capital appreciation bonds (cabs): do they have a legitimate role in municipal & school finance

Capital Appreciation Bonds (CABs):

Do They Have a Legitimate Rolein Municipal & School Finance

September 25, 2012

Capitol Public Finance Group · 1900 Point West Way, Ste. 273 · T (916) 641 2734 · capitolpfg.com

Introductions

Slide 2

Presentation Overview

Slide 3

Slide 4

Why Borrow?

• Spread Cost Over Many Budget Years

– Based on useful life of project

– Project of benefit to many years worth of students/citizens/taxpayers

• Revenues Received Over Time

• Conserve Cash/Cash Management

• Minimize Construction and Other Cost Increases

Slide 5

What Does a Borrowing Pay For?

Slide 6

Facility or Infrastructure Construction

Land Acquisition

Building Acquisition

Facility or Infrastructure Renovation, Upgrade or

Expansion

Capital Vehicles & Equipment Purchase

Traditional Types of Long-Term Debt:Voter/Landowner Approved Debt

Slide 7

Traditional Types of Long-Term Debt:Non-Voter Approved Debt

Slide 8

Interest Payment Methods on Bonds

Slide 9

Slide 10

Recent Headlines Have BroughtCABs into the Spotlight

Slide 11

General Obligation Bonds (GO Bonds)

• Voter approved, long-term debt– Authorized under one of two voter approval methods

Traditional 2/3

Prop. 39 – 55%

– Available only to schools

• Approval method determines rules by which bonds can be issued and proceeds can be spent– Bond proceeds can only be spent on projects

explicitly identified at the time the bond measure was approved

Slide 12

Issuing GO Bonds

• Taxpayers authorize an amount of total bonds to be issued– Issued in series over time

• Amount of issuance limited by legal bonding capacity

• Prop. 39 created additional limitations:

Slide 13

Proposition 39 Tax Rate Limitations

Type of DistrictTax Rate Limit (Per

$100,000 of Assessed Value

Unified School District $60

Union School District $30

Community College District $25

Understanding GO BondIssuance Constraints

• Bond debt is repaid by ad valorem taxes levied on all taxable property within a district’s boundaries

– Tax rates a function of annual bond debt service and total assessed value in the district

Slide 14

Slide 15

School District XYZ’s Used CABs toIssue Additional Bonds

When Otherwise Could Not Have• Had authorization for $15.2 million of bonds• Issued $8 million of bonds

– During a time when assessed value was rapidly increasing

• Assessed value began to decline and additional bonds were needed– Had already reached the maximum Prop. 39 tax rate

for the entire term of the bonds already issued

• Issued an additional $5 million of bonds using CABs

Slide 16

Assessed Value in Many CA Communities

Slide 17

$0

$100,000,000

$200,000,000

$300,000,000

$400,000,000

$500,000,000

$600,000,000

$700,000,000

$800,000,000

$900,000,000

$1,000,000,000

2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

XYZ School DistrictDistrict-Wide Assessed Value Increased Rapidly from 2003-04 Through 2007-08 But Then Experienced a Significant Decline

8.74%

8.60%

19.07%

8.93% -7.33%

-9.91%

-6.39%-2.97%

Slide 18

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

XYZ School District GO Bond Debt ServiceSeries 2005 GO Bonds Have An Increasing Debt Repayment

Schedule Over 25 Years, Likely to Coincide With Assessed Value Growth Rate Assumptions Made at the Time of I ssuance

Total Annual Interest

Total Annual Principal

Repayment on capital

appreciation bonds begins

Debt Service Increases by an

Average of 5.76% Per Year

Slide 19

$0.00

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

$80.00

$90.00

$100.00

Per

$100,0

00 of

Assessed V

alu

eXYZ School District Has Exceeded its Prop. 39 Tax

Rate Limitations and Won't Be Able To I ssue Additional Bonds Into the Foreseeable Future

ACTUALPROJECTED - BASED ON 2% A.V. GROWTH

Slide 20

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

Debt Repayment on the Bonds Spans 40 Years and is Structured So Repayment Begins After the Series 2005

Bonds Are Paid Off

Total Annual Interest

Total Annual Principal

Minimal Debt Service Payments Through

2031 when the Series 2005 Bonds are Paid Off

$28.5 Million of Interest Will Be Paid on $4.4

million of Capital Appreciation Bonds

Debt Service Increases by an

Average of 5.05% Per Year

Slide 21

Total Series 2005 Debt Serivce

Total Series 2008 Debt Service

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

Debt Service on the Combined 2005 Bond Measure Bonds Increases at Approx. 4.6% Per Year, Likely to Coincide with Assessed Value Growth Rate Assumptions Made at the Time Bonds Were Issued

Combined DebtService Increases by an Average of 4.6%

Per Year

Comments on this OverallGO Bond Structure

• CABs used to enable the school district to issue bonds that it otherwise would not have been able to issue under Prop. 39– Don’t know what the communication to their

governing board and community was

– Don’t know what their project needs wereWere they already under contract?Was it for a necessary facility?Did they communicate to the community and

decided this was the best decision? The answers to these questions informs us as to

whether a responsible decision was made.

Slide 22

Slide 23

School District QRS Issued CABs toMaximize Bond Proceeds

to Fund Necessary Projects• Small elementary school district with total

assessed value of $700 million– Prop. 39 tax rate cap of $30/$100,000 of a.v. limits

amount that can be issued

• All schools at capacity and need to construct new facility costing $20 million– State funds 40%, or $8 million (50% matching program

rarely provides 50% of actual school cost)– Developers fund 30%, or $6 million

• Used CABs to increase debt service annually to correspond to projected increases in a.v.

Slide 24

Slide 25

$-

$5.00

$10.00

$15.00

$20.00

$25.00

$30.00

$35.00

$0

$50,000

$100,000

$150,000

$200,000

$250,000

Tax R

ate

Per

$100,0

00 of

a.v

.

With a Fully Amortized Current Interest Bond, District QRS is Able to I ssue $3.6 Million of Bonds

I nterest

Principal

Tax Rates

Level Debt Service Payments Result in

Declining Tax Rates as Assessed Value Grows Over

40 Years

Prop. 39 Tax Rate Limit of $30/ $100,000

of a.v.

Slide 26

$-

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

Tax R

ate

s P

er

$100,0

00 of

a.v

.

By Using CABs, District QRS is Able to I ssue $5.6 Million of Bonds

CAB Interest

CAB Principal

CIB Interest

CIB Principal

Tax RatesEscalating Debt Service

Payments Result in Level Tax Rates at $30/ $100,000

of a.v. as Assessed Value Grows Over 40 YearsProp. 39 Tax Rate

Limit of $30/ $100,000 of a.v.

Comments on this OverallGO Bond Structure

• CABs used to enable the school district to fund the construction of a necessary school– Without CABs, this district would not have

been able to obtain enough money

• Even with the expensive cost of the CABs over 40 years, a conscious decision was made to issue the bonds in this manner

Slide 27

Slide 28

School District ABC Issued CABsto Maximize Tax Rates

• Large unified school district issues CABs as part of overall bond plan

• Limits term to 25 years

• CABs only a small part of the district’s overall debt portfolio

– Over $350 million of bonds, $26 million were CABs

• Layered on top of CIBs to level out debt service when combined with other bonds issued

Slide 29

Slide 30

$0

$5,000,000

$10,000,000

$15,000,000

$20,000,000

$25,000,000

$30,000,000

$35,000,000

CABs Were Used to Make Overal Debt Service More Level Over 25 Years

CAB Interest

CAB Principal

CIB Interest

CIB Principal

Other Outstanding GO Bonds

CABs Were Used to Level Out Debt Service on

Overall Bond Measure

Comments on this OverallGO Bond Structure

• CABs were issued to level out overall debt service– Did not rely on estimated increases in

assessed value

• Overall debt repayment ratio less than 2:1

• Shorter term, 25 year, CABs

Slide 31

Other Uses of CABs

• Not only used in conjunction with GO Bonds

– COPs or revenue bonds

Often to defer repayment to match a specific revenue source

– Developer fees, CFD taxes, future capital contributions, etc.

– Federal Government issues them

Savings bonds

Have become prevalent for school GO Bonds because of the limitations of Prop. 39

Slide 32

Slide 33

CABs Can Be Issued Responsibly

• Communication and education is essential– Cost information

– Risks/benefits

– alternatives

• Need to consider the overall goals of the agency

• Enable projects to be constructed today to avoid construction cost escalation

• Spread project costs over several budget years– Consider inflation

Slide 34

Often Costly CABs Are IssuedWithout Proper Education

• Many board/community members do not understand the costs

– Don’t know the right questions to ask

• Industry professionals can encourage an issuance to profit from the financing

• Aggressive assessed value growth projections can compound the problem and cost.

Slide 35

Questions?