Proposed restrictions on school bonds would harm districts

Seth Rosenblatt

Seth Rosenblatt

We’ve seen this pattern time and again. Some public agency or public official gets negative press for apparent bad behavior. Often it is deserved, and sometimes not. But far too frequently the press oversimplifies the situation and reduces the story to sensational sound bites. Then politicians jump into the fray, promising to fix the situation and “protect taxpayers” (who wouldn’t support that?). But it’s likely that the issue is more nuanced than at first perceived, and policymakers risk overreacting. And the worst part is that often the cure is worse than the disease.

Such may be the case regarding the recent legislative proposals on Capital Appreciation Bonds (CABs). The lack of critical thinking and thoughtful dialog on this issue has been scary, and we are in serious danger of doing more harm than good to both taxpayers and responsible school districts across the state. The net result of this potential legislation is that it will likely (a) reduce the bond capacity of school districts, (b) delay receipt of proceeds to use for construction projects, and/or (c) increase the present-value cost to taxpayers.

Quick primer: There are generally two types of bonds that school districts issue. The first, called Current Interest Bonds (CIBs), require the borrower to pay the interest payments each year, and then at the end of the term pay back the entire principal amount. The other, Capital Appreciation Bonds (CABs), just have the interest accrue over time, and then both the principal and all of the accrued interest is paid back at the end of the term. Naturally CABs will have a greater total payment at the end of their term, as interest payments were accrued rather than paid along the way, and CABs will likely have slightly higher interest rates because of the lack of current income to the investor. In both cases, all payments are made from a tax assessment on property owners—the tax collected becomes the money available to “service” the bond. If a district issues a Proposition 39 bond (the ones which only need 55% to pass), there is a statutory limit on that tax assessment allowed (the “tax rate limitation”). This inherently limits the “bonding capacity” of the district. Also, some bonds have “call” provisions which allow the principal amount of the bond to be paid back early. Most districts build bond programs to layer the bond repayment schedules to create a relatively level tax burden over time (structured around previously issued bonds to maintain tax rate targets) and spread that burden over the life of the facilities (essentially it’s a combination of many individual bonds with different structures and terms to create these level payments over time and within existing bonding capacity limits). This often requires both CABs and CIBs to make the math work, and of course it’s dependent upon when funds are needed, the interest rates at the time, the total amount of bonds authorized, and the overall tax rate limitations.

The current controversy stems from the fact that the Poway Unified School District issued CABs that will cause them to repay ten times the original bonds’ proceeds at their maturity in 40 years. Other districts have had similar issues with the seemingly high “repayment ratios” (the total amount of the repayment divided by the original amount) with CABs.

To be clear, I’m not defending Poway—nor, frankly, do I have any of the details or context about their situation—but even if their actions were improper or ill-advised in any way, that hardly means that the zeal to avoid such situations in the future should cause us to enact a single standard across the state that could be very damaging for many public schools. While well intentioned, some of the proposals coming from Sacramento are problematic because they (a) apply a one-size-fits-all approach to financings that disregard a district’s unique characteristics and prior debt issuances, (b) disregard market factors, and (c) ignore basic finance principles such as the time value of money.

It’s a basic principle of finance that money today is worth more than money tomorrow (and less than money yesterday). This is illustrated a few ways. The most common way is to look at inflation of goods and services. The price of milk was a lot cheaper decades ago than it is now, and will be more expensive in the future. The median home price in the U.S. is about eight times what it was 40 years ago. The other common way to illustrate this principle is interest on money (which has been historically higher than inflation). For example, if you were to take out a loan, at a 6% interest rate, making no payments along the way and compounded over 40 years, you will accumulate a balance ten times the amount you borrowed. Does that mean you got a bad deal? Not necessarily, because effectively (if interest rates averaged 6% over those four decades), the money you’ll be repaying with is worth one-tenth the amount of the money you borrowed.

Unfortunately, the proposal to limit the repayment ratio to 4-1, while intended to reduce nominal borrowing costs, ignores how bond series are structured. The first issuance of a bond program typically has the lowest repayment ratio because districts have more taxing capacity (i.e., they may issue shorter term bonds). As bonds get issued and upfront tax capacity is utilized, later bond financings tend to have higher repayment ratios. Moreover, due to the time value of money, repayment ratios are meaningless absent information on the term of such repayment. They measure “nominal” dollars spent (meaning the total of all money spent ignoring that a dollar today is worth more than a dollar tomorrow).

Additionally, the proposal in Sacramento to limit all school bonds—not just CABs—to a 25-year maturity ignores the simple fact that almost all school facilities last a lot longer than 25 years (in our district, we’re about to remodel or replace some facilities more than 50 years old!). Limiting the term of these bonds would have the effect of forcing current taxpayers to subsidize future taxpayers, who will still enjoy use of an asset for which they didn’t pay.

In the absence of context, bond term limits and repayment ratios are both inherently arbitrary. In addition, these proposals also ignore the fact that most districts issue Prop. 39 bonds, which already have a tax rate limitation that prevents the district from having a bond program with excessive repayments in any given year and hence serves as a protection to taxpayers and a limit on borrowing. And given that such tax rate limitations are always disclosed in Prop. 39 bond elections, there is transparency. To my knowledge, these proposals coming from Sacramento do not distinguish between Prop 39 bonds and other general obligation bonds. Districts with Prop. 39 bond programs may be most negatively affected by the current legislative proposals, as existing tax rate limitations combined with a reduced ability to use capital appreciation bonds will limit districts’ flexibility to structure bond series in the most rational way and address needed modernization or safety projects.

Two of the other proposals coming out of Sacramento are less onerous but still require discussion. These include giving greater oversight responsibilities to county offices of education as well as requiring that bonds be “callable,” i.e., they can be paid off prior to maturity. While the former proposal adds another layer of administration and bureaucracy to the process, this could be a reasonable check and oversight on districts that step over the line—at a minimum it will force a public dialog about special circumstances. A call option on all bonds would of course be a benefit to districts, but it’s important to point out that requiring bonds to have this feature would increase their price to taxpayers as investors are forgoing certainty in future interest payments and would have to be compensated for this (another basic principle of finance).

I have been disappointed by much of the press on this topic with attention-grabbing headlines about repayment ratios that simply ignore the time value of money and simple principles of finance. In addition, many school districts are extremely concerned that, in reaction to perceived poor decisions by a handful of school districts, the state is considering far-reaching and one-size-fits-all legislation that could adversely impact responsible school districts.

Of course the big irony in all of these discussions is that many districts’ more aggressive stance in bond financing is a direct result of the failure of our state to provide proper funding for building and remodeling aging school facilities, particularly in an era where we desperately need new 21st century facilities. In the absence of the state taking responsibility, many local communities have stepped up to pass bond measures to support their struggling local schools. And now we may be stifling that.


Seth Rosenblatt is a member of the Governing Board of the San Carlos School District. He also serves as the president of the San Mateo County School Boards Association and sits on the Executive Committee of the Joint Venture Silicon Valley Sustainable Schools Task Force. He has two children in San Carlos public schools. He writes frequently on issues in public education, including in both regional and national publications as well as on his own blog.

Filed under: Commentary, School Finance, State Education Policy


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23 Responses to “Proposed restrictions on school bonds would harm districts”

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  1. Paul on Mar 27, 2013 at 9:05 am03/27/2013 9:05 am

    • 000

    Just to be clear, Seth, I was talking about a different kind of oversight committee, formally called the “audit committee” and present in a private, publicly-traded U.S. corporation. This is a committee of the board of directors, with the attendant authority and responsibility. The committee can contract for legal or other advice, independently of the full board, let alone of corporate management.

    The bond oversight committees that you mention are made up of citizens, not directors. It is clear that the members have no particular authority, and not clear that they have a fiduciary responsibility, in the way that board members would. Bond oversight committees cannot contract for external advice; what little information they get is provided by the management of the public agency whose bond they “oversee”.

    Bond oversight committees were created as a sop to naïve voters, not as a practical mechanism to prevent, or detect and stop, waste and fraud.

  2. Paul on Mar 26, 2013 at 3:14 pm03/26/2013 3:14 pm

    • 000

    Navigio, you raise an excellent point about the need for a cancellation contingency (liquidated damages?).

    A familiar study of transportation infrastructure projects found that a 50% cost overrun was typical.

    It’s not so bad with school infrastructure, but I remember a high school construction case on the Central Coast a few years ago, where there were overruns at every stage. The building was occupied years late, and there was a protracted battle between the district and the general contractor over mold and other construction quality issues. I came away with the sense that neither district staff, nor board members, were sufficiently savvy to build a new high school.

    Seth, one issue with your hope that school board members will exercise oversight is that most are volunteers, without personal staffs, to boot. And school boards are rarely structured along the lines of private corporate boards, with oversight committees. I have seen cases where such committees were added, but only after the California public agencies in question had participated in multi-million dollar frauds.

    One fifth of school districts have CABs, so we’re not talking about outliers, by any means.. Lockyer’s involvement tells me that something very suspicious has happened.


    • Seth Rosenblatt on Mar 26, 2013 at 4:20 pm03/26/2013 4:20 pm

      • 000

      Paul — I think that having school board members as volunteers is actually a net benefit, as not career politicians they are less susceptible to bias and political pressures (there are definitely exceptions for the largest of school districts) — see my earlier EdSource piece on this topic: Also, do note that all Prop 39 bond measures do have to have oversight committee with specific statutory representation from different members of the community, including taxpayer rights groups. And to be clear, my reference to “outliers” was not districts with CABs (as you can probably tell, I’m arguing that’s fairly normal) — my reference to outliers was cases of abuse and mismanagement, which are the exception rather than the rule.

  3. navigio on Mar 26, 2013 at 1:15 pm03/26/2013 1:15 pm

    • 000

    I have to agree with Paul on this issue.

    I dont think the difference in value of money between now and the future is such a good argument. Obviously it can help to explain the ratios, but once you start compounding interest you are essentially amortizing inflation into the loan. You are not ‘getting anything’ extra from doing that, except more debt.

    While I expect its true that CABs might provide more flexibility in evening out debt payments, more responsible planning could do the same thing. Furthermore, I seriously doubt that is the reason they were created.

    And while outliers are just that, if policy allows them to happen, something is wrong.

    The worst part about our facilities bond fiascos (and yes many of them are) is that they damage the capacity for districts to raise education funding through elections (ie parcel taxes). That is something people tend to miss.

    The one additional thing I’d like to see come out of sacramento is the ability to structure a bond such that it can be ‘cancelled’ midway if the project gets out of control. I seriously doubt we will ever get any accountability associated with facilities bonds (or any others for that matter) until something drastic like that happens. Of course it wont. Too many people (other than kids) make money off of facilities bonds.


    • Seth Rosenblatt on Mar 26, 2013 at 4:30 pm03/26/2013 4:30 pm

      • 000

      Navigio — I’m sorry to vehemently disagree with you about the time value of money, but compounding interest is a basic principal of finance. If one were to pay the bond interest payments along with way — say, for example, in a CIB — then you’d be paying with money worth more than the money you’d be paying with at the end of the term. The only way to compare them apples to apples would be to do a Discounted Cash Flow (or it’s inverse, an Internal Rate of Return). This is how the market values any investment. If you were to do such a DCF for two bonds — one CIB and one CAB — with the same interest rate, they would have the same present real value by definition. Of course there are different risk profiles (and cash flow profiles) associated with each, but whole point is that repayment ratios measure “nominal” dollars, not “real” dollars — that is the fundamental flow and why it is arbitrary.

      • navigio on Mar 26, 2013 at 5:04 pm03/26/2013 5:04 pm

        • 000

        Hi Seth. The other basic principle of finance is that if the rate of return on a loan does not exceed inflation, the lender is not making money by financing it (though there are some exceptions to that–see the Fed). My point was not that there is no such thing as time value of money, quite the contrary. It was that when you ‘finance inflation’ by continuing to borrow the interest due, you are not ‘saving’ anything at all, even though time value makes it sound like you are (I would even go so far as to argue you will lose money, even though the present value may appear the same at a given point in time). In fact, my point, maybe put another way, is that you are effectively removing the advantage that time value gives you when you finance your interest as well as principle. Time value is an extremely important concept for many people because they have home loans with fixed payments for the duration of the loan, and, I would add, those payments service both interest and principle. The reason a few people choose to push interest due onto the principal of the loan is more as a way to gamble with someone else’s money that the market will do something specific, rather than as a sound investment strategy. So I dont think we vehemently disagree about anything, except whether financing interest is a good idea. :-)

        • Seth Rosenblatt on Mar 26, 2013 at 5:20 pm03/26/2013 5:20 pm

          • 000

          Navigio — Maybe we’ll need to take this conversation offline, but your financial analysis is incorrect. Time value of money is not only real, it is perpetually underestimated. With extremely limited exceptions (there was point this was true in Japan), interest rates always exceed the rate of inflation (in fact, this difference is what is referred to as the “real” rate of interest). But inflation does happen to money. If it didn’t, there would be no such concept as interest — everyone would just ask you to return the same amount of money you borrowed. From a net present value point of view, it is completely irrelevant whether you finance interest. It has the same net present value assuming the same interest rate. The only difference is risk profile and cash flow. The reason why most home loans serve interest and principle is that the homeowner often doesn’t want to have a balloon payment at the end of the term, and the lender wants to decrease the loan to value ratio in case the value of the home goes down. And you are also incorrect in your assertion that the only reason people finance interest is “to gamble with someone else’s money” — particularly in the case of CABs, it’s a way (in combination with a bunch of other bonds) to actually even out payments over time to stay within a level tax limit. The same analogy holds true for equity investments — some companies pay dividends over time, while some do not. But that does not mean one company is doing something wrong — it’s just better matches their company’s profile and investment strategy (and stockholder needs). And you bet that the companies that don’t pay dividends have to have a better overall return on their stock price than companies that do in order to be valued the same way by the market — in effect, the lack of dividend payments are compounded into the increasing stock price. Obviously the main difference between equities and bonds (other than tax treatment differences) is the lack of certainty over future prices. But on average, the exact same principle holds. As this is not an efficient forum for this discussion, I’d be happy to talk to you on the phone or e-mail. I’ve studied economics and worked in finance for many years. Just send me an e-mail at

          • navigio on Mar 26, 2013 at 5:46 pm03/26/2013 5:46 pm

            • 000

            Hi Seth, thanks for taking the time to respond. Unfortunately, I think you are still missing my point. (thats probably my fault as I am not always good with being exact in expressing my thoughts.) Quickly, I agree with you on the existence of time value of money (and of inflation and interest). We disagree on whether its a good idea to finance interest. You’re right of course that in (finance) theory it should make no difference, but in reality it has all sorts of other consequences, especially in the public sector. Although I may email you anyway, one of the values of public forums is that more than one person learns something. :-)

  4. diane_scheerhorn on Mar 25, 2013 at 3:38 pm03/25/2013 3:38 pm

    • 000

    Thank you for this well written article. It gave me a very concise overview of the changes that may take place with Bond acquisition.

  5. Seth Rosenblatt on Mar 25, 2013 at 11:35 am03/25/2013 11:35 am

    • 000

    Of course there is potential for mismanagement as well as conflicting incentives for advisors, but it is the job of elected officials to be the trustees of the taxpayer dollars. Locally elected school boards – elected as laypeople by design – already manage billions of taxpayer dollars. This is the very nature of the democratic process. And most school boards take this role very seriously, rely on outside expertise when they need to (and question it appropriately), and work within existing laws that already provide substantial taxpayer protection (bond passage by supermajority vote, existing tax rate limitations, etc.). Also, in almost all cases, bond programs are crafted in partnership with the County Treasurer as well. There’s lots of checks and balances already in the system…it’s just that the press only reports on the outliers. And the bottom line is that regardless of whether you think these new regulations are a good idea, it will stifle investment in our public schools, regardless of the wishes of local voters.


    • el on Mar 25, 2013 at 1:54 pm03/25/2013 1:54 pm

      • 000

      So Seth – perhaps you can answer my question – is there a guide out there for how to create a school bond measure? If I wanted to do it myself, for my district, how would I know what to do, what needs to be done, what it should cost, etc? If a guide like this does not exist, it would be a huge public service for someone knowledgable to create it. I think those trustees need more access to information and guidance, and independent guidance, than is available currently.

      The Willits case is personally alarming to me because it seems that several fairly smart and generally well-regarded people completely missed the implications of that particular arrangement, including a fairly conservative County BOE financial process. Three year projections went out without that $5m payment anywhere in any budget. That so many people missed it is extremely troubling.

      To get a good picture, and know how much is press bias, we probably need to see all the CABs statewide and take an accounting on good/bad/indifferent.

      This is an article evaluating the situation in Humboldt County:

      But I agree, the financing is a real problem, and fundamentally comes back to the fact that schools are struggling to find the money to do the job we charge them with.

      • Seth Rosenblatt on Mar 25, 2013 at 3:22 pm03/25/2013 3:22 pm

        • 000

        El — I suspect there are many resources available, but I don’t know of a specific guide out there. I can research it further. But one place to start would be a bond attorney — districts employ bond counsels while they are considering floating a bond measure, and they are normally an excellent, and balanced, resource.

        • el on Mar 25, 2013 at 6:24 pm03/25/2013 6:24 pm

          • 000

          That would be great, Seth. I have done some investigating and have really gotten nowhere. From my perspective, under the current system, it’s the consultants who hold all the cards, and you just have to hope you have good ones who are looking out for the kids and the taxpayers. It’s too easy for them to cook the documents and the books for the trustees to truly execute due diligence, from what I have seen. It’s not necessarily that the numbers aren’t disclosed, but instead that there’s little understanding of what you’re buying and what it ought to cost.

    • Paul on Mar 25, 2013 at 3:07 pm03/25/2013 3:07 pm

      • 000

      The school board can offer general advice and say yes or no, but the details of a bond financing package do not originate at the board level.

      Why would ordinary citizens serving on the school board be expected to understand bond financing, if the employees whose job descriptions include that responsibility (superintendent and director of business services or other similar title), do not, either?

      Whether they work for school districts or for the county office of education, former school principals with their administrative credentials or, worse yet, with their doctoral degrees in “education” or “school leadership” or “organizational change” are not qualified to recommend bond financing packages to school boards. The more restrictions, the better!

      • Seth Rosenblatt on Mar 25, 2013 at 3:28 pm03/25/2013 3:28 pm

        • 000

        Paul — we will obviously have to agree to disagree on this matter on a philosophical level. Of course very few details originate at the board level — that’s not the board’s role. But the board’s role is to require enough information necessary to make a decision and ensure that their representatives (Superintendent, CBO, and/or outside representatives) have the appropriate expertise. Financial management in general is a huge job for any school district, staff or the board. The Superintendent’s and CBO’s job descriptions absolutely include this. Of course as in any organization, some may be better at it than others, but that’s where the board needs to understand what information and expertise required to make a decision. This system actually works pretty well.

  6. el on Mar 25, 2013 at 10:24 am03/25/2013 10:24 am

    • 000

    I appreciate your concern about one-size-fits-all regulation, but at the same time I think we do have a problem here.

    One of my concerns is that it does not seem to be possible for a district to totally manage their own bond campaign and issue – it is a job for consultants. Consultants are paid based on a percentage of the bond. They have no skin in the game, no liability for the tax or the good use of the money. Their incentive is to get the district to seek as much money as possible. And of course, it makes sense to the district – get the one time costs of an election and the campaign and the like in one go – to ask for more rather than less. You can’t easily ask for a phase 2. The commission is paid out of the bond, so it’s not like the district is out money for it out of their regular budget, another disincentive that is likely inflating the cost.

    I’ve asked here several times about resources that would help me to understand the process involved in getting a bond on the ballot and then having the various mechanics for selling the bonds. No one has ever responded to me. How can I know what a fair price is for that service if I don’t understand what needs to be done? It would be a huge help to create more transparency so that district trustees are partners rather than marks in deciding what kind of financing to do and how to go about it.

    Another cautionary tale is the Willits Unified School District, who was recently surprised to learn they have a $5m balloon payment due in July 2014 for $3.787M in borrowing they did in 2010. The total cost of these bonds is going to end up at $40.5 million. Apparently no one caught this – and those numbers alone show that they would have been better off saving their $5m and starting their construction in July 2014, allowing them to pay for it in full.


    • John Fensterwald on Mar 26, 2013 at 8:16 am03/26/2013 8:16 am

      • 000

      el: Indeed, there may be problems. Bill Lockyer is calling for an investigation between unholy relationships between school boards and financial underwriters: I assume he is on to something; districts rely on campaign help of those who underwrite the bonds, and the campaign contributions may be included in the fees charged to the districts.

  7. Paul on Mar 25, 2013 at 8:26 am03/25/2013 8:26 am

    • 000

    Public school districts do not possess the financial management expertise needed to oversee, let alone make, the sophisticated choices that Seth mentions. Although there are exceptions, superintendents and directors of business services are usually holders of administrative credentials — former school principals, in other words.

    It is hard to conceive of a school building that will not need major renovations (a capital expense, as opposed to routine repairs, which can be considered an operating expense) within 25 years. That is the perfect repayment term.

    School districts that use financing manoeuvres forbidden by this bill aren’t trying to save money. Rather, they are trying to indulge the public’s desire for things that the public isn’t willing to pay for. A welcome consequence of the bill is that the public will have to reduce its expectations or increase its near-term financial contribution to public school facilities.

  8. Paul Muench on Mar 25, 2013 at 7:03 am03/25/2013 7:03 am

    • 000

    Are these bonds serviced by parcel taxes, taxes based on property values, a combination of both? How difficult is it to determine if a district will not be able to meet future service obligations? How much risk are districts allowed to take? Is there a reasonable way to put a limit on risks taken?


    • Seth Rosenblatt on Mar 25, 2013 at 7:23 am03/25/2013 7:23 am

      • 000

      Paul – bonds are serviced by “ad volorem” taxes, meaning ones which are a percentage of assessed property values. When a bond is passed, the voters approve a maximum authorized amount that can be issued. Also, in the case of Prop 39 bonds, there is a maximum percentage of assessed value that can be set as that tax rate. In any case, these bonds – like all others – are given a credit rating by the rating agencies, but in general they are considered very safe investments because they are backed by the levy on the assessed value of the property in the district. So, it’s not the district that meets the future obligation per se. The major risk would be if there is a substantial decrease in assessed values over time versus what was projected…in that case, the percentage assessment would need to increase to cover the bond service payments.

      • Paul Muench on Mar 25, 2013 at 8:37 pm03/25/2013 8:37 pm

        • 000

        So voters can control the risk exposure by controlling the amount of bonds that may be issued. Seems like the Prop 39 bonds are harder to manage since they have a cap on % assessed value that can be taxed. I assume they are worth less due to that fact. Do you know of any district that has run into a problem with too many Prop 39 bonds where they can’t raise taxes to cover the payments? I would think that the financial meltdown of 2008 would’ve been a good test for how districts are managing bond risk. Do you know of any numbers about how well CA districts managed bond risk for that crisis?

        • Seth Rosenblatt on Mar 25, 2013 at 8:58 pm03/25/2013 8:58 pm

          • 000

          Paul — I don’t have any of that data, but I do know that even in economic downturns, property values don’t decrease that much, and sometimes not at all (this is why property tax is a much less cyclical source of revenue than income or sales tax). There are always exceptions of course, but this is why these type of bonds tend to have very good credit ratings. The tax rate limitation in Prop 39 bonds, however, will definitely serve to limit the total amount of bonds that any district may issue. If a district has “used up” the tax limit, they just can’t issue new Prop 39 bonds at all (until enough have been paid down), regardless of the terms.

          • el on Mar 26, 2013 at 10:38 am03/26/2013 10:38 am

            • 000

            Seth, I believe in the Willits case that they are running into the problem of property values dropping substantially, particularly given that the projection was that property values would be increasing. I have not paid close attention, but I do believe Willits will be having to cut money out of their operations budget to make the balloon bond payment.

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