Certificates of participation (COPs)

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Certificates of participation (COPs) are a kind of municipal debt which can be contracted by cities without voter approval.

Courts have ruled that, because of their structure, COPs do not constitute long-term obligations of the issuing authority, and are therefore exempt from state and local laws that require voter approval of long-term debt. COPs were used by El Paso County to finance the expansion of the jail and the county courthouse, and were used by the city to pay for the renovation of City Hall.

Theoretically, a municipal government can decline to renew the annual lease that underlies the certificates of participation. Although such an action would carry adverse consequences for the government, it would not constitute an act of default, and would not trigger cross-default clauses in other, voter-approved debt.

For this reason, COPs are difficult to market unless insured.

Triple-A rated tax-free municipal bonds have traditionally yielded about 85 percent of the 10-year Treasury note. During the current financial crisis, the spread has reversed, with such securities yielding as much as 186 percent of the 10-year note. This spread is even more pronounced for lower-rated municipals, for which there is little or no demand.

Single-A municipals, if marketable, are priced at more than 200 basis points above triple-A issues.

As presently structured, the city’s proposed debt would mature in 25 years. The council resolution approving the COPs caps the allowable interest rate at 6.25 percent.

On the secondary market, COPs and other municipal debt similar to the city’s proposed issue offer investors high yields.

For example, senior notes issued to expand the Denver Convention Center, maturing in 2030, carrying a 5 percent coupon, are now trading at a discount. On Feb. 23, an investor sold notes with a face value of $225,000 at a 44 percent discount, giving the buyer a yield to maturity of 8.366 percent.

COPs issued by Pueblo County, supporting a pollution control project by Public Service of Colorado, originally yielding 5.1 percent, maturing on Jan. 1, 2019, issued at 100, were sold by an investor on March 2 for 90.947, giving a yield to maturity of 6.352 percent.

E-470 capital appreciation revenue bonds, maturing in 2022, are trading around 37, giving a yield to maturity of 7.5 percent.