If Orange Unified voters approve Measure S this November, newly authorized bonds will be added to an already large district debt. A California Policy Center review of OUSD financial reports finds that the district owed $120 million to bond investors as of June 30, 2016.
The largest portion of OUSD’s bond obligations takes the form of an unusual OPEB bond. While many California public agencies have issued bonds to cover their pension obligations, few have borrowed to cover Other Post Employment Benefit obligations. OUSD is a pioneer in this area, but it is not clear whether innovation in OPEB funding is desirable.
In April 2008, OUSD’s board approved the issuance of a variable-rate bond to cover the district’s estimated $93.8 million OPEB obligation. The plan was to invest the proceeds into an actively managed portfolio of bonds and stocks. The bond proceeds and investment gains would be used to pay retiree healthcare expense, freeing the district’s general fund to cover educational expenses.
In May 2008, the district issued $94.8 million of “Index Rate Taxable Retirement Health Benefits Funding Bonds, Series A.” One million dollars of the bond proceeds went to various service providers including California Financial Services, who acted as the financial advisor on the deal for a fee of just over $450,000.
The remaining proceeds were invested in a vehicle called Futuris Public Entity Investment Trust, which is managed by Keenan & Associates. The investment got off to rocky start due to the Great Recession. In the fiscal year ending June 30, 2008, the trust lost $3.3 million; it shed another $7.3 million in the year ending June 30, 2009.
The investment losses exacerbated a fiscal crisis confronting OUSD at the time. The board engaged the state’s Fiscal Crisis and Management Assistance Team to assess district finances. In its report, FCMAT recommended that the board “seek advice from an independent investment advisor regarding strategies to address the decline in OPEB bond program asset values.”
It is not clear from board minutes whether this recommendation was followed, but the stock market rebound that started in 2009 raised the value of OUSD’s investments and relieved its fiscal distress. Last year, Standard and Poor’s upgraded the OPEB bonds from A+ to AA- citing the district’s “very strong available general fund reserves.” The district also benefited from its choice to issue variable rate bonds, with interest rates periodically reset based on changes in the London Interbank Offer Rate (LIBOR). Although banks attempted to manipulate LIBOR, it fell during the Recession and has remained low ever since. Consequently, debt service costs for the OPEB bonds have been lower than expected.
That said, it does not appear the bonds have provided the general fund relief originally intended. Each year the district pays about $2.9 million in debt service on the OPEB bonds, and it remains unclear whether the invested bond proceeds can shoulder the district’s mounting retiree healthcare costs. In some recent years, the district has transferred additional money into its Retiree Benefits Fund to support OPEB payments.
In addition to the $83 million still outstanding on the district’s OPEB bond, OUSD also owes $28 million on Certificates of Participation and $9 million on Capital Lease obligations. OUSD also has two Mello-Roos districts that have issued bonds. The $12 million in outstanding principal on these Mello-Roos bonds (issued by Community Facilities Districts 2005-1 and 2005-2) is technically not an obligation of the school district, but debt service payments are funded by taxes on certain homes within OUSD.
STANTON, Calif. – It was a Wednesday afternoon in early March, a more innocent time in Stanton, California. Gathered in the community center of the Plaza Pine Estates, we were like Adam and Eve in the Garden of Eden before they ate the apple that gave them a second-grader’s sense of good and evil.
Plaza Pine Estates is a well-manicured mobile home park so close to Beach Boulevard – the 26-mile state highway that functions as an asphalt riverbed moving automobiles between the foothills of inland Southern California and sprawling Huntington Beach State Park – that you can hear the dopplering traffic inside the community center.
That’s where Councilman David Shawver led a parade of public officials, including a county firefighter and two sheriff’s deputies, in a celebration of Stanton’s voter-approved hike in the city’s sales tax – from 8 to 9 percent, the highest in Orange County.
The so-called Talk with the Block series – there’ve been three-dozen so far, an official said – are supposed to be about community concerns. But at this one, at least, the communication was mostly one-way – what your computer scientists might describe as less input than output.
Speaker after speaker depicted that increase in the sales tax as the penny-thin line between civilization and chaos. And, in the end, the tax isn’t an ordinary tax, they said, but a “shared tax” – by which they apparently mean that the tax will hit residents as well as humans they called “outsiders.”
“The penny sales tax is a shared tax, a tax from people who drive through our community,” said Shawver. “They drive up and down Beach Boulevard, stop to get gas, and we get one penny. One penny! And thanks to that one little penny, we’ve been able to restore critical public safety assets.”
It also hits anyone who shops in Stanton, of course, though not (the officials stayed carefully on message) grocery and pharmaceuticals shoppers.
But it’s all for a good cause, Shawver said: public safety.
Stanton has a well-earned reputation for violence – it’s among the toughest towns in a county more famous for cat-fights among wealthy housewives than gunfights, gangs and prostitution.
“I’m not going to fool you,” said Shawver, a council veteran. “Public safety is expensive, but I am concerned with maintaining the level of service that you demand.”
Public safety in Stanton is indeed expensive – and getting pricier. This year, the city will pay an additional $1.1 million for public-safety, most of that the escalating cost of pay and benefits for its $220,000-per-year cops and firefighters. Those pay packages were negotiated by the powerful sheriffs and firefighters unions – the same unions that backed Shawver’s 2014 sales tax hike.
If it weren’t for a few lousy public investments over the last several decades, the city might be able to pay its sheriffs and firefighters even at that stratospheric level. But Shawver was among those on the city council who approved Stanton’s play in Vegas-style redevelopment schemes until Gov. Jerry Brown killed them in 2011. Stanton, Orange County’s poorest city, now pays millions on bonds to hold property it purchased while betting on its steady appreciation. Interest payments this year alone: $2,323,887. Unless the city refinances that debt, it’ll pay $42 million in interest by 2040.
And there’s bad news just ahead for Shawver and other Stanton officials. Residents qualified a tax repeal for the November ballot; if successful, that’ll put a ding in the city’s income statement. So will the steady rise in the cost of cops and firefighters: Thanks to more rigorous accounting (and the reporting of the Orange County Register’s Teri Sforza), Orange Countians recently learned for the first time that the Fire Authority is actually running in the red, with deficits – especially for retirement pay and other health benefits – exceeding assets by $169 million for the fiscal year that ended in June.
That has other cities so enraged, they’re talking about leaving the authority and even privatizing firefighting.
But not Shawver. When it comes to the county’s sheriffs and firefighters, “There are no finer government agencies,” he asserted.
We might have believed that in a more innocent time, before the Talk With the Block. But later that night, we discovered that Shawver, a 28-year veteran of Stanton’s redevelopment fiascos, has served for 21 years as his city’s representative on the board of the Orange County Fire Authority.
This is the second of an occasional series of posts on municipal bond issuance costs. You can see the first one, focusing on Fullerton, here.
In a recent study of 800 municipal bond issues for UC Berkeley, I found that issuance costs varied widely – from less than 0.2% of face value to over 10%. Issuance costs are to local governments like points are to a consumer taking out a home mortgage. In both cases, the goal should normally be to minimize them. While consumers have many forums to compare against and thus reduce financing costs, local government officials have been less fortunate – but that situation is starting to change.
Aside from publishing the study, I also released a data set showing each bond’s total issuance costs – as shown on Official Statements – and itemized details for a sub-sample of the bonds. My group obtained these details by sending Public Records Act or Freedom of Information Act requests to local government bond issuers. We found that the largest components of issuance costs were underwriting expenses, legal fees, financial adviser expenses, rating agency fees and bond insurance premiums.
While my study provides data for a nationwide sample of bonds, the California State Treasurer’s Office has now posted issuance cost details for all municipal bonds issued in the Golden State. This impressive data set can be found here. The data were collected by the California Debt and Investment Advisory Commission (CDIAC), a unit of the State Treasurer’s Office. Under state law, California local governments must report their debt data to CDIAC. The commission had been publishing some of this data, but Treasurer John Chiang, an advocate for transparency, recently decided to publish everything, including details on issuance costs.
Issuance Costs often > 10%
A review of the California data shows numerous issuance cost ratios in excess of 10% of the issued amount – and even some exceeding 20%. Just like a consumer would never pay 20 points on a home mortgage, it is hard to understand why a bond issuer would do the same.
Many of the higher issuance cost levels were associated with small bond issues from rural school districts and special districts. Since some of the issuance costs don’t vary with issuance size, they can hit small issuers relatively hard. Further, small issuers often receive lower bond ratings, creating the necessity to purchase municipal bond insurance. However, bond insurance was not a factor in a couple of the 20%+ cost of issuance situations I found in the CDIAC data.
In 2013, San Jacinto special districts (called Community Facilities Districts) issued two special tax bonds totaling $985,000 and $925,000 respectively. In each case, costs of issuance exceeded 20%.
Focusing on the $925,000 bond, we find that the district received a mere $532,066 of the bond proceeds (see the Official Statement). The Estimated Sources and Uses of Funds on page 6 of the document, show $90,428 being deposited into a reserve fund and a total of $295,890 going to the underwriter and other service providers. The remaining $6,616 reflected an original issue discount, arising from the bonds being sold below face value.
The debt service schedule on page 10 of the Official Statement shows that the district will spend $1,240,252 of interest on the $925,000 of bonds through 2043. Total debt service of $2,165,252 over the life of the bond issue is four times the net proceeds received by the district. All in all, not a great deal for San Jacinto’s taxpayers.
In response to a public records request, San Jacinto Unified School District provided an itemized listing of the issuance expenses aside from the underwriter’s fee which is reproduced below. The underwriter on the deal, Stifel Nicolaus and Company, received $35,890.
I would welcome insight from industry experts on these costs either in the comments section below or by email at email@example.com.