Financing with Bonds

1. Financing with Bonds 2007 IASBO ANNUAL CONFERENCE

2. GKST Public FinancePublic Education Group Name Telephone e-mail Jamie Rachlin (312) 441-2601 jnrachlin@gkst.com Tim King (217) 762-4578 tim.king@gkst.com Todd McDonald (217) 762-4579 todd.mcdonald@gkst.com

3. Debt financing for schools is broad and complex. This overview has been assembled to summarize school borrowing for novice School Finance managers. This document will look at: • Common reasons for issuing bonds • Sources of bonding authority • Referendum, backdoor referendum or non-referendum processes • Types of school bonds • The Property Tax Extension Limitation Act and the Debt Service Extension Base • How much a District can borrow and repayment structures

4. WHY DO DISTRICTS BORROW MONEY? • Don’t have cash to pay project cost • Tax caps limit ability to raise cash • Reduce tax burden on current residents • Spread project cost over its useful life

5. WHERE DOES AUTHORITY TO BORROW COME FROM? • Federal Law • Ability to issue tax-exempt bonds • Legal use of proceeds • Repayment requirements • State Law • Borrowing options • Steps required to borrow • Parameters for repayment

6. WHAT DO DISTRICTS BORROW FOR?

7. PRIMARY TYPES OF SCHOOL BONDS • Debt Certificates: a hybrid lease/installment purchase contract type of instrument that allows a school district to incur debt for tangible items. • Alternate Revenue Bonds: these are general obligation bonds that are payable from a specified source but have a general obligation backup. The revenue source must offer debt service coverage of 1.25x. Sometimes called a “double barreled bond”. • Non-voted General Obligation Bonds. For capped districts, these must be paid from the DSEB and are called a “Limited Tax Bond”. • Life/Safety Bonds: these are bonds that specifically fund Health/Life and Safety to a school building pursuant to a State Order. • Working Cash. Subject to formula test to determine the maximum authorized amount. • Funding Bonds: wide range of uses, from paying ongoing expenses of the district to funding new construction. • Voted General Obligation Bonds: for any valid voted purpose, payable from a property tax levy. • Notes and Warrants: Short-term to cover cash flow shortfalls.

8. Non-Referendum • No referendum required if State Orders the sale of bonds (e.g. Fire Protection Health/Life Safety) • No referendum required if bonds are payable from operations (e.g. Debt Certificates) • Referendum • A simple majority vote in a general election, generally used for major renovations or stand alone building projects. • Backdoor Referendum • When required by law (e.g. Working Cash Bonds, Funding Bonds, Alternate Revenue Bonds) • Board resolution determines to commence process • Noticed published in local paper gives residents 30 days to petition against bonds • Petition must be signed by, in general, 10% of the district’s registered voters or bonds can be issued

9. BORROWING OPTIONS UNIVERSE FOR ILLINOIS SCHOOLS *Note that schools can vote authority to sell bonds for a legal purpose.

10. HOW MUCH CAN THE DISTRICT BORROW? • Indebtedness limitations • Referendum/Ordinance • Debt Service Extension Base • Working cash formula (Federal restrictions, too)

11. INDEBTEDNESS LIMITATIONS • School Districts Maintaining K-8 or 9-12 • Indebtedness may not exceed, for any purpose or by • any amount, 6.9% of value of taxable property. • School Districts Maintaining K-12 • Indebtedness may not exceed, for any purpose or by • any amount, 13.8% of value of taxable property. • Exceptions: • Rapidly growing districts • Financially distressed districts.

12. DEBT SERVICE EXTENSION BASE (DSEB) Where a district is in a tax capped county, the Property Tax Limitation Law applies and imposes restrictions on borrowing by limiting a District’s authority to levy for non-voted general obligation bond as follows: Debt Service Extension Base (DSEB) is the annual principal and interest allowed by law that can be levied for limited tax bonds in capped counties. It is based on the non-referendum debt levy of the district in the year in which caps were legislated or voted. • For Capped Districts Only • The annual levy for non-voted general obligation bonds is limited to the District’s DSEB. • In the case of Cook and Collar Counties, the DSEB is the 1994 levy, while the Downstate Counties are restricted to their levy at time cap is voted. • Those with no non-voted general obligation bonds outstanding • when capped have no DSEB.

13. WORKING CASH FUND FORMULA Authorized Amount: Working Cash Fund Bonds (“WCF Bonds”) are issued for the purpose of creating or increasing a working cash fund. The amount can be issued is subject to the following formula: (.85 x Educational Fund Levy) + (.85 x Personal Property Replacement Tax Entitlement) - WCF Bonds Outstanding - or - Balance of WCF Whichever is the greater amount.

14. HOW MUCH DO YOU NEED TO BORROW? Start With: Needs to be funded Add: Costs of Issuance Insurance Capitalized Interest Contingency (discount on bonds) Subtract: Interest on proceeds Equals: Total Borrowing Need The District must account for many expenses and revenues besides the project to be funded.

15. HOW MUCH DO YOU WANT / ARE YOU ABLE TO PAY? • Sources of funds for debt service (Unlimited Tax General • Obligation versus Lease or Revenue) • Future needs • Dollar amount versus levy rate • Political considerations • Capped districts: Difference between DSEB and outstanding • debt service There are both legal and practical restrictions on how much annual debt service the District will pay.

16. COMING UP WITH A DEBT REPAYMENT STRUCTURE Much like a mortgage, bonds are repaid over time. The District has some flexibility to decide how quickly to repay its bonds*. Some considerations would be: • Level levy versus level debt: If the district is expecting significant growth, it may want to shift the cost of debt service to future residents. Structuring the bonds with an estimated level levy results in increasing debt service over time, thereby shifting more of the cost of borrowing to future residents. • Shorter versus longer repayment: Lengthening the repayment period lowers the annual debt service but raises the total interest costs. In general, a district would want to match the life of the asset it is purchasing to the repayment schedule. • Shaping around outstanding debt: When a longer repayment period is appropriate and desirable the District can further delay repayment of principal until existing bonds are paid off. By paying interest only on bonds for a period, a district can minimize the increase in its debt levy.

17. Structuring Examples 14cents 11cents 41cents 3cents 22cents 14cents

18. Is Borrowing GOOD or BAD?

19. It Depends! • Why are you borrowing? • Is there an ability to repay the debt? • Does borrowing reduce or enhance future flexibility? • How much does it cost to borrow?

20. WHAT ARE PREMIUM BONDS? • Bonds with a high coupon, sold for more than face value (par) • Investor yield requirement is 4.0% • Stated interest rate is 5.0% • Bond has additional value due to interest rate, so investor pays more for it. Premium can allow fewer bonds to be issued to fund a given project, or to generate additional proceeds when bond size is capped.

21. WHY ARE PREMIUM BONDS USED? • By Investors • Less sensitive to interest rate fluctuations • Increased cash flow in low yield environments • By Issuers • Cover cost overruns • Deal with debt limitations • Deal with debt limitations, cover cost overruns and defer debt service simultaneously (Premium CABs) Investors generally seek small amounts of premium, while issuers may require substantial amounts well in excess of market norms.

22. HOW MAY PREMIUM BONDS HURT? • Callable premium bonds – Investors only pay the premium through the call date. If the bonds aren’t called, the yield will be higher. If the bonds are refunded, there are additional costs of issuance. • Super-premium bonds – If issued to accomplish a larger project than originally planned, debt service will exceed original projections. Understand why premium bonds are being used and determine whether there has been proper communication to the Board and community.