California school districts are financing projects by pushing debt payments as far as 40 years into the future, defying a warning from the Los Angeles County treasurer while incurring interest that dwarfs principal by 10-to-1 or more.
Last year, 55 school districts were among local authorities selling bonds that mature in more than 25 years, the most since 2007, according to data compiled by Bloomberg. The practice is akin to state and local governments raising pension benefits without funding them, said John Hallacy, head of municipal research at Bank of America Merrill Lynch. Increased retirement costs helped push Stockton and San Bernardino into bankruptcy court this year.
“It’s not so much kicking the can down the road as it is burying a drum of toxic waste in the back of the school,” said Jonathan Fiebach, a partner at Grant Williams LP, a Philadelphia investment advisory firm.
Agencies, including the Poway Unified School District in San Diego County, modernized and expanded campuses using zero-coupon bonds that mature a generation or more into the future. Poway is deferring all payments on $105 million in bonds issued last year until 2033 after officials promised voters four years ago that the securities wouldn’t raise taxes. By the time all the bonds mature in 2051, the district will pay $1 billion in interest, the data show.
The practice persists in California, Illinois and other states, even though Michigan outlawed the bonds in 1994 and Los Angeles County Treasurer Mark Saladino last year counseled California school officials against issuing them.
“You don’t want to saddle future taxpayers with the debt for facilities that are being built and used today,” Hallacy said in a phone interview from New York. “In some ways, it’s like adding pension benefits without finding a way to pay for them.”
Many California school districts are doing just that. Since May 2011, according to Bloomberg data, 11 districts have issued capital-appreciation bonds maturing in 40 years -- the longest term allowed under California law. The notes provide cash for classrooms, libraries and athletic fields at a time when stagnant property values limit short-term borrowing, school finance officials said. State law caps bonded indebtedness at $30 for each $100,000 of property value.
Tax-exempt capital-appreciation debt is similar to so-called zero-coupon bonds, except that the investment return on the principal is reinvested at a compound rate until maturity. The securities usually yield more than coupon bonds to compensate investors for the longer holding period before they receive any income.
Zero-coupon bonds are offering some of the the highest yields compared with benchmark municipals since at least October 2001, when Bloomberg Fair Value data begins. Yields on an index of zero-coupon bonds maturing in 30 years and rated AA-, Standard & Poor’s fourth-highest grade, were 1.46 percentage points more than top-rated munis with similar maturity yesterday, Bloomberg Fair Value data show. The yield spread between the two indexes was as wide as 1.53 percentage points on July 30.
Declines in property taxes may induce more districts to pursue longer-term bond deals, said Marilyn Cohen, founder of Envision Capital Management Inc. in Los Angeles, who has $195 million of munis under management.
“I’m sure California is the worst offender,” Cohen said in a telephone interview. “Property taxes have gone to hell in a hand basket in California.”
Declining property taxes and increased pension costs have squeezed school districts and cities across California. The California Public Employees Retirement System was listed as the largest unsecured creditor in Chapter 9 bankruptcy filings by the cities of Stockton and San Bernardino.
California schools could lose as many as three weeks of the academic year if voters reject Governor Jerry Brown’s ballot measure to temporarily raise sales taxes and income taxes on higher earners. Brown built $5.5 billion in cuts to education into the $91.3 billion California budget this year if voters turn down the proposal in November. Those reductions would apply to operating costs such as teacher salaries rather than construction projects.
State law allows districts to issue bonds maturing as long as 25 years into the future on their own; greater maturities require approval from county treasurers.
Saladino wrote an open letter in May 2011 counseling finance officials throughout the state against deferring debt more than 25 years. Extending maturities beyond that point results in a “significantly higher debt burden,” Saladino wrote.
None of the 11 tax-exempt bonds maturing in 40 years was in his county. Six were in San Diego County, the state’s second-most-populous behind Los Angeles.
“When the housing market stalled and retreated as it did, districts were counting on a certain level of assessed valuation, and when it went away, they couldn’t raise the capital they needed,” said Glenn Byers, Los Angeles County’s assistant treasurer, in a telephone interview. “So they turned to this abusive tactic.”
California Treasurer Bill Lockyer hasn’t taken a position on these bonds, said Joe DeAnda, a spokesman.
In 1994, Michigan lawmakers banned the use of long-term, zero-coupon bonds for school construction after newspaper articles documented their ultimate costs.
In San Diego County, the Santee Unified School District sold $3.5 million in bonds last year with no payments due until 2026. The largest, $40.3 million, is payable in 2051. In all, the district will pay almost $65 million to satisfy the debt, the Bloomberg data show. Voters in Santee, which borders the Poway district, approved $60 million in bonds in 2006 to modernize the district’s nine campuses with library technology centers, athletic fields and other facilities.
By pushing most of the debt burden far into the future, Santee was able to “leverage scarce resources” to enlarge a school system pressured by population growth while staying within the state-mandated debt limit, said Karl Christensen, the district’s chief business officer, in an e-mail.
San Diego County Treasurer Dan McAllister said many districts are struggling to come up with funding for much-needed expansion and modernization projects, causing them to turn to nontraditional instruments. McAllister has approved the longer-term bonds even though debt service on some “is a pretty outrageous proposition,” he said.
“We are under advisement that to stop or impede the process, if it were to cause fiscal harm to the school district, it could cause litigation against the county,” McAllister said in a telephone interview.
The Poway and Santee bond sales were managed by Stone & Youngberg LLC, which was acquired last year by St. Louis-based Stifel Financial Corp. (SF) Stifel’s media-relations department didn’t return phone messages left last week and yesterday.
Three of the 11 districts with capital-appreciation bonds maturing in 2051, including Poway, were advised by Dolinka Group LLC, a consultancy in Irvine, California, that has worked for more than 250 school districts, community college districts and county offices of education, according to its website.
Declines in property taxes, as well as the cap on indebtedness, have deprived districts of revenue for building and modernizing facilities, Benjamin Dolinka, the consultancy’s president, said in an e-mailed statement responding to questions. Without the long-term bonds, school districts would have to either scale back their construction efforts or “substantially” increase property taxes, Dolinka said.
“This would lead to inequality in schools -- the ’have’ facilities and the ’have-nots’ -- greater deterioration of existing school facilities, overcrowding of existing school facilities, and a significant increase in costs due to inflation associated with improvements being done in multiple phases,” Dolinka said.
Capital-appreciation bonds aren’t unique to California, nor to schools. The Metropolitan Pier and Exposition Authority, which owns the Navy Pier and McCormick Place in Chicago, in June sold $75 million of such bonds maturing in 2051 to help fund an expansion of the McCormick Place convention center. The authority needed the money to make up for the loss of taxes on hotels, restaurants and car rentals because of the recession that began in 2008, said Richard Oldshue, the chief financial officer.
By the time the final payments come due in December 2051, the authority will have paid $591 million, more than eight times the principal amount, Bloomberg data show.
Following are pending sales:
CHICAGO’S BOARD OF EDUCATION plans to issue $500 million of revenue bonds as soon as today for school construction, Bloomberg data show. The bonds are secured by state aid revenue and property-tax collections, according to bond documents. Moody’s Investors Service rates the sale A1, its fifth-highest grade. (Added Aug. 14)
NEW YORK STATE THRUWAY AUTHORITY is set to borrow $550 million of bonds backed by personal-income taxes as soon as next week, Bloomberg data show. Standard & Poor’s rates the credit AAA, its highest grade. (Updated Aug. 14)
ENERGY NORTHWEST, which provides electricity to 1.5 million customers in Washington, plans to borrow $777 million of electric-revenue bonds, including taxable debt, as soon as Aug. 15, Bloomberg data show. Proceeds will help finance fuel purchases and capital upgrade, according to bond documents. Standard & Poor’s rates the bonds AA-, its fourth-highest grade. (Updated Aug. 14)
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