Ed Committee backs crackdown on interest-deferred bonds
March 20, 2013 | By John Fensterwald | 9 Comments
Despite opposition from several education organizations, the Assembly Education Committee on Wednesday voted 6-0 for a bill that would severely restrict school districts’ ability to float construction bonds that would saddle future taxpayers with huge balloon payments.
These financial instruments are known as capital appreciation bonds, or CABs, and they have become common over the past decade. By deferring payments on the bonds for sometimes decades and extending the term of the bonds to 30 or 40 years, districts can end up paying interest amounting to 10 times the principal or more, instead of twice the principal as is common for a standard 25-year school bond.
Poway Unified has become the CAB poster child. Taxpayers will pay no interest on the first 20 years of a $100 million construction bond in that district. When it’s fully paid off in 40 years, they will have shelled out $1 billion. But Poway Unified’s is not the extreme case. An analysis of SB 182, the bill approved Wednesday, cited an example of a district in San Bernardino County that will end up paying 23 times the amount of the original bond – $6.6 million in debt service on a 28-year bond, issued in 2010 for $283,600.
“The people who will benefit from the bond pay zero; the next generation will bear the burden with serious consequences,” said Joan Buchanan, D-Alamo, the chair of Assembly Education and the cosponsor of the bill with Sen. Ben Hueso, D-San Diego.
More disclosure, tighter reins on terms
AB 182 wouldn’t ban CABs; a district could take out one with an interest deferral of, say, two or three years, and a 25-year term, if that fit their needs, Buchanan said. But it would curtail their use by:
- Demanding more public disclosure. Some school board members have said they didn’t know what CABs were and didn’t understand the financing terms when they approved them. The bill would require school boards, before approving a CAB, to do an analysis spelling out the total cost, justify the reason a CAB has been recommended, and compare the cost of the CAB with traditional financing.
- Limiting the debt service ratio – how much districts will pay in total interest and principal payments relative to the principal alone – to 4 to 1. This is still higher than for current interest bonds that most districts issue. They operate like a mortgage, charging a uniform, ongoing interest rate.
- Requiring that each individual bond that a district issues comply with that 4-to-1 ratio, as opposed to the blended average of all of the bond measures authorized by a district. Averaging ratios is “how Wall Street packaged subprime mortgages,” testified state Treasurer Bill Lockyer, who has crusaded for curbing CABs. “But if it’s a rotten deal, it’s rotten no matter how much perfume you put on it.”
- Limiting all school bonds, not just CABs, to a length of 25 years, as already required under the Education Code. Buchanan said that districts have been doing an end-run around the Ed Code by issuing General Obligation bonds with longer terms. Some opponents of the bill called for exempting standard non-CAB bonds from the 25-year limit. But Buchanan said it is important to “tie financing to the asset; otherwise people who pay for the improvement do not benefit from it.” School upgrade projects generally are timed to last 25 years, after which they are available for state modernization funds, she said.
- Requiring all CABs over 10 years to give districts the option of paying them off early. Opponents say this stipulation would raise the cost of the CABs.
Districts have increasingly turned to CABs since the recession, because declining property values, particularly in the Central Valley and Southern California, have constricted districts’ capacity to issue new bonds. School districts are limited to how much debt they can issue at any time in relation to a district’s assessed value. (For unified districts, the maximum value of bonds they can issue is 2.5 percent of property valuation.) Faced with immediate building needs, districts have turned to CABs, which give districts flexibility by postponing interest and principal payments while assuming that rising property values will enable them to pay off old bonds and issue new ones in coming decades. Bond holders, in turn, forgo payments initially but reap a huge payoff down the road from compounded interest.
An estimated 200 school districts and community colleges – about 20 percent of the total – have issued CABs in the past decade. Dan McAllister, the treasurer-tax collector of San Diego County, said that since 2007 a dozen of the 42 school and community college districts in the county have financed 44 bond issues that included CABs; the average debt ratio to principal was 7.4 to 1, he said.
Among groups that oppose AB 182 or want some of the restrictions changed are the Association of California School Administrators, the California Association of School Business Officials, the California School Boards Association and the Small School Districts’ Association.
Dilemma of declining property values
Patti Hererra, executive director of the Riverside County School Superintendents’ Association, said she was concerned about districts’ ability to fund construction needs because of low property valuation. Brian Rivas, a lobbyist for the school boards association, seconded Hererra’s concern and said the “bill overcompensates” for the problems caused by CABs.
Disagreeing with Lockyer, Jeff Vaca, executive director of governmental relations for the school business officials’ organization, said that the debt-to-principal ratio should apply to the entire bond program voters approved and not to each individual bond, to give districts latitude to meet building needs. And the maximum term of a bond should be no less than 30 years, he said. In a letter to the Education Committee, he said that the combination of higher construction costs and decreased state aid have created “enormous facilities funding needs, some to the point of crisis.”
“We believe it is important that any legislative solution not create any insurmountable facilities problems for school districts and community colleges that are using CABs in a fiscally responsible manner,” he wrote.
Buchanan, a former school board member, sees the crisis differently, as one of responsibility to taxpayers. “If we don’t police ourselves with reasonable limitations to sell these instruments, then voters will never approve another bond. And that will create an even bigger problem,” she said.