, the investor owns a portion of the revenue stream generated by the leased asset.
Here's a more detailed breakdown:
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Definition: A Certificate of Participation (COP) is a type of municipal security structured as a lease agreement. This lease agreement allows a government entity to acquire assets (like buildings, equipment, or land) without directly issuing debt.
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How it Works:
- A government entity (e.g., a city, county, or school district) enters into a lease agreement with a third party (often a non-profit corporation).
- The third party then sells certificates of participation to investors.
- The investors receive payments from the lease revenues generated by the government entity's use of the asset.
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Security: COPs are secured by lease payments made by the government entity. This differs from general obligation bonds, which are backed by the full faith and credit of the issuer (i.e., taxing power). Because they are secured by lease revenues, they are typically riskier than general obligation bonds.
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Key Features:
- Lease-Based: COPs are structured as lease agreements, meaning that the government entity doesn't technically own the asset until the lease is paid off.
- Tax-Exempt: Like municipal bonds, the interest income from COPs is often exempt from federal (and sometimes state and local) income taxes.
- Flexibility: COPs can be used to finance a wide range of projects, including schools, hospitals, and infrastructure improvements.
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Example: A city needs a new fire station but doesn't want to issue general obligation bonds. They can enter into a lease agreement with a non-profit corporation, which then sells COPs to investors. The city makes lease payments to the non-profit, which then distributes the payments to the COP holders.
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Risks:
- Appropriation Risk: The government entity must appropriate funds each year to make the lease payments. If the government entity fails to appropriate funds, the COP holders may not receive their payments.
- Credit Risk: The creditworthiness of the government entity is a factor in determining the risk of the COP.
In summary, COP finance offers a flexible funding mechanism for government entities by allowing investors to participate in lease revenue streams linked to specific assets.
