Certificate of Participation is a financial document used in bond issues where investors receive returns based on rental income. It allows municipalities to finance capital facilities without incurring debt restrictions and investors to receive payments throughout the project. In case of default, investors can assume control of the facility.
The Certificate of Participation is a financial document that is often used when a municipal government or other government entity creates a bond issue. Instead of paying interest on the bonds or guaranteeing a face value at the end of the project, the investor receives a return based on the rental income associated with the offering. Making use of this process can work very well for the municipality, as it will free the issuer from restrictions on the amount of debt that can be incurred during the course of the project.
For many cities and towns, the Certificate of Participation approach to a bond issue will follow a simple formula. A bond issue is created to finance the construction of some type of capital facility within the city limits. Instead of directly owning the facility during the construction period, the City essentially leases the facility during the construction period and makes installment payments toward the lease. When the payment schedule is complete, the municipality assumes ownership of the entire facility.
For the investor, the Certificate of Participation represents proof of participation in the bond issue. Buying a portion of the rental income can be an attractive alternative to the more traditional bond for a couple of reasons. Payments are made to the investor for the duration of the project, based on the percentage of interest that the investor has in the lease. This means that the investor does not necessarily have to wait for a bond to mature before beginning to receive a return on investment. Of course, the payments specified by the terms of the Certificate of Participation can be deferred until later in the project, if the investor prefers to receive larger payments at less frequent intervals.
In the unlikely event that the municipality does not comply with the agreement, the terms of a Certificate of Participation provide investors with the ability to assume control of the facility. Once the default is complete and the transfer of title is in the hands of the investors, they are free to do whatever they want with the asset. This includes the ability to complete the facility and sell it to a private investor, or choose to join in and use the entire structure for your own purposes.
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