BILL ANALYSIS Ó SENATE GOVERNANCE & FINANCE COMMITTEE Senator Lois Wolk, Chair BILL NO: AB 182 HEARING: 7/3/13 AUTHOR: Buchanan FISCAL: Yes VERSION: 6/27/13 TAX LEVY: No CONSULTANT: Grinnell SCHOOL BONDS Sets a maximum debt-to-principal ratio, and other limits on bonds issued by school and community college districts. Background and Existing Law When public agencies issue bonds, they essentially borrow money from investors, who provide cash in exchange for the agencies' commitment to repay the principal amount of the bond plus interest in the future. The California Constitution requires counties, cities, and school districts to get voter approval for long-term debt (Section 1, Article XIIIA). Counties, cities, school districts, community college districts, and some special districts can issue general obligation (GO) bonds, secured by ad valorem, or according to value, property tax revenues with 2/3-voter approval. Proposition 39 (2000) allows school districts and school facility improvement districts to issue GO bonds to build, rehabilitate, or replace schools with 55% voter approval subject to certain conditions. However, community college and school districts cannot levy a tax to approve a bond in any year that exceeds $60 per $100,000 of assessed valuation for a unified school district, or $30 per $100,000 of assessed valuation for other school districts. Additionally, each local agency is subject to the Constitutional debt limit, which requires two-thirds voter approval to encumber public funds beyond the current fiscal year (Section 18, Article XVI). To issue a bond, a community college or school district first orders an election and approves ballot measure language. Second, the county registrar distributes a sample ballot containing the text of the measures, a projection of tax rates needed to repay the bond prepared by the district, a legal analysis from the county counsel, and arguments for and against the bond measure. If voters AB 182 -- 06/27/13 -- PageB approve the measure, the district then passes a resolution to sell the bonds. When a school or community college district's voters authorize a bond, they authorize the county to increase the property tax rate in an amount necessary to repay the bond according to the schedule determined by its board. The tax applies to the assessed valuation of all property within the school or community college district, and is added onto each district residents' property tax bill. Historically, districts will make fixed payments of principal and interest over the useful life of the facility, commonly known as a "current interest bond" or CIB. However, if the district's assessed valuation declines, the county must increase the tax to borrow the same amount, all else equal. Given recent declines in assessed valuation, many districts couldn't sell bonds in amounts they planned for, because the tax rate necessary to meet the debt service payments would exceed the limit. In response, community college and school districts have issued "capital appreciation bonds" or CABs that defer payment of principal and interest for up to 20 years, thereby allowing the community college or school district to issue more debt than with CIBs. With a CIB, the tax increases once the district levies the tax to repay the bond; under a CAB, the district waits up to 20 years to assess the tax, during which time deferred principal and interest compound, increasing the ratio of debt payments to principal. The district hopes that assessed valuation will have rebounded sufficiently to prevent shifting resources from education purposes to repay bondholders the higher amounts they demand to wait 20 years for repayment. The community college or school district can use the bond proceeds to build facilities, but deferring repayment makes the debt expensive. CABs have debt to principal ratios of anywhere from 3.5 to 1 all the way to 23 to 1, where CIB's debt-to-principal ratios are typically around 2 or 3 to 1. According to recent research, of a total of 648 CABs issued since 2007, 349 have a debt-to-principal ratio above 3.5. Of those 349, agencies have borrowed $18.9 billion to AB 182 -- 06/27/13 -- PageC receive only $2.9 billion in principal.<1> News reports have focused upon a CAB issued by the Poway Unified School District, which approved a $105 million bond in 2008. Poway USD sold the bond in 2012, but only begins making payments in 2032, eventually maturing in 2052 after a scheduled $981 million in payments for a ratio of 9.34 to 1. Poway USD assumed that assessed valuation would drop in the first three years, be flat in year four, but grow at a 2.5% annual rate in each following year, thereby providing a sufficiently robust base for repayment in 20 years. Other non-school agencies have also issued CABs, due to a similar lack of growth in assessed valuation. For many years, the Education Code provided the sole avenue for school and community college districts to sell GO Bonds, which limited the number of years a community college or school district could issue a bond to 25 years, with a maximum interest rate of 8%. In 1993, the Legislature added sections to the Government Code to allow cities, counties, cities and counties, special districts, and school and community college districts to issue 40-year CABs and very similar "zero coupon bonds," by resolution, subject to three limitations (SB 872, Kopp): The overall cap on interest rate of 12%, The local agency sells the bonds at public sale, The annual payments of principal and interest on an issue of bonds must be structured so that the minimum annual debt service doesn't exceed the maximum annual debt service by 10%, unless the deviation is the result of accelerated repayment, known as the "10% rule." The Board of Supervisors in the county in which a community college or school district wants to sell bonds under the Education Code must approve a resolution authorizing the sale, either specific to the issue or a blanket resolution for all school districts. Under the Government Code, school districts can also sell bonds directly in a public sale, but only need board of supervisors' approval to do so in a private sale. In 1999, the Legislature allowed community college and school districts to sell bonds in private sales (SB 1118, ------------------------- <1> James P. Estes "Capital Appreciation Bonds: the Creation of a Toxic Waste Dump in Our Schools." CSU San Bernardino, Department of Accounting and Finance. AB 182 -- 06/27/13 -- PageD Alarcon, 2013). Ten years later, the Legislature repealed the 10% rule when it allowed all local agencies to sell bonds at private sales (AB 1388, Hernandez, 2009). Additionally, neither the Government Code nor the Education Code provides a maximum ratio of debt-to-principal ratio or a "call" requirement. Call requirements allow issuers to refinance older bonds in the future on better terms, but investors demand higher interest rates to compensate them for the risk they take of early repayment on a callable bond. Currently, school districts and school facility improvement districts may sell bond anticipation notes (BANs), which are short term debt instruments issued prior to the sale of a bond, or a portion of a bond issue. The district sells notes to investors, who provide cash to the district, which the district subsequently repays plus interest from the proceeds of the bond sale or from issuing another note. School districts and school facility improvement districts must use note proceeds for the same purposes as the bond, or to repay previously issued BANs. Districts cannot issue BANs in an amount that exceeds that of the unsold authorized bonds. The Legislature first authorized BANs in 1999, but restricted their maturities to one year (SB 1118, Alarcon), then expanded the allowable maturity to five years (AB 1368, Mullin, 2007). Proposed Law Assembly Bill 182 limits school district bond issuance under both the Education and Government Codes. In the Education Code, the bill: Caps total debt service for each bond series at 4 to 1. Requires capital appreciation bonds maturing more than 10 years after its date of issuance to be subject to redemption with or without a premium beginning in the tenth year, also known as "callable." In the Government Code, the bill: Caps, at 30 years, the term of any bond issued by a school district or community college district, Imports the bill's Education Code debt service cap and "call" requirement, and applies them to any capital appreciation bonds issued by a school or community college district, and AB 182 -- 06/27/13 -- PageE Applies current Education Code provisions capping interest rates at 8% and issuance costs to 2%, limiting terms to 25 years, and setting a maximum discount of 5%, among other provisions, to capital appreciation bonds issued by a school or community college district. The measure also changes the information that the school or community college district board sees before it enacts the resolution authorizing the sale of capital appreciation bonds to include: An analysis of the overall costs of the capital appreciation bonds, A comparison of the overall cost of current interest bonds, The reason capital appreciation bonds are being recommended, A copy of the disclosure made in compliance with Rule G-17 adopted by the federal Municipal Securities Rulemaking Board, and Disclosure of the financing term, time of maturity, repayment ratio, and the estimated change in assessed valuation of local property. AB 182 allows school or community college districts that issued BANs to obtain a one-time waiver from the State Board of Education of the Chancellor of the California Community Colleges, respectively, of the bill's debt service cap, call requirement, and changes to the information the school or community college district sees before enacting resolution authorizing the sale. The proceeds of the issuance subject to the waiver shall only be used to repay the BAN. Additionally, the school or community college district must provide an analysis from a financial advisor unaffiliated with the school or community college district showing the total overall costs of the proposed bond, how the issuance is the most cost-effective method, and the reasons why the school or community college district can't meet the requirements of the bill. State Revenue Impact No estimate. Comments AB 182 -- 06/27/13 -- PageF 1. Purpose of the bill . According to the author, "Funds for the construction and modernization of school facilities are derived from state education general obligation (G.O.) bond funds, local G.O. bonds, and developer fees. Bond funds must be approved by voters, who agree to pay additional ad valorem taxes based on property values. Once bonds are authorized, school districts can issue (or sell) the bonds. Current law authorizes school and community college districts to issue local bonds from the Education Code and the Government Code. The parameters are slightly different under the two Codes, namely, a 25 year maximum term and 8% interest rate under the Education Code and a 40 year maximum term and 12% interest rate under the Government Code. In 2000, Proposition 39 was passed, which allowed school districts and community college districts to pass local education bonds with 55% voter approval. A companion bill enacted that year, AB 1908 (Lempert), imposed limitations on a district's level of bonded indebtedness and on the amount of tax that can be collected to pay for a bond. An elementary or high school district has a bonding limit of 1.25% of taxable property and a tax rate limit of $30/$100,000 of assessed valuations, a unified school district has a 2.5% bonding limit and $60/$100,000 of assessed valuation, and a community college district has a 2.5% bonding limit and $25/$100,000 of assessed valuations. The most common type of bonds issued are current interest bonds (CIBs), whereby the issuer pays interest and, perhaps, principal, almost immediately and on a semi-annual basis. Over the last five years, school districts have increasingly resorted to the use of capital appreciation bonds (CABs) due to the housing downturn and low assessed valuations. CABs allow higher levels of borrowing by deferring payment of principal and interest for up to 40 years, with the anticipation that property values will increase substantially by the time the bonds are due. Because benefits are not realized for a long period of time, interest for a CAB is higher, is accrued and compounded over time. Consequently, CABs result in much higher interest costs than CIBs, some with total debt to principal ratio of over 10 to 1. The total debt service to principal ratio of CIBs is generally around 2 to 1. Taxpayers living in the district decades from the time the bond is approved will be the ones paying the bond when it matures, and at much higher costs than if taxpayers were AB 182 -- 06/27/13 -- PageG paying on an ongoing basis. For example, a district in San Diego County will be paying almost $1 billion for a $105 million bond in 40 years, almost 10 times the amount borrowed. Another district in San Bernardino County will pay $6.6 million for a $283,000 bond in 29 years, 23 times the amount borrowed. A district in Kern County will pay $15.5 million for a $1 million bond in 38 years, 15 times the amount borrowed. A simpler way to think about it is that capital appreciation bonds are like negative amortized home mortgages, and we know the problems they caused in the housing market. This bill does not prohibit CABs. The bill establishes parameters for the issuances of bonds to ensure that the costs of bonds are not excessive. Specifically, the bill limits the term of CABs to 25 years and the term of CIBs in the Government Code to 30 years, establishes a maximum debt service to principal ratio of 4 to 1 for bonds issued out of the Education Code, requires CABs longer than 10 years to be callable (refinanceable) at the option of the issuer, requires transparency measures if CABs are proposed, such as requiring the local governing board agenda to indicate that CABs are proposed, requiring an informational meeting prior to the meeting to approve a CAB, requiring governing board members to be provided with the costs of a proposed CAB compared with the cost of a CIB, and requiring disclosure of specific information about the CAB. Information must include the term of the financing, the repayment ratio, the time of maturity, and the projected change in assessed valuations. In order to enable districts that have issued Bond Anticipation Notes (BANs) to retire the BANs, the bill authorizes a district to request a one-time waiver from the provisions of the bill from the State Board of Education or the Community College Chancellor's office if the school or community college district submits a report from an independent financial advisor not affiliated with the district or underwriter used by the district indicating the total overall costs for the proposed issuance, how that issuance is the most cost effective method, and the reasons why the school district or community college district is unable to meet the provisions of the bill. A BAN is a short-term debt that is used to fund facility projects prior to and in anticipation of the sale of local G.O. bonds. Proceeds from the issuance of the G.O. bonds are used to pay the BAN. If GO bonds are not available, the BAN would have to be paid using general funds. According to data provided by the California Debt and Investment Advisory Commission AB 182 -- 06/27/13 -- PageH (CDIAC), which collects information on bond issuances, approximately 35 BANs that were issued since 2009 have maturity dates on or after January 1, 2014. Limiting the term of CABs to 25 years and the term of CIBs to 30 years will lower the costs of bonds. According to the CDIAC, the majority of general obligation bonds CABs issued between January 1, 2007 and November 1, 2012 were issued by school and community college districts: 85.6% by school districts, 12.7% by community college districts, with 2% from local governmental entities. This is one of the reasons the bill focuses on school and community college districts. This bill is also consistent with the recommendation of State Treasurer Bill Lockyer and county treasurers to limit debt service to principal ratio to an acceptable level of no more than 4 to 1. Districts may feel that they must use CABs in order to deliver on the projects approved by voters. However, districts also have a responsibility to taxpayers. Taxpayers living in the district 40 years down the road should not be the ones burdened with paying for facilities built today. If the projected increases in property values are not realized, future taxpayers may be required to pay more than the amount agreed to by taxpayers who approved the bonds." 2. Push and pull . The key policy question posed by AB 182 is: to what degree should the state oversee school and community college district debt issuance? Currently, state law prescribes maximum interest rates, terms, discount amounts, as well as disclosure and issuance requirement that a school or community college district must meet before selling debt, among others. Currently, no state government entity must approve a local general obligation debt issuance, no matter how creative, allowing school and community colleges to determine the appropriate level of debt to meet local needs within state limits. AB 182 restricts this discretion by tightening these limits in response to recently issued CABs with high debt-to-income ratios, but keeps the power to borrow firmly within school or community college district discretion. The Committee may wish to consider whether AB 182 strikes the right balance between local autonomy and state oversight of school and community college debt issuance. 3. Rough justice ? School districts and finance professionals argue that AB 182 is too restrictive on school and community college debt issuance in the following AB 182 -- 06/27/13 -- PageI ways: The bill caps each bond series to a 4 to 1 debt service to principal ratio. Generally, a voter approved bond authorization is broken into series the issuing local agency sells over time. Critics argue that the standard should be applied to the total authorization, not the individual series, as the overall authorization can be constructed in a way that meets the ratio but allows a district to issue individual bond series that allow it to borrow money sufficient to meet infrastructure needs. The bill doesn't allow school and community college districts to issue CIBs past 30 years, when current law allows 40 year CIBs. Because CIBs require periodic payments, they can't allow for the compounding of interest that leads to the high debt levels CABs have. Critics want 40 year CIBs restored, either absolutely or subject to state of county office of education approval. The measure's debt to principal ratio will further constrict local borrowing should interest rates rise from current historic lows. As interest rates rise, debt costs rise necessarily, so a district that issues a bond that meets the 4 to 1 ratio today may not in the future. Critics argue that the bill should include some mechanism that adjusts for future interest rate changes. Additionally, the BAN waiver component of the bill requires districts seeking the waiver to obtain an analysis from a financial advisor unaffiliated with the district. However, any financial adviser completing such an analysis would expect compensation, so he or she could no longer be "unaffiliated." Critics argue that the requirement would be costly if not impossible to comply with, would result in delayed bond sales and construction due to the time incurred to obtain state approval, and suggest these districts be either grandfathered in or allowed to use its current advisor. Critics also point out that by importing Education Code requirements upon bonds issued using the Government Code grants too much power to counties to impose additional requirements on bond structures that comply with AB 182. They want the county's authority to insist on additional conditions limited or removed if the bond structure meets this bill's requirements. AB 182 -- 06/27/13 -- PageJ 4. Other ways ? California takes a more laissez-faire approach to local debt issuance than many other states. However, this model has given rise to CABs, whereby future taxpayers in districts issuing them must pay the excessive debt used to build facilities today that may be outdated or obsolete by the time they get to use them. David Gamage of the Haas School of Business at UC Berkeley and Darien Shanske of UC Davis School of Law state that policymakers should be concerned about local debt issuance, because smaller districts lack expertise in municipal finance and tend to pay higher borrowing costs, and the related problem of pay-to-play arrangements where bond underwriters seeking contracts with local agencies finance bond campaigns.<2> Gamage and Shanske recommend that California adopt North Carolina's system whereby the North Carolina Local Government Commission must approve all local debt issues, or the State of New York's requirement that the State Comptroller must approve any local bonds not sold in public sales. While Gamage and Shanske's solution would interject the state into local debt issuance in an unprecedented way, and far beyond the current issuer fees and information requirements, supporters of this approach suggest that the state needs a stronger tool to prevent the intergenerational transfer of payment obligation that CABs allow. 5. Know your role . Currently, according to the County Association of Treasurer-Tax Collectors, the County Treasurer-Tax Collector has no authority under the Education Code or the Government Code to prevent the issuance of any school district bond. The County Board of Supervisors has the duty under the Education and Government Code to issue school district bonds, except when the district has a qualified or negative budget certification. No discretionary act on the part of the Treasurer-Tax Collector is required under either code as a condition precedent to the issuance of any school district bond. Tax collectors can and will work with school districts to reduce repayment ratios by doing such things as structuring the bond repayment schedule to start sooner, or assist in renegotiating terms arranged by financial advisors. Concurrence of the Treasurer-Tax Collector in the final structure is not legally required before the bond can be issued. The Committee may wish to consider whether ------------------------- <2> David Gamage and Darien Shanske, "The Case for a State Level Debt-Financing Authority." State Tax Notes. January 21, 2013. AB 182 -- 06/27/13 -- PageK strengthening the role of the County Treasurer-Tax Collector will help ensure better oversight of school and community college district debt issuance. 6. Incoming ! On June 26th, the Senate Committee on Education approved AB 182 as amended by a vote of 8 to 0. As approved by the Assembly, the measure prohibited school and community college districts from issuing bonds using the Government Code. As amended, the measure: Removed the prohibition, but limited to 30 years the number of years any bond issued by a school district or community college district can run, Applies the bill's change to Education Code applying a debt service cap and call requirement to any capital appreciation bonds issued by a school or community college district, and Imports current Education Code provisions capping interest rates at 8%, limits terms to 25 years, limiting issuance costs to 2%, and applying a maximum discount of 5%, among other provisions, to capital appreciation bonds issued by a school or community college district. The Committee is hearing the measure as the Committee of second reference. 7. Technicals . Committee Staff and the State Treasurer's Office recommend the following amendments: Education Code: 15146 (b)(1)(E) If the sale includes bonds which allow for the compounding of interest, such as capital appreciation bonds, disclosure of the financing term and time of maturity, repayment ratio, and the estimated change in assessed value of local property. (2) If the sale includes bonds which allow for the compounding of interest, such as capital appreciation bonds, the resolution shall be publicly noticed on at least two consecutive meeting agendas, first as an information item and second as an action item. Additionally, In the BAN waiver section, the waiver should also include Section 5 of the bill in both places. Government Code: 53508.5 (a) Notwithstanding any other law and except as provided in subdivision (b),the number ofnoyears the whole or any part of abond issued by a school district or community college district pursuant to this articleis to runshall have a maturitynotAB 182 -- 06/27/13 -- PageL exceed ing 30 yearsfrom the date of the bonds or date of the any series thereof. (b) Notwithstanding any other law, a school district or community college district that intends to issue bonds which allow for the compounding of interest, such as capital appreciation bond s, pursuant to this article shall comply with the requirements of Sections 15143, 15144, 15144.1, 15144.2, and 15146 of the Education Code. Insert into the Education Code the following definition of bonds in Government Code: "Bonds" means bonds, notes, warrants, or other evidence of indebtedness payable, both principal and interest, from the proceeds of ad valorem taxes that may be levied without limitation as to rate or amount upon property subject to taxation by the legislative body. Assembly Actions Assembly Education 6-0 Assembly Floor 75-0 Senate Education 8-0 Support and Opposition (06/28/13) Support : Bill Lockyer, California State Treasurer; California Association of County Treasurers and Tax Collectors; California League of Bond Oversight Committees; California Taxpayers Association; Contra Costa County Board of Supervisors; Dan McAllister, San Diego County Treasurer-Tax Collector; Howard Jarvis Taxpayers Association; Humboldt Taxpayer's League; Mark Luce, Napa County Board of Supervisors; Sierra County Board of Supervisors; Siskiyou County Board of Supervisors. Opposition /Opposed Unless Amended - Association of California School Administrators; California Association of School Business Officials; California Association of Suburban School Districts; California School Boards Association; Coalition for Adequate School Housing; Community College League of California; Fresno Unified School District; Riverside County Superintendent of Schools; San Diego Unified School District; Small School Districts' Association. AB 182 -- 06/27/13 -- PageM