BILL ANALYSIS                                                                                                                                                                                                    



                                                                  AB 182
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          Date of Hearing:   March 20, 2013

                           ASSEMBLY COMMITTEE ON EDUCATION
                                Joan Buchanan, Chair
              AB 182 (Buchanan and Hueso) - As Amended:  March 12, 2013
           
          SUBJECT  :   Bonds: school districts and community college  
          districts

           SUMMARY  :  Deletes the authority for school districts and  
          community college districts to issue general obligation (GO)  
          bonds under the Government Code and establishes additional  
          parameters for GO bond issuances under the Education Code.   
          Specifically,  this bill  :  

          1)Specifies that the ratio of total debt service to principal  
            for each bond series shall not exceed four to one.

          2)Specifies that a capital appreciation bond (CAB) maturing more  
            than 10 years after its date of issuance shall be subject to  
            mandatory tender for purchase or redemption before its fixed  
            maturity date, with or without a premium, at any time at the  
            option of the issuer, or from time to time, beginning no later  
            than the 10th anniversary of the date the CAB was issued.

          3)Provides that if the sale of bonds includes CABs, the agenda  
            of the governing board meeting approving the sale shall  
            identify that CABs are proposed.  Requires the governing board  
            to be presented with the following information:

             a)   An analysis containing the total overall cost of the  
               CABs.

             b)   A comparison to the overall cost of current interest  
               bonds (CIBs).

             c)   The reason CABs are being recommended.

             d)   A copy of the disclosure made by the underwriter as  
               required by Rule G-17 adopted by the federal Municipal  
               Securities Rulemaking Board. 

          4)Strikes the authority for school districts and community  
            college districts to issue bonds or refunding bonds under the  
            Government Code.








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           EXISTING LAW  :  Authorizes school districts and community college  
          districts to issue GO bonds upon approval by voters and  
          establishes a process and guidelines for such issuances under  
          the Education Code.  Authorizes any city, county, city and  
          county, school district, community college district, or special  
          district to issue GO bonds, secured by the levy of ad valorem  
          taxes, and establishes a process for such issuances under the  
          Government Code. 

           FISCAL EFFECT  :  This bill is keyed non-fiscal by the Legislative  
          Counsel.

          COMMENTS  :   Background  .  School districts and community college  
          districts pay for the construction and rehabilitation of school  
          and community college facilities through a combination of state  
          education bond funds, developer fees, and local bond funds.  GO  
          bonds must be approved by voters, who agree to an ad valorem  
          (per assessed value of property) tax to pay for the bonds.   
          Prior to 2001, passage of a local bond required a 2/3  
          supermajority vote.  In 2000, voters approved Proposition 39,  
          which provided an option for approval of a local education bond  
          based on a 55% vote rather than a 2/3 vote.  Concurrent to the  
          initiative, the Legislature passed AB 1908 (Lempert), Chapter  
          44, Statutes of 2000, that required school districts to appoint  
          a local bond citizens' oversight committee to oversee bond  
          expenditures and review the required performance and financial  
          audits required of a Proposition 39 bond, and imposed  
          limitations on bonded indebtedness and tax rates as follows:


            ------------------------------------------------------------- 
           |                          |Limit on       |Limit on Tax Rate |
           |                          |Bonded         |per Assessed      |
           |                          |Indebtedness   |Valuation         |
           |--------------------------+---------------+------------------|
           |Elementary and High       |1.25%          |$30/$100,000      |
           |School Districts          |               |                  |
           |--------------------------+---------------+------------------|
           |Unified School Districts  |2.5%           |$60/$100,000      |
           |--------------------------+---------------+------------------|
           |Community College         |2.5%           |$25/$100,000      |
           |Districts                 |               |                  |
            ------------------------------------------------------------- 
             








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          Proposition 39 also requires school districts and community  
          college districts to identify the school facility projects that  
          would be funded by the bond, among other provisions.

           Bond issuance  .  Once bonds are authorized or approved by voters,  
          districts can issue or sell the bonds.  Bonds can be sold in  
          increments or in total.  It is not unusual for an authorized  
          bond to take many years before the amount of total authority is  
          exhausted.  The bonds can be sold through a competitive sale or  
          a negotiated sale.  Under a competitive sale, the issuer (school  
          district or community college district) determines the terms of  
          the sale in a sealed bid and a bidder offering the lowest  
          interest cost is awarded the bid.  In a negotiated sale, the  
          issuer selects an underwriter who purchases the bonds from the  
          issuer and then resells the bonds to investors.  

           Types of bonds .  Current interest bonds (CIBs) are the  
          traditional type of bonds sold.  CIBs are similar to traditional  
          home mortgages whereby the issuer makes interest (and principal)  
          payments almost immediately and on an ongoing semi-annual basis.  
           CABs are another form of bond (or other debt issuance).  Under  
          a CAB, the issuer can delay payments, thereby also delaying the  
          need to collect tax payments for a number of years.  Frequently,  
          although not always, CABs cannot be refinanced (callable).      

           Concerns with CABs.   According to the authors, this bill was  
          introduced due to concerns about the use of CABs, the large debt  
          that result through CABs, and the tax burden to future tax  
          payers.  CABs are more costly.  They work by extending the term  
          of a bond.  The longer the term, the more expensive it gets.   
          Since investors do not reap benefits immediately, they are  
          willing to purchase CABs anticipating larger returns.  Even  
          though payments are not made immediately, interest is accrued  
          and compounded until maturity, at which time, the investor  
          receives a single payment for both interest and principal.  The  
          total debt service (principal and interest) to principal ratio  
          is typically around 2 to 1 for CIBs, but can be 10 to 20 times  
          the principal for CABs.  According to data provided by the  
          California Debt and Investment Advisory Commission (CDIAC), the  
          total debt service to principal ratio was as high as 23.4 to 1  
          for one school district issuance located in San Bernardino  
          County.  The district received $283,600 in bond funds in 2010,  
          but will be paying a total of $6.6 million by the end of 28  
          years.  This example represents the highest total debt service  








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          to principal ratio.  The majority of the CABs had lower ratios,  
          but compared with CIBs, were still more costly.  If the amount  
          borrowed is large and the term of the bond is long, the overall  
          cost for the CAB can be massive.  For example, the total debt  
          service to principal ratio of Poway Unified School District's  
          2011 CAB that has been highlighted by the media is under 10 to 1  
          (9.3 to 1).  The large dollar amount - almost $1 billion cost to  
          borrow $105 million - highlight how high the cost can be for  
          borrowing today while paying later.  Homeowners in Poway today  
          are getting a free ride, while homeowners living in the area  
          years later will be paying the almost $1 billion price tag for  
          facilities that will be 20- to 40-years-old.  


           Why use CABs  ?  CABs became a more popular vehicle for generating  
          facility revenue after the housing downturn.  CABs also became  
          more do-able after a bill enacted in 2009 eliminated a 10% limit  
          on the annual amount of debt increase.  Because the rate of the  
          tax levy is capped and is based on property assessed valuations,  
          low housing market prices reduce the amount of funds that can be  
          generated.  For example, a home that was valued at $600,000 in  
          2005 located in a unified school district with a $60 per  
          assessed valuation cap would have yielded $360 per year ($60 x  
          6) whereas the same home might yield $240 today if the home has  
          dropped to an assessed value of $400,000.  When coupled with a  
          limit on bonded indebtedness based on a percentage of the  
          taxable property of the district, districts argue that the only  
          way to generate the funds needed to house students or modernize  
          facilities is by deferring the payments with the prediction that  
          property values will rise to a sufficient level in the future to  
          pay the debt.  This mechanism is risky.  There is no guarantee  
          that the projected growth in property value will be realized.  


           What does the bill do  .  According to the authors, this bill was  
          introduced to impose parameters on bond issuances to limit  
          costly CABs.  It does not prohibit CABs, although it is likely  
          that there will be a reduction in the use of CABs.  The bill has  
          four main components:


          1)The bill removes the authorization for school districts and  
            community college districts to issue local GO bonds under the  
            provisions of the Government Code.  Under current law, school  
            and community college districts can issue GO bonds under the  








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            provisions of the Education Code or under the provisions of  
            the Government Code, which governs bond issuances for any  
            city, city and county, special district, as well as school  
            district or community college district.  There are some  
            notable differences between the two codes.  The Government  
            Code authorizes the term of bonds to be up to 40 years,  
            whereas the Education Code limits term of bonds to 25 years.   
            The Government Code authorizes issuers to issue on their own,  
            whereas the Education Code requires school districts to go  
            through county boards of supervisors.  The Government Code  
            authorizes a maximum interest rate of 12% whereas the  
            Education Code limits interest rates to 8%.  By requiring  
            school districts and community college districts to issue  
            bonds under the provisions of the Education Code, costly CABs  
            that have up to 40 year terms can no longer be issued.    


          2)The bill limits the ratio of total debt service to principal  
            for each bond series to four to one.    


          3)The bill gives issuers the option of asking for a callable  
            feature for any CAB longer than 10 years, beginning no later  
            than the 10th year from the date of issuance.  Many CABs do  
            not allow refinancing, even if interest rates go down or if a  
            school district determines that it is able to pay off the bond  
            before maturity.  Callable CABs cost more than a noncallable  
            CAB.  Financial advisors estimate an increase between the  
            ranges of 10 to 30 basis points (.1 to .3 percent), but  
            allowing a district to refinance will have longer-term  
            financial benefits.   


          4)The bill requires notifications and specified information to  
            be provided to local governing boards if CABs are proposed to  
            be used.  This is to provide greater transparency.  The agenda  
            of a governing board meeting must indicate that a CAB is  
            proposed and the governing board must be provided with the  
            total overall cost of a CAB, compared with the cost of a CIB,  
            along with the reason a CAB is being recommended.  The  
            governing board must also be provided with the disclosure  
            required of underwriters by the Municipal Securities  
            Rulemaking Board reminding clients that underwriters do not  
            have fiduciary duty to the issuer.  









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           Why school districts only  ?  Opponents have expressed concerns  
          that the bill affects school districts and community college  
          districts but not other governmental entities.  The authors  
          state that the bill was introduced because school districts are  
          by far the largest users of CABs.  According to CDIAC, of the  
          490 GO bond CABs that were issued between January 1, 2007 and  
          November 1, 2012, 481 (98%) were issued by school districts  
          (85.5%) and community college districts (12.6%), with just 9  
          (2%) by local government entities.   


           Why limit term of CIBs  ?  This bill affects more than just CABs.   
          The term of CIBs will also be reduced to 25 years.  According to  
          the authors, a basic tenet of financing is to tie the term of  
          the infrastructure to the term of financing.  Since the  
          education bond program allows modernization funds to be accessed  
          when buildings are 25 years old, limiting the financing to 25  
          years achieves this goal and prevents the situation where a  
          community is paying for the construction of the facilities and  
          current improvements at the same time.  Opponents have expressed  
          concerns that limiting the term of CIBs will disadvantage school  
          districts in the competitive markets.  CIBs are generally 25 to  
          30 years.  This bill is unlikely to affect CIBs too greatly.   
          However, the authors may wish to consider increasing the term of  
          CIBs to 30 years.    


           Four-to-one ratio  .  The authors state that they weighed the  
          options of limiting the ratio of total debt service to principal  
          versus imposing a four or five percent annual debt increase  
          limit.  After consultation with a number of stakeholders,  
          including the State Treasurer, the authors concluded that the 4  
          to 1 ratio limit will provide districts with flexibility to  
          structure their debt repayments, respond to changing interest  
          rates, and allow for reasonable payment schedule for tax payers.  
           Opponents have expressed concerns that limiting the total debt  
          service to principal ratio to 4 to 1 is too low and applying the  
          ratio per series will inhibit a district's ability to issue CABs  
          that are not egregious.  Opponents suggest raising the ratio to  
          6 to 1 and applying the ratio on a per bond authorization basis.  
           An analysis of the CABs issued between 2007 and 2012 show that  
          many would have been able to meet both the 25 year term and the  
          4 to 1 ratio.  While the structures of each CAB may be  
          different, a cursory view indicates that CABs can still be  








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          issued under the conditions of the bill while limiting their  
          overall costs.  Allowing the ratio to be applied on a per bond  
          authorization basis will continue the practice of costly CABs.    
                


           Limits on bonding capacity and tax rates  .  One of the main  
          reasons why districts have turned to CABs is due to the limits  
          on bonded indebtedness and the fixed tax rates that were  
          established in 2000 as described above.  The statute does not  
          provide for adjustments over time.  Districts have sought and  
          received waivers to increase their percentage of bonded  
          indebtedness from the State Board of Education (SBE).  The SBE,  
          however, has not considered increases to the tax rates.  It's  
          been more than 12 years since the enactment of the bonded  
          indebtedness and tax rates caps.  The authors may wish to  
          consider a review of the need to adjust the limits.   


           Committee-suggested amendments.

           1)Bond Anticipation Notes (BANs):  A BAN is a short-term debt  
            that is used to fund facility projects prior to and in  
            anticipation of the sale of local GO bonds.  Districts may  
            issue BANs as interim financing if, for example, the sale of a  
            GO bond is not timely (e.g., the assessed valuation is low and  
            will not yield the amount of revenues a district needs).  BANs  
            may be authorized for no more than five years and have lower  
            interest rates and payments than GO bonds.  Proceeds from the  
            sale of the GO bonds are used to repay the BANs.  Concerns  
            have been expressed that districts that have issued BANs may  
            have anticipated the use of CABs to repay the BANs.  If a  
            district is unable to issue a bond, the district would have to  
            pay the BAN with general funds, which could put a district in  
            financial risk.  According to the CDIAC, approximately 35 BANs  
            that were issued since 2009 have maturity dates on or after  
            January 1, 2014.  

            Staff recommends allowing districts that issued BANs prior to  
            December 31, 2013 to seek a one-time waiver of one or more  
            provisions of this bill from the SBE or the Chancellor of the  
            California Community Colleges for community college districts  
            if the school district or community college district submits  
            an analysis conducted by an independent financial advisor not  
            affiliated with the school district, community college  








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            district or underwriter used by the district showing the total  
            overall costs for the proposed issuance, how that issuance is  
            the most cost effective method, and the reasons why the  
            district or community college district is unable to meet the  
            provisions of the bill.      
            
          2)Technical amendment:  Staff recommends a technical amendment  
            in the section of the bill giving the issuer the option to  
            request a callable feature as follows:

               "A capital appreciation bond maturing more than 10 years  
               after its date of issuance shall be subject to mandatory  
               tender for purchase or redemption before its fixed maturity  
               date, with or without a premium, at any time  at the option  
               of the issuer  , or from time to time, at the option of the  
               issuer, beginning no later than the 10th anniversary of the  
               date the capital appreciation bond was issued."
           
           Arguments in support  .  State Treasurer Bill Lockyer states, "I  
          understand many districts face a critical need to build or  
          modernize facilities for their children, and I recognize that  
          falling property tax assessments, revenue losses, and statutory  
          debt service limits have all combined to reduce districts' debt  
          financing options, at least at the present time.  However, we  
          cannot continue to use debt financing tools, such as CABs, that  
          force tax payers to pay, at times, more than 10 times the  
          principal to retire these bonds.  In too many cases, these  
          transactions have been structured with 40-year terms that delay  
          interest and principal payments for decades, resulting in huge  
          balloon payments.  Moreover, school board members and the public  
          have not always been fully informed about the total costs and  
          risks associated with issuing capital appreciation bonds.  As a  
          result of such CAB deals and lack of transparency, our future  
          generations in many California school districts will be burdened  
          with heavy taxes for years and years to come."  

           Arguments in opposition  .  All of the opposition letters  
          submitted to the Committee have an "oppose unless amended"  
          position.  Generally, the opposition supports more transparency,  
          but is concerned that the bill will inhibit school districts'  
          ability to secure funding to house students and provide for  
          renovations as promised to voters through their bond  
          initiatives.  While some of the opponents do recognize the need  
          to establish some parameters to prevent extreme CABs, they argue  
          that CABs, if done appropriately and in a limited way, are  








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          effective.  The requested amendments vary from organization to  
          organization.  They include expanding the term of CABs to 30  
          years, restoring the term of 40 years for CIBs, increasing the  
          total debt service to principal ratio to 6 to 1 and applying the  
          ratio to bond authorization, grandfathering in bonds that are  
          already approved but not issued, and allowing districts to seek  
          a waiver from the SBE to increase the tax rates.  

           REGISTERED SUPPORT / OPPOSITION  :   

           Support 
           
          Bill Lockyer, California State Treasurer
          California Association of County Treasurers and Tax Collectors
          California Taxpayers Association
          Dan McAllister, San Diego County Treasurer-Tax Collector
          Humboldt County Board of Supervisors
          Sierra County Board of Supervisors

           Opposition 
           
          Association of California School Administrators (Oppose unless  
          amended)
          California Association of School Business Officials (Oppose  
          unless amended)
          Coalition for Adequate School Housing (Oppose unless amended)
          Riverside County Superintendent of Schools (Oppose unless  
          amended)
          Small School Districts' Association (Oppose unless amended)
           
          Analysis Prepared by  :    Sophia Kwong Kim / ED. / (916) 319-2087