A bill that would rein in the type of build-now, pay-later school bonds that saddle a future generation of taxpayers with costly balloon payments passed another hurdle after the author, Assembly Education Committee Chair Joan Buchanan, D-Alamo, accepted changes easing a few of the restrictions she had proposed.
Having passed the Senate Education Committee on Wednesday, AB 182 now moves to another committee in the Senate, where school administrators and business officials with reservations will get another crack at it.
Sensational revelations about school districts approving bonds with long-term interest charges 15 to 20 times the principal have focused attention on the bill and arcane details of capital appreciation bonds (CABs). The bill also has pitted State Treasurer Bill Lockyer and county finance officials who oversee some bond purchases against school administrators.
Lockyer, comparing CABs to the mortgage scandals of the housing boom, advocates banning them. School administrators and some school boards have countered that such a step would be excessive and counterproductive.
CABs allow a district to defer interest and principal payments on school bonds for decades, but at a stiff price: compounded interest charges and other fees that make the total repayment pricey. Over the past decade, an estimated 200 K-12 and community college districts, many of which had reached their bonding capacity, have turned to CABs rather than delay new building and renovation projects. According to Buchanan, all but 2 percent of the 650 CABs issued in California since 2007 were to K-12 and community colleges; local governments issued the remainder.
Poway Unified is the most often cited example of CAB abuse, though it’s not the worst case. In 40 years, Poway will have repaid $1 billion on a $105 million CAB – more than nine times the face value. A standard, 25-year current interest bond, or CIB, typically carries with it an overall debt services to principal ratio of 2:1 or 3:1;
interest and principal are repaid typically twice a year. Other districts have floated CABs with debt ratios exceeding 20:1.
In testimony before the Senate Education Committee last week, Lockyer called CABs “subprime deals and payday loans” that amount to “foolish policy.” School districts that use them “aren’t dealing with the community in an honest way,” he said.
While he said he was sympathetic with districts whose property tax base had shrunk during the recession, limiting their ability to float new construction bonds, the state should deal with that problem through building aid.
Others blamed bond counsels who made fat fees off complex deals that district administrators and school trustees either didn’t understand or, in turn, didn’t explain fully to taxpayers. Because interest payments would be deferred, trustees could say to voters that CABs wouldn’t increase their taxes. Their assumption – a gamble – is that by the time payments are due, rising property values will have generated enough revenue to cover the increase in debt.
Buchanan said using CABs “violates a basic principal of capital financing that ties the life of the financing to the life of an improvement.” With CABs, the next generation of taxpayers will begin to pay for a previous school modernization project while facing the need to finance the next upgrade.
While officials from school organizations – among them the California Association of School Business Officials, the California School Boards Association and the Association of California School Administrators – acknowledge some controls on CABs are needed, they also say that the issue has been mischaracterized. As one piece in an overall financing strategy, CABs can make sense, they said. Lewis Hall, a Beverly Hills Unified board member, testified that a CAB was needed to keep a critical construction project on time. Otherwise, he said, the timeline will be pushed back eight years, and the district will face inflated construction costs.
Terms of AB 182
School districts can issue construction bonds in two ways: through the Education Code, which limits any school bond to a term of 25 years and 8 percent, non-taxable interest, or through the more lenient Government Code, which permits bonds of up to 40 years and 12 percent interest. School districts mostly have used the Government Code to issue CABs.
The latest version of AB 182, which reflects changes that Buchanan negotiated with Senate Education Chair Carol Liu, D-La Canada-Flintridge, contains the following key elements:
- Length of bonds: All CABs for school districts would go through the Ed Code, subject to the 25 year limit and 8 percent maximum interest rate. Districts could continue to use the Government Code to issue standard bonds, but the maximum term for school construction bonds would be 30 years, down from 40. (School groups will likely continue to oppose the shorter terms.)
- Repayment ratio, the combination of total interest and principal payments in proportion to the bond’s face value: No more 9:1 or anything close to it. The maximum would be 4:1. (Some school groups are OK with the ratio, but want it to cover the value of all of the individual bonds authorized in a bond series, averaged together. But Buchanan and Lockyer say there should be no hiding bad decisions behind averages. Poway’s 9:1 CAB would have been permitted, since it was one piece of a big bond issue. Jeffrey Vaca, deputy executive director of the California Association of School Business Officials, said Wednesday that an alliance of school groups will continue to oppose the bill unless the ratio is tied to a 30-year bond market index, giving districts leeway when rates rise.)
- Paying off CABs: All CABs must be callable, allowing districts to pay off the principal early. This provision will raise the cost slightly. (School groups support this provision.)
- Transparency: Buchanan had included disclosure requirements in the bill. The amended version strengthens them. There must be a financial analysis of the CAB, a rationale for it, a comparison with the cost of a standard bond and information about the underwriter. There would be two public presentations, an informational hearing then a vote at a subsequent meeting. (School groups support these conditions.)
Buchanan said it’s critical that CAB reforms pass. Homeowners typically see a 2:1 repayment ratio on their mortgages and will not tolerate CABs with bad terms.
“I don’t know how anyone can justify these kinds of deals,” she said. “If we don’t get CABs regulated, I am now sure how we will be able to get another state school board issue passed. We need to be good stewards of taxpayer money.”