Los Angeles Spurns Build America Debt for $290 Million in School Bonds
The Los Angeles Unified School District, the second-largest U.S. school system after New York City, plans to sell $290.2 million in Qualified School Construction Bonds to tap a bigger federal subsidy than offered by the Build America program.
The Los Angeles issue, scheduled for April 22, would be the second-largest use of the taxable school bonds since they were created last year, together with Build America Bonds, under President Barack Obama’s economic stimulus program. The school obligations are part of a $449.7 million sale that will be the second-largest in a week of $5.8 billion in municipal issuance, according to data compiled by Bloomberg.
About $2.8 billion in so-called QSCBs have been sold nationwide, compared with more than $95 billion in Build America Bonds, according to Bloomberg data. The federal government subsidizes as much as 100 percent of interest costs on the school bonds and 35 percent on Build America Bonds.
“We’re early adopters,” said Timothy Rosnick, controller of the school district, which sold the largest QSCB issue, $318.8 million, in October. “The tax subsidy is much higher under QSCBs than BABs, our net cost is much cheaper, so that’s why we use them.”
The school bond subsidy is paid directly to the issuer, a change that came last month when Congress passed the Hiring Incentives to Restore Employment Act. The program previously offered investors a tax credit on interest paid.
Los Angeles Unified will sell $290.2 million in school bonds, its entire allotment from the federal government, and $159.5 million in tax-exempt debt, according to a preliminary offering document. The QSCBs will mature in 2027 and the tax- exempt obligations will be due in less than 10 years, Rosnick said. Proceeds will be used for construction and remodeling of schools, earthquake resistance and other purposes. The bonds are backed by voter-approved property tax revenue.
“The tax-credit structure has only cobbled together a slim following in the market, it’s a thinly traded product compared to BABs,” said Philip Villaluz, a New York-based municipal analyst at Advisors Asset Management Inc. of Monument, Colorado. “They might have to price it attractively to the market, given the recent issues the city has faced.”
The school district’s debt is rated Aa3 by Moody’s Investors Service and AA- by Standard & Poor’s, the fourth- highest investment grades. Fitch Ratings downgraded the city of Los Angeles one level to A+, fifth-highest, on April 16, saying cash reserves are reaching a “very low level.” Moody’s cut the city’s rating one level, to Aa3, earlier this month.
California, the lowest-rated U.S. state, is ranked Baa1 by Moody’s, three steps above non-investment grade, and A- by S&P, four levels above.
‘The L.A. Label’
“I don’t think yields will suffer from the L.A. label, but maybe the California overhang,” Rosnick said. “The bonds are secured by an unlimited tax pledge which can only be used for the debt service of the bonds.”
Yields on 16-year QSCBs issued by Boston last month, rated AA+ by S&P, traded with a yield of 5.304 percent on April 9, about 1 basis point more than when issued, according to Municipal Securities Rulemaking Board data.
That compares with 4.21 percent for a top-rated, 17-year education bond, according to Bloomberg data, and 6.1 percent for a comparable obligation on the Wells Fargo Build America Bond Index. A basis point is 0.01 percentage point.
Qualified school bonds “are just about the lowest cost of financing on earth,” said Jean Buckley, president of Tamalpais Advisors Inc. in Sausalito, California, the financial adviser for the Los Angeles offering.
Investors in the school district’s October sale got a 5.96 percent federal tax credit and a 1.54 percent taxable coupon interest rate.
“We expect a much better reception now that it’s tax subsidy,” Rosnick said. “We had much higher spreads in October than we wanted to see because there wasn’t the investor demand because of the tax-credit system.”
Underwriters led by Goldman Sachs Group Inc. will market the school bonds. A group led by Citigroup Inc. will market the tax-exempt debt.