Questionable Practices in the World of Bonds, or Are They?

1. Questionable Practices in the World of Bonds, or Are They? Session ID: FIN34 Session Title: Questionable Practices in the World of Bonds, or Are They? Room: 104C Day: Saturday, April 6th, 2013 Time: 3:15 – 4:15 p.m. These materials have been prepared by a CASBO Associate Member. They have not been reviewed by State CASBO for approval, so therefore are not an official statement of CASBO.

2. Panel Participants 2013 CASBO ANNUAL CONFERENCE & SCHOOL BUSINESS EXPO • David B. Olson Managing Director KNN Public Finance dolson@knninc.com • Dr. Luis Ibarra Ed.D. Associate Superintendent of Business Services Oceanside Unified School District luis.ibarra@oside.us

3. Outline of Presentation Big Picture Issues Capital Appreciation Bonds Oceanside USD’s Story Moving Forward Other Questionable and/or Controversial Practices Appendix A: Questions You Should Be Asking Appendix B: Other Questionable and/or Controversial Practices

4. Big Picture Issues

5. Timeline September 2012: Voice of San Diego article. October 2012: Lockyer speech at the Bond Buyer Conference. January 2013: Hueso introduces legislation. Ongoing barrage of negative discussions and stories.

6. Impact What are these stories implying? What do you want the public to think about you? What policies and practices would you like to be able to describe to a critic?

7. Your Job Adequate facilities for students. Facilities that meet community standards. Good stewards on taxpayer monies. To always be learning.

8. Key Elements in the Process Understanding of core issues. Identification and open discussions of challenges as they emerge. Consideration of both alternatives and alternative perspectives. Never lose sight of original goals and objectives.

9. Capital Appreciation Bonds

10. How They Work • Type of bond that does not pay regular interest (interest accumulates until maturity). • Typically used in conjunction with other bonds or in context of a broader program to provide an overall debt service obligation that escalates over time. • Interest rate is typically higher (and sometimes much higher) than on traditional current interest bonds.

11. Why Did They Become So Common? • Post-Proposition 39 construction boom. • Industry practice that assessed values would perpetually increase. • Economic collapse of 2008. • Existing programs structured with too little flexibility. • Under-appreciation (by schools and their advisors) of the uniqueness of the economic situation and of the resulting divergence of perspectives.

12. What Makes for an Explosive Story? • Financings with an identifiable project and a high payback ratio. • Financings with a relatively long-term (particularly if the asset being funded has a shorter useful life). • Financings that diverge in substantive ways from original financing plans approved by voters. • Situations where the financing team ignores high profile third-party advice. • Situations where the case can be made that the advice of consultants was driven by financial incentives. • Situations where school district decision-makers claim to have been poorly informed.

13. Oceanside USD’s Story

14. Oceanside USD Community of 129,500 in North San Diego County. 21,009 students and 23 schools. Facility issues in the late 1990s.

15. Oceanside USD’s Program Acknowledged need for a series of bond measures. 2000 Proposition H and 2008 Proposition G. Approach to facilities improvements. Successes and community support.

16. Emerging Challenges Economic collapse coincided with election success. From the beginning: a “constrained” program. Open and ongoing dialogue. Decisions to gradually slow the program. Discussions of long-term solutions.

17. What Oceanside USD is Glad to Be Able to Say Tax rates remained at target levels. We made adjustments to the program from the beginning. We built in flexibility (and call features). We had an open process (that included both supporters and critics). We began discussing alternatives early on.

18. Moving Forward

19. Things Sometimes Ignored in the Stories • CABs have been effectively used by California school districts for more than twenty years. • Current taxpayers are rarely if ever let off the hook entirely. • CABs are typically used to smooth annual payments and rarely create spikes in future repayment obligations. • Many school districts issued CABs in conjunction with larger current interest bond components (and sometimes QSCBs). • Program-wide repayment ratios remain below 4 to 1 for almost all school district bond programs.

20. Questions to Consider • Did school districts become too comfortable in relying on future tax base growth in designing bond programs? • To what extent should future tax base growth be used to increase capacity for prospective future debt versus paying for past issues? • Should bond programs funding long overdue facilities improvements be structured differently than bond programs funding necessary maintenance and modernization? • How and when should a school district consider de-leveraging a bond program?

21. Proposed Legislation • AB 182 (Buchanan and Hueso). • Input from Treasurer Bill Lockyer and county treasurer organizations. • Key provisions: • Reduce maximum term from 40 years to 25 years. • Limit the repayment ratio for individual transactions to 4 to 1. • Reduce the maximum nominal interest rate from 12% to 8%. • Requires call provisions on any bond maturing in more than ten years. • Expected outcome.

22. Other Questionable and/or Controversial Practices

23. Other Questionable and/or Controversial Practices Aggressive AV Assumption Forty-Year Bonds Negotiated Sales Costs of Issuance Campaign Contributions Free Campaigns

24. Other Questionable and/or Controversial Practices Pre-Packaged Teams Solar Financings Technology Bonds JPA Structures Underwriter Funded Costs of Issuance Creative Uses of Bond Premium

25. Best Practices

26. Bond Program Management Make sure that original bond program is reasonable, flexible, and well-communicated to all stakeholders. Review bond program regularly and discuss any potential need for adjustments in a timely manner. Solicit input from independent third-parties (including your county treasurer) when appropriate. Don’t ignore your critics.

27. Consider Financing Alternatives • Start with clearly stated policy objectives. • Ask your consultants to identify choices that are embedded in the proposed plan of finance. • Ask consultants to describe one or more alternatives to the proposed plan of finance. • Build plenty of time for staff and community input. • Conduct a post-mortem at the conclusion of the financing process.

28. Appendix A: Questions You Should Be Asking

29. Questions You Should Be Asking • Basic Questions • Financing Team • Bond Sizing and Issuance Timing • Bond Repayment Term and Structure • Payback Ratio • Questions on Assumptions (AV/Program Needs) • Questions on Future Flexibility • Questions on Refunding Bond Issuances • Questions on Interim Financings

30. Basic Questions (1) • Financing Team Members: • Who are the financing team members and what are their roles? • How were the financing team members selected? • Financing team members can include bond and disclosure counsels, underwriters, financial advisors, paying and escrow agents, and rating agencies.

31. Basic Questions (2) • Sizing: • Why are we borrowing the proposed amount? • Project needs • Bond program constraints • Timing: • Why are we issuing bonds now? • Project schedule • Market environment

32. Basic Questions (3) • Repayment Term and Structure: • How long will it take to completely repay these bonds? • When will we start paying interest on these bonds? • When will we start paying principal on these bonds? • School districts may issue bonds with repayment terms of up to 25 years under the education code and currently up to 40 years under the government code. • Bonds that defer interest payment until maturity are called capital appreciation bonds, or “CABs”, which have higher interest expense relative to current interest bonds.

33. Basic Questions (4) • Payback Ratio: • How much are we borrowing? • What is the total future repayment? • For a typical municipal current interest bond issuance with a 4% escalation in debt service obligations, the payback ratio is about 2.9 to 1. • Bond issuances featured in news articles have payback rations of 10 to 1 (and higher in some cases). • County officials have highlighted school district issuances with high payback rations.

34. Questions on Assumptions What are the tax rate targets in connection with the bond program and how were they determined? What are our tax rates projected to be over time and based on what assumptions?

35. Questions on Flexibility • Can we refinance or refund these bonds in the future? • Are there any additional costs associated with the flexibility to refinance or refund these bonds? • Optional call features on bonds allow the school district the flexibility to restructure or refinance the bonds in the future.

36. Questions on Refundings • Is this a current or advance refunding? • Refunding bonds that occur more than 90 days prior to the call date are considered an “advance” refunding and are restricted from being advance refunding again. • How much in savings is being generated by the refunding? • The industry standard is to pursue refundings with at least 3% in savings (as a percentage of refunded par amount) net of upfront financing costs. A higher savings threshold can be established by the Board.

37. Questions on Interim Financings Why are we pursuing an interim financing? What are the alternatives to the proposed interim financing? How will this interim financing be repaid? What needs to happen in order for us to pay off this interim financing? If these events do not occur, what are our options?

38. Appendix B: Other Questionable and/or Controversial Practices

39. Aggressive AV Assumptions • Advantages of creating a rosy scenario. • Consequences of being wrong. • How to decide. • Who decides? • Understanding impact of Prop 13; • Over-reaction can go in both directions. • Consider de-linking tax base growth and escalation of debt service.

40. Forty-Year Bonds Matching repayment to useful life. Dangerous when used in combination with escalating debt service. 2009 change in the law. Prospective changes: AB 182.

41. Negotiated Sales • Negotiated and competitive sales. • What are the concerns? • Interest rate concerns. • Concerns about underwriting spread. • Other concerns. • Can an FA and/or the County Treasurer help? • Dodd-Frank changes.

42. Costs of Issuance • Value to having a team that understands your program. • How much are we talking about? • Factors that influence price. • CDIAC database - what do others pay on similar transactions? • Legal and reporting requirements.

43. Campaign Contributions • What do campaigns cost? • What are the critics concerned about? • Do disclosure rules solve the problem? • Competitive selection processes, limiting donations, and other solutions.

44. Free Campaigns • How does it work? • Are people still doing it? • Where do you draw the line? • Questions regarding fundamental election fairness, pay-to-play, and appropriate use of public funds.

45. Pre-Packaged Teams • Value of efficiency and simplicity. • Loss of independent voices. • The concept of co-marketing. • To what extent are these conflicts of interest inevitable?

46. Solar Financings • California school districts are good candidates for solar. • Solar financings can never guarantee savings over business as usual costs (which are inevitably unknown). • Temptation to prioritize shift from operational cost (general fund funded) to capital cost (bond funded). • Be careful about useful life issues. • Is there an advantage to phasing?

47. Technology Bonds • iPads for every student. • What does the law say? • Be VERY careful about useful life issues. • Are technology endowments the answer? • What about parcel tax revenues?

48. JPA Structures • Flexibility of JPA law. • Uses and abuses over time (cash-out refunding, double-your-money QSCBs, authorization to authorization cost shifting). • Discuss with independent third-parties. • Costs and benefits of court validation.

49. Underwriter Funded Costs of Issuance The history – par or better bids and bidder’s option insurance. The next phase – underwriter funded costs of issuance. California State Attorney General letter. Bond counsel opinion. Underwriter reaction.

50. Creative Uses of Bond Premium • Original issue premium – a bond concept. • Purchase premium – a well-defined figure with a (relatively) well-defined use. • What happens with the money in between the two? • Grey-area uses of received bond premium.