Participation Certificates – Bonds – and the “Shadow Banking” System – Hocus-Pocus Financing – Demystified.

The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks. Former Federal Reserve Chair Ben Bernanke provided a definition in April 2012: “Shadow banking, as usually defined, comprises a diverse set of institutions and markets that, collectively, carry out traditional banking functions–but do so outside, or in ways only loosely linked to, the traditional system of regulated depository institutions. Examples of important components of the shadow banking system include securitization vehicles, asset-backed commercial paper (ABCP) conduits, money market mutual funds, markets for repurchase agreements (repos), investment banks, and mortgage companies.” Shadow banking has grown in importance to rival traditional depository banking and was a primary factor in the subprime mortgage crisis of 2007-2008 and global recession that followed.[1]

A Participation Certificate (PC) (also known as a Certificate of Participation) is a financial instrument, a form of financing, used by municipal or government entities which allows an individual to buy a share of the lease revenue of an agreement made by these entities. It is different from a bond issued by these agencies since participation certificates are secured by lease revenues. Municipal and government entities use this instrument to circumvent restrictions that might exist on the amount of debt in other forms they are able to take on.

Participation certificates are a new form of credit instrument whereby banks can raise funds from other banks and other central bank approved financial institutions to ease liquidity. In this case banks have the option to share their credit asset(s) with other banks by issuing participation certificates. With this participation approach, banks and financial institutions come together either on risk sharing or non-risk sharing basis. While providing short term funds, participation certificates can also be used to reduce risk. The rate at which these certificates can be issued will be negotiable depending on the interest rate scenario.

On June 14, 2013, the city of Detroit announced, as a policy move to preserve cash during its financial crisis, that it would not be making payments [1] on a certificates of participation it had issued.

At its meeting on October 19, the Tustin City Council approved selling bonds in an amount not to exceed $45 million dollars to complete financing Tustin Ranch Road from Walnut Avenue south to Warner Avenue.

The bonds will have no financial impact on the City’s budget, as all
payments of principal and interest will be paid solely from revenues generated by development at Tustin Legacy. The bonds will also be used to fund other major infrastructure projects at Tustin Legacy.

Funds to complete the road will come from a variety of funding sources,
including these bond proceeds and funds from the City of Irvine allocated to mitigate traffic impacts from its adjacent development, the Irvine Business Complex. No monies from the general fund will be used.

To provide for business start-up opportunities and expansion of existing businesses, the Tustin Community Redevelopment Agency provides access to a variety of financing programs authorized by either the federal or state government, as well as programs provided by other private, public and non-profit agencies. The Agency also provides technical assistance, educational support and other similar needs of a non-financial nature to the business community. A brief summary of the possible assistance and incentive programs that can be made available are as follows:
Zoning incentives to encourage economic development through:

Floor area ratio bonuses
Allowance for mixed use projects
Combining of public and private uses
Planned Unit Developments
Density bonuses
Assistance in land assembly:
Land banking
Eminent domain
Land swaps
Land write downs
Assistance with construction of infrastructure improvements.
Provision of technical assistance.
Provision of developer unique financing opportunities, consisting of:
Tax Increment Financing
20% Housing Set-Aside Funds
Special Purpose Financing Districts
1911, 1913, 1915 Acts
Mello Roos Community Facilities Act of 1982
Landscape and Lighting District of 1972
Revenue bonds
Lease Revenue bonds
Tax Allocation bonds
Lease Purchase financing
Industrial Development bonds
Certificates of Participation
Mortgage Revenue Bonds
Loans and Advances
Land Disposition Proceeds
Rental Payments
Participation in future cash flows

Certificates of Participation (COPs). A form of lease revenue bond that permits the investor to participate in a stream of lease payments, installment payments or loan payments relating to the acquisition or construction of specific equipment, land or facilities. In theory the certificate holder could foreclose on the equipment or facility financed in the event of default, but so far no investor has ended up owning a piece of a school house or a storm drainage system. A very popular financing device in California since Proposition 13 because COP issuance does not require voter approval. COPs are not viewed legally as “debt” because payment is tied to an annual appropriation by the government body. As a result, COPs are seen by investors as providing weaker security and often carry ratings that are a notch or two below an agency’s general obligation rating.