BILL ANALYSIS �
REVISED
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB 182 HEARING: 7/3/13
AUTHOR: Buchanan FISCAL: No
VERSION: 7/1/13 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,
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and arguments for and against the bond measure. If voters
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
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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
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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
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(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 or 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.
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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.
Make the above changes to 155144.2 and 15146(c).
Additionally, In the BAN waiver section, the waiver
should also include Section 5 of the bill in both
places.
Change 15146(b)(1)(E) to read: "If the sale
includes capital appreciation bonds, disclosure of the
financing term and time of maturity, repayment ratio,
and the estimated change in the assessed value of
local taxable property within the school or community
AB 182 -- 06/27/13 -- PageL
college district over the term of the bonds ."
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
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
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Supervisors.
Opposition /Opposed Unless Amended - Association of
California School Administrators; California Association of
School Business Officials; Beverly Hills Unified School
District; California Association of Suburban School
Districts; California School Boards Association; Coalition
for Adequate School Housing; Community College League of
California; Fresno Unified School District; Oceanside
Unified School District, Riverside County Superintendent of
Schools; San Diego Unified School District; Small School
Districts' Association.