BILL ANALYSIS                                                                                                                                                                                                    




                     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 of   
                no   years the whole or any part of a  bond issued by a  
               school district or community college district  pursuant  
               to this article   is to run  shall  have a maturity   not   






          AB 182 -- 06/27/13 -- PageL

               exceed  ing  30 years  from 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.






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