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How California School and College Districts Acquire and Manage Debt (Section 4 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
You are here: How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


How Educational Districts Acquire and Manage Debt 

It’s likely that most California voters have limited familiarity with the organization and governance of their local school and community college districts. When voters authorize their local educational districts to borrow money for construction by selling bonds, presumably they trust that the local school or college district will exercise prudence in managing the process.

Sometimes their trust is betrayed.

To discourage abuse of the school construction finance system, voters need to be aware of how their local government is organized and managed. They also need to realize that state law does not explicitly give Independent Citizens’ Bond Oversight Committees broad authority to review construction programs funded by bond measures.

How can voters become informed about bonds and the process of borrowing money for educational construction through bond sales? Is there a way to explain in clear plain language what actually happens after voters approve a bond measure and authorize a school or college district to borrow money via bond sales?

Bonds Help Local Governments Borrow Money to Better Serve the People

When people talk about municipal securities or municipal bonds, they’re talking about state governments or local governments borrowing money from investors with the promise to pay it back to them later, with interest. Municipal (derived from the Latin word municipium, meaning a free city) simply means a local government, such as a county, city, water district, sanitation district, irrigation district, utility district, transportation district, cemetery district, mosquito vector district, and many other kinds of special districts formed by the people to serve the people. And it includes school districts and community college districts.

Despite a lack of public attention to bonds, this method of debt finance is important, especially for governments such as California’s school districts and community college districts that want to initiate or continue major construction programs. U.S. Securities and Exchange Commissioner Luis A. Aguilar recently described the importance of municipal bonds:

It is difficult to overstate the importance of the municipal securities market. There is perhaps no other market that so profoundly influences the quality of our daily lives. Municipal securities provide financing to build and maintain schools, hospitals, and utilities, as well as the roads and other basic infrastructure that enable our economy to flourish. Municipal bonds’ tax-free status also makes them an important investment vehicle for individual investors, particularly retirees. Ensuring the existence of a vibrant and efficient municipal bond market is essential, particularly at a time when state and local government budgets remain stretched.

Such comments are appreciated by state and local governments as murmuring continues in Washington, D.C. that income from municipal bonds should lose tax-exempt status.

Basic Information About California K-12 School Districts

In the case of a local elementary school district (kindergarten though eighth grade), high school district (ninth through twelfth grade), or unified school district (kindergarten through twelfth grades), voters elect a board of trustees (often called a “school board” or a “board of education”) to oversee operations of the school district and make major decisions as representatives of the people. The board appoints a District Superintendent and other professional administrators to handle day-to-day management of the district.

In addition, each county has an elected County Board of Education and an elected County Superintendent of Schools with specific responsibilities. There is also a State Board of Education appointed by state elected officials to oversee education policies that are common for all school districts in the state. There is also a State Superintendent of Schools elected by the people of California.

Table A-1 (“California K-12 School Districts 2013-2014 – Ranked by Enrollment”) lists 945 elementary school districts, high school districts, and unified school districts with enrollment tracked by the California Department of Education as of June 15, 2015.

Basic Information About California Community College Districts

In the case of a local community college district, voters elect a Board of Trustees (often called a “college board” or a “governing board”) to make decisions for the college district as representatives of the people. There is also a Board of Governors of the California Community Colleges appointed by state elected officials to oversee education policies that are common for all college districts in the state. The Board of Governors appoints a Chancellor of the California Community Colleges and other professional administrators to handle day-to-day management of the state college system.

Boards for the University of California and California State University systems are appointed by state elected officials and not directly chosen by the people.

As of June 15, 2015 there are 72 community college districts in California with 112 colleges. (Some districts contain multiple colleges.) Table A-2 (“California Community College District Enrollment Fall 2014 – Ranked by Number of Students”) lists these districts.

What Are the Independent Citizens’ Bond Oversight Committees? 

To strengthen the arguments for Proposition 39 in 2000, the California legislature passed Assembly Bill 1908, the “Strict Accountability in Local School Construction Bonds Act of 2000,” with these stated intentions:

  1. Vigorous efforts will be undertaken to ensure that school and college districts spend the proceeds of bond measures, including those passed under criteria of Proposition 39, in strict conformity to law.
  2. Taxpayers will directly participate in the oversight of bond expenditures.
  3. Members of the oversight committees appointed for these purposes will promptly alert the public to any waste or improper spending of money borrowed through bond sales.
  4. Unauthorized expenditures of school construction bond revenues will be vigorously investigated, prosecuted, and restrained by the courts.

A school or college district board must appoint an independent citizens’ bond oversight committee with 60 days after the board enters the election results in its minutes. The committee must include at least seven members to serve for a term of two years and for no more than two consecutive terms. District employees, officials, vendors, contractors, or consultants are prohibited from serving on the committee, and it must include at least one “active” representative of the following groups:

  1. a business organization, located within the district, representing the business community
  2. a senior citizens’ organization
  3. a bona fide taxpayers’ organization
  4. for a school district: parents or guardians of children enrolled in the district
  5. for a school district: parents or guardians of children enrolled in the district who are also active in a parent-teacher organization, such as the Parent Teacher Association or school site council
  6. for a community college district: students who are currently enrolled in the district and also active in a community college group, such as student government
  7. for a community college district: organizational support groups of the district, such as advisory councils or foundations

These committees have several responsibilities listed in state law meant to ensure the district spends bond proceeds only on projects listed in the ballot statement and avoids spending bond proceeds on ineligible projects, programs, or “teacher or administrative salaries or other school operating expenses.” State law also assigns these committees to review “efforts by the school district or community college district to maximize bond revenues by implementing cost-saving measures.”

The committee does NOT have a explicit oversight role for how the district pays for these construction projects, and a narrow interpretation of the law could claim that oversight committees do not have legal authority to review bond sales. However, the California League of Bond Oversight Committees (CalBOC) believes these committees have the authority to review and comment on the structure of bond issues under the provisions for reviewing “cost-savings” measures. Districts often defer to legal counsel for interpretations of the responsibilities and limitations of oversight committees.

A Private Organization Has Taken Responsibility for Independent Citizens’ Bond Oversight Committees

Currently a private organization is providing services and advice to oversight committees. The California League of Bond Oversight Committees (CalBOC), founded in 2006, is a non-profit public service organization that filled a need for training, education, and legislative advocacy for the state’s bond oversight committees.

This arrangement has shortcomings. A private organization is dependent on voluntary financial contributions and a committed volunteer leadership, and it lacks power to take action against educational districts that fail to comply with state laws. Membership and involvement is dependent on the motivations and self-initiative of individual bond oversight committee members. CalBOC does not have any professional staff to monitor districts, collect data, and provide it to the public.

In addition, school districts can discourage oversight committee members from participating in the California League of Bond Oversight Committees, and some school district administrators openly disparage it. Some district administrators and legal counsel don’t want oversight committees interpreting their purpose broadly and consuming district staff time and district funds on investigations outside of a narrowly-defined purview.

The author of this report has been and continues to be a member of the Advisory Committee for the California League of Bond Oversight Committees (CalBOC).

Translating School Finance Decisions For Ordinary People to Understand

For many Americans, the phrase “stocks and bonds” evokes the image of an established and wealthy investor. Someone who buys a stock becomes an owner of a corporation, and someone who buys a bond becomes a creditor who is owed money by a corporation or a government. It’s likely that more Americans could explain stocks than could explain bonds.

The lack of public awareness or knowledge about bonds may be attributable to the complex provisions of certain bonds and the fact that bonds typically do not offer the very large potential returns offered by equity in growing firms.

Bonds rarely get news media attention outside of a few financial wire services such as Bloomberg, Reuters (which had a “MuniLand” blogger), and specialty publications such as The Bond Buyer. And in popular culture, depictions of bond brokers have been mainly limited to two books by Tom Wolfe: The Bonfire of the Vanities (subsequently made into a movie) and I am Charlotte Simmons.

What Is a Bond?

Some technical definitions of a bond are listed in Table 10. But rather than focusing on the definition of a bond, Californians need to focus on what a bond does in practice.

For a school or community college district, issuing (“selling”) bonds means the district borrows money for a specific length of time from investors with the obligation to return all of that money to them when that time period ends. The amount borrowed is called the principal.

During that length of time the district pays a fee to the investors, either on a regular basis (for Current Interest Bonds) or accumulated with compounded interest at the end of the time period (for Capital Appreciation Bonds). The amount paid is called interest.

The term of maturity between borrowing the money and paying back the money with interest can be one to three years (short-term bonds) or decades (long-term bonds). Under California law, a school district or community college district cannot issue a current interest bond with a maturity over 40 years. As a result of Assembly Bill 182 enacted in 2013, California local governments are now prohibited from issuing Capital Appreciation Bonds with a maturity over 30 years.

AB 182 allows a school district or community college district to issue Current Interest Bonds bonds with a term of maturity between 30 and 40 years. The district must use that borrowed money for projects with a “useful life” that equals or exceeds the term of maturity.

What Are “General Obligation Bonds” Referenced in Ballot Language for Bond Measures?

Corporations and state and local governments issue bonds to raise money. Bonds sold by local governments are called municipal bonds. An appealing aspect of many municipal bonds for investors is their tax-exempt status.

Municipal bonds such as those sold by California school districts and community college districts for construction are called general obligation bonds, meaning they are backed by the “full faith and credit” of the districts. These districts theoretically have legislative power to collect enough money through property taxes, other borrowing, selling assets, or other sources of revenue to fulfill their obligation to make payments on the bonds when due. Those taxes are collected from property owners in the district. (Revenue bonds are another kind of municipal bond, paid off through tolls, lease payments, user fees, or other service payments.)

Comparing Current Interest Bonds to Capital Appreciation Bonds

When voters are asked at an election to approve a bond measure to pay for construction at a school district or community college district, they generally have been told that a “Yes” vote will authorize the sale of general obligation bonds to fund that construction.

California educational districts are issuing two kinds of general obligation bonds: Current Interest Bonds and Capital Appreciation Bonds. Usually the district does not tell voters what kind of general obligation bonds it will sell, unless it specifically passes a resolution before the election stating it will not sell Capital Appreciation Bonds and includes that condition in the ballot statement.

1. Current Interest Bonds (also called Fixed Rate Bonds)

These are the “traditional” kind of municipal bonds. A buyer of Current Interest Bonds gets a periodic interest payment (usually semi-annually). When the bond matures, the buyer gets the principal back.

2. Capital Appreciation Bonds (also called Zero Coupon Bonds)

A buyer of Capital Appreciation Bonds does not receive semiannual or other periodic interest payments. Instead, the buyer receives all of the interest – compounded over the length of maturity for the bond – together with the principal when the bond matures. There is no regular payment of interest, but the accumulated (“accreted”) interest is compounded over many years, making the wait a worthwhile investment. Capital Appreciation Bonds are purchased at a deeply discounted amount from their face value.

Capital Appreciation Bonds are discussed in more detail in Section 5.

Two Costs to Educational Districts of Borrowing Money Via Bonds

From the perspective of the school district, the additional financial cost of borrowing money by selling bonds as opposed to spending money from the district general fund results from (1) interest and (2) transaction fees.

Interest

If someone borrows $1000 for five years from a lender at an annual interest rate of 5 percent, the borrower and the lender agree that the borrower will pay back the $1000 over five years and also pay 5% of that $1000 ($50) multiplied by five years for a total of $1250. The borrower gets the $1000 immediately to use, and the lender earns annual interest income of $50 over five years for a total of $250. Both parties consider themselves to get a benefit from the transaction.

Likewise, if a school district issues a traditional $1000 Current Interest Bond at an annual interest rate of 5 percent with a five-year term of maturity and an investor buys the bond at its face value of $1000, the school district gets the $1000 immediately to use for construction, and the investor earns annual interest income of $50 over five years for a total of $250. When the five years are over, the investor gets the $1000 back. Both parties get a benefit from the transaction. In addition, the investor does not have to pay taxes on the interest.

School districts usually sell series of bonds as a package with different maturities and interest rates.

Transaction Fees (Issuance Fees)

Bond buyers are not the only party to make money from bonds issued by California school districts and community college districts. Similar to taking out a mortgage, a variety of parties in the financial services industry are involved in the preparation and sale of bonds, and each party gets a fee for participating in the transaction. These fees are classified as “costs of issuance.”

To prevent these fees from cutting into the amount of money authorized by voters for construction, educational districts routinely inflate the interest rates on bonds they sell so that the price is higher than the face value of the bond. After the bonds are sold, that extra money, or “premium,” is used to pay the costs of issuance.

Table 8: Types of Issuance Fees
underwriter’s discount
bond counsel fees
disclosure counsel fees
paying agent fees
escrow agent fees
rating agency fees
bond insurance fees
verification agent fees
financial advisor fees
printing fees
other miscellaneous expenses

How are Municipal Bonds Bought and Sold? Who Buys Them?

Municipal bonds are not traded on an exchange like stocks. Instead, investors buy and sell bonds “over the counter” through dealers and brokers registered with the Municipal Securities Rulemaking Board (MSRB), a self-regulatory organization overseen by the U.S. Securities and Exchange Commission. These dealers and brokers act as underwriters or intermediaries between issuers and investors. They charge fees, or “mark-ups” for the transactions.

Once a school district sells a bond, the bond can be traded in the municipal bond market. The price will fluctuate and investors will be concerned about yield — the amount of income earned as prices rise and fall.

According to Federal Reserve statistics, individual investors hold a little more than two-thirds of municipal bonds, about 42 percent directly and about 28 percent through mutual funds and other investment vehicles. Major institutional investors include asset management firms, insurance companies, and commercial banks.

One of the arguments to cap or eliminate the federal tax exemption for income from municipal bonds is that the exemption mainly benefits wealthy individuals who buy bonds as a tax-exempt investment. Buyers of municipal bonds do not generally “keep the money in the community” because they aren’t in the community. And they generally do not buy bonds issued by educational districts to “help the children” or “provide vocational training to veterans.” They buy them to make money.

Ironically, the same Progressive activists who call for higher taxes on the rich also tend to support educational bond measures that help the rich to earn investment income that is tax-free. Forcing the rich to pay taxes on income earned through municipal bonds could collapse the demand for these bonds and make borrowing money for construction a much more expensive proposition for school and college districts.

Table 9: Some Advantages for Investors in Municipal Bonds
Interest earned on municipal bonds is usually exempt from federal and state income tax.
In the case of general obligation bonds, principal and interest are secured by the full faith and credit of the issuer and usually supported by either the issuer’s taxing power. Despite negative nationwide publicity about a relatively small number of bankrupt local governments (such as the California cities of Vallejo, Stockton, and San Bernardino), a government defaulting on municipal bonds is “extremely infrequent,” according to Moody’s. They are thus a relatively safe investment.
In the case of Current Interest Bonds, investors get a regular interest payment, usually semi-annually. There is a regular, dependable income stream.
In the case of Capital Appreciation Bonds, investors can earn a substantial amount of interest over a long period of time through compounding while still enjoying the relatively safe investment of general obligation bonds.

How Does an Educational District Pay Back the Borrowed Principal Plus Interest on Bond Sales?

People pay back the principal and interest on car loans, school loans, and mortgages using their income. Educational districts pay back the principal and interest on bonds using their “income,” that is, taxes collected from property owners in the district.

After a school district or community college district borrows money by selling bonds for construction, it informs the county auditor and county treasurer/tax collector. Based on the assessments of property value determined by the county assessor, the county treasurer calculates the appropriate tax rate and generates individual tax bills for owners of property such as houses, farms, apartment buildings, commercial buildings, manufacturing facilities, business infrastructure, and undeveloped land. A specific rate and tax for each bond measure is listed on the tax bill.

These taxes are called ad valorem taxes. Ad valorem is Latin for “according to worth” and indicates that taxes are levied (imposed) on property owners in proportion to the assessed value of their property.

Does Renting or Leasing Mean That You Don’t Pay for Educational Construction or the Cost of Borrowing Money for It?

Households that rent property or businesses that lease property do not pay property taxes directly. However, it is not true to claim or think that renters or lessees don’t have to pay for educational construction and the costs of borrowing money to pay for that educational construction. Property owners can and do incorporate the cost of their property taxes into their rents or leases. Bond sales by a school or college district may result in higher rent.

Technical Definitions of Bonds

Notice that the common term in all of these definitions is debt. When a school or college district sells bonds, it borrows money from investors and must pay them the money back over time, with interest.

Table 10: Technical Definitions of Bonds
SourceDefinition
California Education Code Section 15140.5 (added to law by Assembly Bill 182 in 2013)Evidence of indebtedness payable, both principal and interest, from the proceeds of ad valorem property taxes that may be levied without limitation as to rate or amount upon property subject to taxation by the governing board of the school district or community college district.
Glossary on the Municipal Securities Rulemaking Board (MSRB) websiteThe written evidence of debt, which upon presentation entitles the bondholder or owner to a fixed sum of money plus interest. The debt bears a stated rate(s) of interest or states a formula for determining that rate and matures on a date certain.
U.S. Securities and Exchange Commission website definition of municipal bondsDebt securities issued by states, cities, counties and other governmental entities to finance capital projects, such as building schools, highways or sewer systems, and to fund day-to-day obligations. Investors who buy municipal bonds are in effect lending money to the bond issuer in exchange for a promise of regular interest payments, usually semi-annually, and the return of the original investment, or “principal.” The date when the issuer repays the principal, the bond’s maturity date, may be years in the future. Short-term bonds mature in one to three years, while long-term bonds generally will not mature for more than a decade. 
Internal Revenue Service Tax-Exempt Governmental Bonds Compliance Guide description of municipal bondsTax-exempt bonds are valid debt obligations of state and local governments, commonly referred to as “issuers” - the interest on which is tax-exempt. This means that the interest paid to bondholders is not includable in their gross income for federal income tax purposes. This tax-exempt status remains throughout the life of the bonds provided that all applicable federal tax laws are satisfied…Governmental bonds are tax-exempt bonds issued by a state or local government, the proceeds of which are generally used to finance activities or facilities owned, operated, or used by that or another government for its own purposes. This can include financing the building, maintenance, or repair of various types of public infrastructure such as highways, schools, fire stations, libraries, or other types of municipal facilities.

Sources

“Statement on Making the Municipal Securities Market More Transparent, Liquid, and Fair,,” U.S. Securities and Exchange Commission, February 13, 2015, accessed June 28, 2015, www.sec.gov/news/statement/making-municipal-securities-market-more-transparent-liquid-fair.html

“Letters to Congress/Administration,” National Association of Bond Lawyers, accessed June 28, 2015, http://registration.nabl.org/about/Governmental-Affairs/Tax-Reform-Resources/Letters-to-Congress-Administration.html

California League of Bond Oversight Committees (CalBOC) www.calboc.org

Reuters “MuniLand” blogger Cate Long blogs.reuters.com/muniland/

The Bond Buyer www.bondbuyer.com

Municipal Securities Rulemaking Board (MSRB) www.msrb.org

Board of Governors of the Federal Reserve System – Data Releases, June 11, 2015, accessed June 28, 2015, www.federalreserve.gov/releases/z1/current/z1r-4.pdf

Capital Appreciation Bonds: Disturbing Repayment Terms (Section 5 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
You are here: Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Capital Appreciation Bonds: Disturbing Repayment Terms

In 1993, California law was changed so that school and college districts could use an innovative form of debt finance called zero-coupon bonds, also known as Capital Appreciation Bonds. These bonds allow school and college districts to borrow now for construction and pay it back — with compounded interest — many years later. The borrowing strategy has been a tempting and dangerous lure for elected school and college boards.

Some people think Capital Appreciation Bonds are a “ticking time bomb” or the “creation of a toxic waste dump.” Others regard critics as uninformed and contend that these debt finance instruments are beneficial for school and college districts. Since the people who will be paying off many of these Capital Appreciation Bonds are now children or not even born yet, there isn’t much incentive to stop the flow of borrowed money that doesn’t need to be paid back for a generation or two.

Capital Appreciation Bonds Get Attention: Some Welcomed It, Some Didn’t

There was a brief time in the last half of 2012 when California news media and even national news media alerted the public to a neglected but long-festering problem involving municipal bonds sold by many California school districts and community college districts. These educational districts chose to borrow money for construction using an unconventional debt finance instrument called a Capital Appreciation Bond.

Capital Appreciation Bonds allow school and college districts to circumvent state laws that limit taxes and debt relative to the total value of property in the districts. But they also subject future generations of Californians to potentially burdensome taxes and debt.

Explaining and Contrasting Current Interest Bonds and Capital Appreciation Bonds

The traditional Current Interest Bonds (also called Fixed Rate Bonds) are relatively easy to understand. If someone buys a Current Interest Bond and holds it until it matures (reaches the end of its time period for borrowing), that buyer receives interest on a regular basis (usually semi-annually). The buyer gets the original principal paid back when the bond reaches the end of its term of maturity.

Here’s an example of how a Current Interest Bond works:

  • An entity buys a $1000 Current Interest Bond issued by a school district at face value (also known as par value) with a 25-year term to maturity at a 2.5 percent interest rate.
  • Each year, for 25 years, the buyer gets $25 in interest from the school district, because 2.5% of $1000 is $25.
  • When the bond matures, the buyer gets the principal of $1000 back from the school district.
  • The total interest earned over 25 years is $625, because $25 times 25 is $625.
  • Although the $625 is income, the buyer will never have to pay tax on that interest if the bond is tax-exempt, as is typical with municipal bonds.

Obviously the school district must levy taxes on property owners each year throughout the 25-year term to maturity so that it has enough money to pay interest each year (and ultimately pay back the principal at the maturity date).

Capital Appreciation Bonds (also called Zero Coupon Bonds) are more difficult to understand. Someone who buys a Capital Appreciation Bond pays for it at a price deeply discounted from the face value (par value) of the bond. The buyer does not receive interest payments until the bond reaches maturity, at which point the buyer is paid the face value of the bond, which is the deeply-discounted price (the principal) plus all of the interest earned during the term to maturity.

During the term to maturity period of the Capital Appreciation Bond, interest accumulates over time. The interest is compounded, meaning interest for a time period is earned on the original amount of money and also earned on any of the interest that has already been accumulated up to that time period.

Compound interest that accumulates as a Capital Appreciation Bond grows in value is called “accreted interest.” “Accreted” (a word derived from the Latin accrescere, to increase) means accumulated over time.

Here’s an example of how a Capital Appreciation Bond works:

  • An entity buys a $5000 Capital Appreciation Bond with a 25-year term to maturity at an interest rate of 5 percent.
  • The discounted price of the bond is $1477.
  • When the bond matures, the buyer gets $5000 back from the school district.
  • The total earned over 25 years is $3,523.
  • Although the $3,523 is income, the buyer will never have to pay tax on that interest if the bond is tax-exempt, as is typical with municipal bonds.

The school district benefits because for many years it does not need to levy taxes on property owners in order to make interest payments. It can borrow much more money through bond sales without being restricted by tax and debt limits established in state law. The community can enjoy the benefits of the bond sales without having to pay for them — at least for a while.

And although the buyer does not get a regular interest payment, the accumulated (“accreted”) interest is compounded over many years, making the wait a worthwhile investment. The cliché about “the power of compound interest” for an investor is accurate.

Why Did Capital Appreciation Bonds Become Popular?

The public first became aware of Capital Appreciation Bonds in 2012 when news media reported on a 2011 debt financing arrangement at the Poway Unified School District. Most reports insinuated that limits on taxes and debt established by the legislature in 2000 in conjunction with Proposition 39 had forced schools and community colleges to borrow money by selling Capital Appreciation Bonds. Allegedly these limits were constraining school and college districts from implementing necessary construction programs at a time of plummeting property values. Educational districts saw Capital Appreciation Bonds as the only debt financing option available to alleviate school overcrowding and ensure children’s safety.

But in reality, Capital Appreciation Bonds have been a component of bond issues by California educational districts for over twenty years. Signed into law in 1993, Senate Bill 872 authorized school and college districts to sell them. Voters in the Windsor Unified School District approved a bond measure on April 12, 1994, and the district proceeded to sell $5,054,761 in Capital Appreciation Bonds in its first series of bond sales. The Old Adobe Unified School District and the Oakland Unified School District soon followed.

Capital Appreciation Bond Origins

The first sentence in a 1982 article in the New York Times declared, “Give Wall Street a headache like double-digit interest rates, and someone will invent an aspirin like the zero-coupon bond.” According to this article, in 1981 J.C. Penney became the first corporation to issue Capital Appreciation Bonds. In 1982, E.F. Hutton became the first bond broker to underwrite Capital Appreciation Bonds for municipal governments.

A survey of news coverage on Capital Appreciation Bonds during the 1980s reveals that the focus of journalistic concern for this new form of municipal debt finance was the risk to investors. Needless to say, Capital Appreciation Bonds endured past the era of high interest rates, and the aspirin for investors became a headache for taxpayers.

Who Buys Capital Appreciation Bonds?

Capital Appreciation Bonds are not necessarily a wise decision for an investor, so who sees an investment advantage in buying them? James Estes, Professor of Finance at California State University, San Bernardino tried to answer this question and reported the results of his investigation in a 2013 paper. After observing that Charles Schwab & Co, Inc. does not offer or sell Capital Appreciation Bonds, he contacted twelve companies that offer municipal bond funds. All twelve claimed they don’t market funds featuring Capital Appreciation Bonds. Company representatives told Estes that Capital Appreciation Bonds were undesirable to their investors because of their lack of current interest payments, their poor yield, and their high risk.

Estes also investigated rumors on the web that CalPERS might be holding many municipal Capital Appreciation Bonds. CalPERS spokesperson Danny Brown denied that CalPERS holds them and cited their risk. Finally, Estes mentions the claim of a finance reporter that international banks hold Capital Appreciation Bonds in a trust administered by Bank of America.

In response to a Twitter inquiry from the author of this report, a former reporter for Voice of San Diego tweeted that he never learned who held the district’s Capital Appreciation Bonds during his 2½ years reporting on Poway Unified School District’s Capital Appreciation Bond fiasco: “The word was that the debt had likely been sold and resold and resold. Also no repository for that info…I always wanted to know.”

In 2014, a municipal bond advisor named Dale Scott of Dale Scott & Company presented a plan to Poway Unified School District for the district to buy back some of its Capital Appreciation Bonds using funds from a property tax increase. One challenge for this district is identifying who owns the bonds so offers can be made to buy them back. Scott pointed out that he had managed to find owners of Capital Appreciation Bonds issued by the Stockton Unified School District and buy back about 30 percent of them. According to an August 20, 2014 article in the San Diego Union-Tribune, “Scott said there is a myth that capital appreciation bonds are impossible to acquire once they are sold, but the reality is the bond holder may have many reasons for selling bonds that may take decades to mature.”

Tax and Debt Limits for Bond Measures Qualified Under Proposition 39 (Enacted Through Assembly Bill 1908 in 2000)
Type of Educational DistrictTax LimitDebt Limit
Unified School District0.06% of taxable property value ($60 per $100,000)2.5% of taxable property value
Elementary School District0.03% of taxable property value ($30 per $100,000)1.25% of taxable property value
High School District0.03% of taxable property value ($30 per $100,000)1.25% of taxable property value
Community College District0.025% of taxable property value ($25 per $100,000)2.5% of taxable property value

Tax and Debt Limits Meant to Assure Property Owners that a 55% Approval Threshold for School Bond Measures Wouldn’t Crush Them

From a school district’s perspective, Capital Appreciation Bonds are attractive because they enable the district to borrow more within its tax and debt limits. California Education Code Sections 15268-15270 sets the current limits. The state has not changed the limits since the enactment of Assembly Bill 1908 in conjunction with Proposition 39 in 2000, although Governor Brown proposed increasing them in his 2015-16 budget. (See Section 2 for background.)

Opponents of Proposition 39 in 2000 pointed out in their ballot arguments that these tax and debt limits were not part of the constitutional amendment enacted through Proposition 39 and therefore could be amended or repealed by the state legislature at any time. This is true.

Districts can set a lower tax or debt limit in the ballot statement for a bond measure. And K-12 school districts can get waivers from State Board of Education to impose higher tax or debt limits. (See Section 6 for background on waivers.)

Tax and Debt Limits Make Funding of Construction Programs Highly Dependent on Assessed Property Valuation

Because tax and debt limits are based on annual assessed property valuation in a district, the limits change yearly as a reflection of the real estate market. If property values increase compared to the previous year, the amount of money that can be borrowed increases relative to the previous year. If property values decline compared to the previous year, the amount of money that can be borrowed that year decreases. Educational districts hope (and usually project) property value to increase at a respectable rate for many years to come.

If the substantial increase in home prices during the mid-2000s gave school and college districts several years to borrow a lot more than perhaps originally anticipated, the dramatic drop in the following years hindered school and college districts, especially those with ongoing construction programs. From 2007 to 2011, assessed property valuation in some regions of California declined by as much as 50%, especially in exurban areas of California that grew rapidly in population during the 2000s as young families sought home ownership at prices they could afford.

Not surprisingly, these same regions needed new school construction to accommodate the children in these young families. Because of tax and debt limits, educational districts could not raise tax rates or borrow more money using traditional Current Interest Bonds to compensate for the loss in revenue resulting from the decline in property values.

Capital Appreciation Bonds are a clever way to circumvent the debt limits. A school or college district can take on a long-term debt obligation of $5000 by selling a bond but declare the debt to be $1300 because the bond was sold at the deeply discounted “principal” of $1300. And by deferring payment to bond investors until the bonds mature, the district can borrow money without exceeding the tax limit.

Hoping for the Best with Capital Appreciation Bonds

Of course, school districts will eventually have to collect a lot of money through levying taxes on property owners to pay principal and accreted interest to the buyers of Capital Appreciation Bonds. Essentially, Capital Appreciation Bonds represent a district’s gamble that assessed values will climb rapidly enough to produce sufficient tax revenue to allow issuers to pay off the bonds when they become due. If the anticipated increase in assessed property valuation fails to occur during the term of maturity, the district cannot pay principal and interest owed in future years.

There is little political disincentive for elected board members to borrow money today for school construction and impose a commitment on future generations to pay it off in 25, 30, or even 40 years. Only the elected board members of the Poway Unified School District have suffered political consequences from approving this kind of debt finance. But future school and college board members (who are children today) may be unjustly subjected to voter ire when the bill on Capital Appreciation Bonds is finally due.

2013: An Incomplete Fix for the Excesses of Capital Appreciation Bonds

Assembly Bill 182 was an attempt to restrain the worst excesses of Capital Appreciation Bonds while still allowing school and college districts to use them as a debt finance tool. It developed out of a proposal from San Diego County Treasurer-Tax Collector Dan McAllister as a response to high-profile Capital Appreciation Bond sales by school districts in his county.

Supporters of this bill were prominent critics of unrestrained Capital Appreciation Bond sales: California State Treasurer Bill Lockyer, the aforementioned San Diego County Treasurer-Tax Collector Dan McAllister, the California Association of County Treasurers and Tax Collectors, the California League of Bond Oversight Committees, the Howard Jarvis Taxpayers Association, and the California Taxpayers Association. Several rural county boards of supervisors supported the bill, as well as the board of supervisors for Contra Costa County, where the West Contra Costa Unified School District, the Mt. Diablo Unified School District, and the Acalanes Union High School District received local attention for risky bond finance schemes, including Capital Appreciation Bonds.

California State Treasurer Bill Lockyer wrote the following in support of Assembly Bill 182:

…many districts face a critical need to build or modernize facilities for their children, and I recognize that falling property tax assessments, revenue losses, and statutory debt service limits have all combined to reduce districts’ debt financing options, at least at the present time. However, we cannot continue to use debt financing tools, such as CABs, that force tax payers to pay, at times, more than 10 times the principal to retire these bonds. In too many cases, these transactions have been structured with 40-year terms that delay interest and principal payments for decades, resulting in huge balloon payments. Moreover, school board members and the public have not always been fully informed about the total costs and risks associated with issuing capital appreciation bonds. As a result of such CAB deals and lack of transparency, our future generations in many California school districts will be burdened with heavy taxes for years and years to come.

But there was also significant opposition to the bill from groups heavily involved in promoting bond measures for school construction, including California’s Coalition for Adequate School Housing (C.A.S.H.), the Association of California School Administrators, the California Association of School Business Officials, and the Small School Districts’ Association. The first legislative analysis written for a committee about AB 182 described the basis for the opposition:

All of the opposition letters submitted to the Committee have an “oppose unless amended” position. Generally, the opposition supports more transparency, but is concerned that the bill will inhibit school districts’ ability to secure funding to house students and provide for renovations as promised to voters through their bond initiatives. While some of the opponents do recognize the need to establish some parameters to prevent extreme CABs, they argue that CABs, if done appropriately and in a limited way, are effective. The requested amendments vary from organization to organization. They include expanding the term of CABs to 30 years, restoring the term of 40 years for CIBs, increasing the total debt service to principal ratio to 6 to 1 and applying the ratio to bond authorization, grandfathering in bonds that are already approved but not issued, and allowing districts to seek a waiver from the SBE to increase the tax rates.

In the end, the bill passed the State Senate 36-0 and passed the State Assembly 78-0. Soon after the bill was signed into law, governing boards of school and college districts were already initiating the sale of more Capital Appreciation Bonds under the new guidelines. This method of debt finance for school and college construction is not going away.

Table 12: Provisions of Assembly Bill 182 (AB 182)
The ratio of total debt service to principal for any series of bonds sold shall not exceed four to one (debt service four times greater than principal).
If the sale of bonds includes bonds that allow for the compounding of interest, including, but not limited to, Capital Appreciation Bonds, the agenda of the governing board meeting at which the sale will be approved shall include a proposed resolution to approve the sale of Capital Appreciation Bonds. Public notice for the resolution must be on at least two consecutive meeting agendas, first as an information item and second as an action item.
The governing board must be presented with the following information:
Disclosure of the financing term and time of maturity, repayment ratio, and the estimated change in the assessed value of taxable property within the school district or community college district over the term of the bonds.
An analysis containing the total overall cost of the Capital Appreciation Bonds.
A comparison to the overall cost of Current Interest Bonds.
The reason bonds that allow for the compounding of interest are being recommended.
A copy of the disclosure made by the underwriter as required by Rule G-17 of the federal Municipal Securities Rulemaking Board.
A Capital Appreciation Bond maturing more than 10 years after being sold must be able to be redeemed before its fixed maturity date, with or without a premium, at any time, or from time to time, at the option of the issuer, beginning no later than the 10th anniversary of the date it was sold.

Case Study: Poway Unified School District’s Egregious Debt Finance

Poway Unified School District created a special School Facilities Improvement District in 2007 and asked voters in February 2008 to authorize $179 million in bonds to finance capital improvements. The bond measure passed with 63.9% support, as it qualified under Proposition 39 for a 55% voter approval threshold.

As a campaign strategy, the district promised voters that the bond measure would not require a tax increase, supposedly because assessed property values would rise enough over time to bring in more tax revenue and pay off the debt service. To keep this promise, the school board subsequently adopted some excessive debt financing schemes.

From 2008 through 2011, the district borrowed the $179 million by issuing four series of bonds, including Current Interest Bonds and non-callable Capital Appreciation Bonds, with some bonds issued to refund earlier bond issues. It even sold some 40-year bonds at the maximum legally allowed interest rate of 8 percent. It used numerous controversial debt finance practices, such as selling bonds at a 20 percent premium over face value, and ended up incurring issuance fees totaling more than $6.7 million.

Perhaps people in the Poway Unified School District did not comprehend the dangers at the time, but the school board realized the district was doing something questionable. In 2010 it filed a validation lawsuit to subvert future lawsuits against their next bond finance deal. This provoked a warning letter from the California Attorney General, but in the end no party chose to be a defendant, thus giving the district legal cover to proceed.

Property owners in the School Facilities Improvement District now have the burden of paying $1.27 billion in debt service through 2051 for the privilege of borrowing $179 million. Poway Unified School District was described in the news media as having “shot to fame” as a “poster child for an era of reckless and risky school bond borrowing” through bond sales that have “reached legendary status.” And it became a rare example of voters making school board members accountable for its decisions on bond finance.

Three of the five board members who voted for the Capital Appreciation Bond deal in 2011 have lost their reelection campaigns, and a fourth chose not to run for re-election. The only remaining board member from 2011 may still be in office because only three candidates (two incumbents and a challenger) ran to fill two seats in the 2012 election. Seeing the popular demand for change, eight candidates ran for three seats in 2014.

Michigan Banned Capital Appreciation Bonds When California Legalized Them

On April 27, 2012, a former reporter for the Detroit Free Press newspaper named Joel Thurtell published a post on his blog entitled “Muni Bomb Ticks in California.” Thurtell wrote about the popularity of Capital Appreciation Bond sales by California educational districts.

Thurtell revealed that the practice was not new; in fact it was common at Michigan school districts in the late 1980s and early 1990s:

Joel on the Road LogoThere’s a school bond scandal brewing as California schools load taxpayers with horrendous debt for the next generation of taxpayers. The blight is called CABs — short for Capital Appreciation Bonds. It hit Michigan in 1988. Within four years of the first CAB issue, Michigan public school debt had doubled to reach more than $4 billion. That was just principal. The interest on the CABs amounted to 200 percent — 300 percent — even 575 percent of principal, depending on the terms of the individual bond issue. Nineteen years ago, I delved into this fascinating but arcane world with its private argot strewn with obscure words like “zeroes” and “basis points” describing fairly simple things in language you need a special dictionary to comprehend. It’s an industry with specialized documents that seem encrypted so that people like you and I will have trouble understanding them.

Thurtell had spent many days of difficult, tedious research at the Michigan State Treasurer’s office scrutinizing paper copies of “Official Statements” produced for Michigan school districts. He produced a “Big Chart” that quantified the prevalence of Capital Appreciation Bond sales and accumulated debt service. On April 5, 1993 the Free Press published the first of a series of Thurtell’s articles about how Michigan school districts were borrowing their money for school construction. The articles changed public policy in Michigan:

Because of my Free Press stories…the state Legislature banned future issues of Capital Appreciation Bonds and ordered that future bond issues be competitively bid rather than rigged through a process the underwriters euphemistically termed “negotiation.” It was huge that CABs were banned, because as you will read in these stories, schools were piling up enormous debt to be paid by future taxpayers. Imagine the predicament schools would have found themselves in had such debt been allowed to continue accumulating into today’s depressed economy. Debt payback was predicated on rosy assumptions called “present value” that predicted large increases in real estate valuation ad infinitum.

At the May 2012 annual conference of the California League of Bond Oversight Committees, the Los Angeles County Treasurer-Tax Collector Mark Saladino and Alicia Minyen, a school bond expert and certified fraud examiner, made presentations that included discussion of Capital Appreciation Bonds. Saladino had written a May 16, 2011 white paper about risky municipal debt finance that referenced school districts issuing Capital Appreciation Bonds. Minyen was a prominent critic of a few school districts in Contra Costa County that had issued Capital Appreciation Bonds in irresponsible ways.

Minyen referenced Joel Thurtell’s articles and blog posts. The author of this report then wrote articles for his personal blog about the Capital Appreciation Bond presentations, and local taxpayer activists throughout the state began contacting him with questions and concerns about Capital Appreciation Bond sales going on in their local school and college districts. Californians who paid close attention to tax and government finance issues from a critical perspective were confused — and suspicious.

Graphic Depictions of Poway Unified School District Bond Debt Inspire Limited Reforms

Voice of San Diego Pie Chart on Poway USD Capital Appreciation BondsFinally a breakthrough in bringing public awareness to the issue occurred in August 2012, when a journalistic web publication called Voice of San Diego published a series of investigative pieces written by reporter Will Carless about the 2011 Poway Unified School District bond sales. The first article hit on August 6, 2012: “Where Borrowing $105 Million Will Cost $1 Billion: Poway Schools.”

It’s possible that Voice of San Diego was successful in bringing sudden and dramatic attention to the practice because of the simple and colorful graphics produced by Keegan Kyle and included with the articles. These graphics portrayed the deals in a way much easier to understand than the analytical writing of policy experts.

Voice of San Diego on Poway Unified School District Capital Appreciation BondsThese articles and the associated graphics were the catalyst for intense statewide public criticism. Voice of San Diego created a spreadsheet, the Los Angeles Times created a database, and other news media outlets compiled information revealing that a couple hundred community college and K-12 school districts in California had issued Capital Appreciation Bonds, with many starting long before property values began to decline in 2007.

California and national news media, state and local taxpayer organizations, and many state and local politicians spent the next year criticizing California educational districts for poor decisions about borrowing money via bond sales for school construction. About a dozen educational districts received a disproportionate amount of negative attention for their Capital Appreciation Bond sales. Criticism ebbed but did not disappear after Governor Brown signed Assembly Bill 182 in October 2013 to put limits and new oversight on Capital Appreciation Bonds.

Backers of Capital Appreciation Bonds Stubbornly Defend Them

Throughout the state and even at the Poway Unified School District, elected district officials and administrators defended their decisions to sell Capital Appreciation Bonds. Their response to criticism was common and consistent:

  1. Voters wanted school construction done as soon as possible.
  2. Capital Appreciation Bonds were the only way available to get the money.
  3. We didn’t do anything wrong.
  4. Look at the complete program instead of focusing on individual bond issues.

These claims generally echoed the arguments of parties involved in the preparation and sale of those bonds. These bond experts knew the obscure and complicated business of municipal bonds, but they also had a financial interest in seeing these bond sales continue.

Tables A-5 and A-6 are comprehensive lists of arguments for and against Capital Appreciation Bonds, with rebuttals.

Table A-5
Arguments for Capital Appreciation Bonds
ArgumentRebuttal
URGENCY
School facilities are desperately needed now: schools are overcrowded, deteriorating, outdated, and unsafe. These claims are rarely quantified. There needs to be an objective way to determine that need overwhelms the risk of massive tax and debt burdens for future generations.
Despite 14 years of Proposition 39, educational districts continue to increase the number of bond measures on the ballot and the total amount authorized to borrow. It seems that spending between $100-$200 billion on construction since 2000 has only increased the need for more.
It’s possible that educational districts are preparing for a population boom that may never occur. Average Daily Attendance for California K-12 school districts has dropped from 5,927,951 in 2003-04 to 5,631,709 in 2008-09 to 5,501,603 in 2013-14. Actual California population growth is lagging behind projections made in the 1990s.
When the bond measure was before voters for consideration, the educational district made promises to residents about what was going to be built and what the tax rate would be. Those promises must be fulfilled. Voters want the projects now.Anecdotally, it appears that voters aren’t necessarily keen on immediately proceeding with construction projects listed in bond measure ballot statements if it requires borrowing money under outlandish terms via sales of Capital Appreciation Bonds or other unconventional methods of debt finance. Taxpayers would rather give their money to their local educational district than to bond investors.
Who actually applies the most pressure on the educational district to proceed with borrowing money? Are educational districts selling Capital Appreciation Bonds or other unconventional methods of debt finance because parents and teachers are demanding it? Or is the political pressure coming from the various interests that contributed to the bond measure campaign and now want to reap the rewards of contracts for this construction program?
Interest rates are low. This is a good time to borrow money, perhaps with a mix of Current Interest Bonds and Capital Appreciation Bonds. Rates may not be so favorable when assessed valuation of property in the district goes up.Interest rates are low and provide an advantage for educational districts issuing Current Interest Bonds, but the outrageous nature of Capital Appreciation Bond negates the benefit of lower rates. The ratio of debt service to principal should not exceed 3 or 4 (at the most) for an individual bond issue.
Educational districts will jeopardize the quality of education for students if they don’t get funding for construction now.Is it true that new and modernized facilities significantly improve academic performance and life preparation for students? Is the impact of bond measures on test scores proportionate to the amount of tax revenue spent on debt service for those bond measures? Or are bond measures simply an easy method to get more money flowing into the district?
Ongoing construction programs would have to stop if funding isn’t obtained now, causing inconvenience, stopping momentum, and risking a higher cost of construction in the future.A realistic projection for assessed valuation of property would allow for better planning of construction-related contracts. Future generations should not have to pay for the risky borrowing practices of this generation’s leaders.
STINGY STATE LAWS COMPEL USE
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because of unreasonably low tax and debt limits established in state law.The California legislature established these limits in state law in 2000 as part of a strategy to boost voter support for Proposition 39, a statewide measure on the November 2000 ballot to modify Proposition 46 enacted in 1986 - an initiative that modified the high-profile Proposition 13 enacted in 1978. Without limits and other additional taxpayer protections, Proposition 39 might have failed, as Proposition 26 failed in March 2000.
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because assessed valuation of property in the districts unexpectedly declined, thus forcing districts to confront tax and debt limits.It’s important to obtain an independent projection of assessed property valuation that does not extend a current exceptional rate of growth for 40 years.
THESE BOND FINANCE DEALS ARE MISUNDERSTOOD
It’s wrong to consider Capital Appreciation Bonds in isolation. They are usually just a piece of a package of bond issues. When considered in conjunction with other bond issues, the debt to principal ratio is usually reasonable.This doesn’t eliminate the reality that bonds are issued that will need to be paid back decades later with compounded interest. Why include them at all?
Focusing on long-term debt service is misleading. Just because there is a high number for aggregate accreted interest in 40 years doesn’t necessary mean that amount will ever be paid. Many Capital Appreciation Bonds are “callable” and can be redeemed (and are being redeemed) with a new issue of refunding bonds that have lower rates and can be issued as traditional Current Interest Bonds. Because of the consistent increasing value of property in California over several generations, an amount that seems high to taxpayers now will not be so daunting decades from now. Routine inflation will reduce the “real” cost of paying back Capital Appreciation Bonds decades from now. This is public money. The decision to borrow money via Capital Appreciation Bonds assumes that assessed valuation of property and the rate of inflation will increase substantially over decades. And some districts (such as Poway Unified School District) have sold Capital Appreciation Bonds that are not callable.
Contrary to claims made after the fact, plenty of information is provided to educational district administrators and elected board members about bond sales. There isn’t an excuse for not understanding the proposal.Information is not presented in a standardized way that is easy to understand. Most school board members do not have a background in accounting, finance, or bonds. In addition, school board members may be hesitant to publicly acknowledge their lack of understanding, especially if everyone else in the room is nodding heads during the bond consultant presentation.
Critics have self-interested motivations to criticize. Traditional and consistent ideological detractors of government schools want to take advantage of yet another opportunity to undermine the system. Cynical politicians want to exploit bad news in order to build a reputation. News media wants to improve reader and viewer ratings through sensational and misleading coverage.Most people would acknowledge that criticism of at least a few bond issues by California educational districts has merit. In addition, there are self-interested motivations for people denying that Capital Appreciation Bonds and other unconventional bond financing are unusual or unwise. Community college and K-12 school district elected officials wanted to stay in office. District administrators wanted to keep their jobs. And of course professionals in the financial industry wanted to continue making a living from the transaction fees generated by bond sales.
Assembly Bill 182 (2013) wasn’t really needed, but it is now law and there are no valid arguments to impose more restrictions on this valuable tool for educational districts.Educational districts are still selling Capital Appreciation Bonds (and also Bond Anticipation Notes) under the assumption that assessed valuation will continue to rise for decades. The bond financing industry will continue to use these schemes to bloat borrowing and collect more transaction fees.
Table A-5
Arguments for Capital Appreciation Bonds
ArgumentRebuttal
URGENCY
School facilities are desperately needed now: schools are overcrowded, deteriorating, outdated, and unsafe. These claims are rarely quantified. There needs to be an objective way to determine that need overwhelms the risk of massive tax and debt burdens for future generations.
Despite 14 years of Proposition 39, educational districts continue to increase the number of bond measures on the ballot and the total amount authorized to borrow. It seems that spending between $100-$200 billion on construction since 2000 has only increased the need for more.
It’s possible that educational districts are preparing for a population boom that may never occur. Average Daily Attendance for California K-12 school districts has dropped from 5,927,951 in 2003-04 to 5,631,709 in 2008-09 to 5,501,603 in 2013-14. Actual California population growth is lagging behind projections made in the 1990s.
When the bond measure was before voters for consideration, the educational district made promises to residents about what was going to be built and what the tax rate would be. Those promises must be fulfilled. Voters want the projects now.Anecdotally, it appears that voters aren’t necessarily keen on immediately proceeding with construction projects listed in bond measure ballot statements if it requires borrowing money under outlandish terms via sales of Capital Appreciation Bonds or other unconventional methods of debt finance. Taxpayers would rather give their money to their local educational district than to bond investors.
Who actually applies the most pressure on the educational district to proceed with borrowing money? Are educational districts selling Capital Appreciation Bonds or other unconventional methods of debt finance because parents and teachers are demanding it? Or is the political pressure coming from the various interests that contributed to the bond measure campaign and now want to reap the rewards of contracts for this construction program?
Interest rates are low. This is a good time to borrow money, perhaps with a mix of Current Interest Bonds and Capital Appreciation Bonds. Rates may not be so favorable when assessed valuation of property in the district goes up.Interest rates are low and provide an advantage for educational districts issuing Current Interest Bonds, but the outrageous nature of Capital Appreciation Bond negates the benefit of lower rates. The ratio of debt service to principal should not exceed 3 or 4 (at the most) for an individual bond issue.
Educational districts will jeopardize the quality of education for students if they don’t get funding for construction now.Is it true that new and modernized facilities significantly improve academic performance and life preparation for students? Is the impact of bond measures on test scores proportionate to the amount of tax revenue spent on debt service for those bond measures? Or are bond measures simply an easy method to get more money flowing into the district?
Ongoing construction programs would have to stop if funding isn’t obtained now, causing inconvenience, stopping momentum, and risking a higher cost of construction in the future.A realistic projection for assessed valuation of property would allow for better planning of construction-related contracts. Future generations should not have to pay for the risky borrowing practices of this generation’s leaders.
STINGY STATE LAWS COMPEL USE
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because of unreasonably low tax and debt limits established in state law.The California legislature established these limits in state law in 2000 as part of a strategy to boost voter support for Proposition 39, a statewide measure on the November 2000 ballot to modify Proposition 46 enacted in 1986 - an initiative that modified the high-profile Proposition 13 enacted in 1978. Without limits and other additional taxpayer protections, Proposition 39 might have failed, as Proposition 26 failed in March 2000.
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because assessed valuation of property in the districts unexpectedly declined, thus forcing districts to confront tax and debt limits.It’s important to obtain an independent projection of assessed property valuation that does not extend a current exceptional rate of growth for 40 years.
THESE BOND FINANCE DEALS ARE MISUNDERSTOOD
It’s wrong to consider Capital Appreciation Bonds in isolation. They are usually just a piece of a package of bond issues. When considered in conjunction with other bond issues, the debt to principal ratio is usually reasonable.This doesn’t eliminate the reality that bonds are issued that will need to be paid back decades later with compounded interest. Why include them at all?
Focusing on long-term debt service is misleading. Just because there is a high number for aggregate accreted interest in 40 years doesn’t necessary mean that amount will ever be paid. Many Capital Appreciation Bonds are “callable” and can be redeemed (and are being redeemed) with a new issue of refunding bonds that have lower rates and can be issued as traditional Current Interest Bonds. Because of the consistent increasing value of property in California over several generations, an amount that seems high to taxpayers now will not be so daunting decades from now. Routine inflation will reduce the “real” cost of paying back Capital Appreciation Bonds decades from now. This is public money. The decision to borrow money via Capital Appreciation Bonds assumes that assessed valuation of property and the rate of inflation will increase substantially over decades. And some districts (such as Poway Unified School District) have sold Capital Appreciation Bonds that are not callable.
Contrary to claims made after the fact, plenty of information is provided to educational district administrators and elected board members about bond sales. There isn’t an excuse for not understanding the proposal.Information is not presented in a standardized way that is easy to understand. Most school board members do not have a background in accounting, finance, or bonds. In addition, school board members may be hesitant to publicly acknowledge their lack of understanding, especially if everyone else in the room is nodding heads during the bond consultant presentation.
Critics have self-interested motivations to criticize. Traditional and consistent ideological detractors of government schools want to take advantage of yet another opportunity to undermine the system. Cynical politicians want to exploit bad news in order to build a reputation. News media wants to improve reader and viewer ratings through sensational and misleading coverage.Most people would acknowledge that criticism of at least a few bond issues by California educational districts has merit. In addition, there are self-interested motivations for people denying that Capital Appreciation Bonds and other unconventional bond financing are unusual or unwise. Community college and K-12 school district elected officials wanted to stay in office. District administrators wanted to keep their jobs. And of course professionals in the financial industry wanted to continue making a living from the transaction fees generated by bond sales.
Assembly Bill 182 (2013) wasn’t really needed, but it is now law and there are no valid arguments to impose more restrictions on this valuable tool for educational districts.Educational districts are still selling Capital Appreciation Bonds (and also Bond Anticipation Notes) under the assumption that assessed valuation will continue to rise for decades. The bond financing industry will continue to use these schemes to bloat borrowing and collect more transaction fees.
Table A-6
Arguments Against Capital Appreciation Bonds
ArgumentRebuttal
THE BOND FINANCE INDUSTRY IS NOT TRUSTWORTHY
Promoters of bond deals are motivated by transaction fees and tend to advance funding proposals in their own interest but harmful to the public interest.Borrowing money for long-term investment is a well-accepted practice in the United States and a fundamental part of our economic system.
Most people involved with bond finance are ethical and enjoy being in a professional financial vocation that helps students and society.
The few bond finance professionals who are alleged to advise decisions not in the interest of their clients earn a bad reputation and can’t stay in the business.
Companies and individuals who work in the business of assisting with capital transfer and earn fees on those transactions are an easy target to malign, but they are essential to a prosperous economy.
Proving their lack of responsibility to the public, the California Public Securities Association in 2009 sponsored Assembly Bill 1388, a self-interested bill that repealed a law requiring that the maximum annual payment of principal and interest on a bond issue cannot exceed the minimum annual payment of principal and interest by more than 10 percent.Actually, this bill helped educational districts by allowing them greater opportunity to borrow money despite reaching state tax and debt limits or despite reaching tax and debt limits indicated in the bond measure.
Excessive competition in the market to win contracts from educational districts for bond finance services has compelled some companies to overstate benefits and understate risks of unconventional bond finance.Increased competition in municipal bond finance gives educational districts the opportunity to compare numerous potential contractors and chose the one that best suits its needs. Districts concerned about debt accumulated through Capital Appreciation Bonds can award contracts to professional service firms that adopt a conservative approach to bond finance.
Increased competition in municipal bond finance has encouraged the development and promotion of more creative and effective options to help educational districts in bond finance, such as Reauthorization Bonds and Ed-Tech Bonds.
Corruption is rampant in the municipal bond finance business, as proven by apparent “pay to play” practices between educational districts and bond underwriters.Many parties in the bond financial industry resent how their reputation is tainted by a few companies that make substantial contributions to bond measure campaigns and/or consult for those campaigns and then obtain no-bid contracts and/or higher transaction fees. They have asked the Municipal Securities Rulemaking Board (MSRB) to restrict parties in the financial services industry from contributing to bond campaigns. They have also collectively adopted a voluntary internal moratorium on the practice.
Some county treasurers, for example in Los Angeles County, have ended business with securities brokers that contribute to campaigns for bond measures. The problem is being addressed.
The Municipal Securities Rulemaking Board already has a regulation requiring brokers, dealers, and municipal securities deals to disclose their campaign contributions to allow public scrutiny of such political activity.
Political campaigns are expensive. Parents and students are unlikely to be major sources of contributions to a campaign to pass a bond measure. There is nothing wrong with companies contributing to a campaign and expressing their First Amendment constitutional right to free speech.
No one has ever proven this practice actually happens.
Claims about this practice come from firms that want to stifle competition from other firms that work harder for educational districts.
Educational districts are no different than victims of loan sharks, payday lenders, mortgage scammers, and other unsavory usurers.Comparisons of professional, certified financial service providers to criminals is unjust. Boards elected by the people consider and vote on proposals for bond issues at public meetings regulated by open meetings laws. The process is highly regulated by the US Securities and Exchange Commission and the Municipal Securities Rulemaking Board. The news media has the opportunity to follow and report on the issue to the public.
LACK OF PUBLIC KNOWLEDGE COMPROMISES ACCOUNTABILITY AND ALLOWS TAXPAYERS TO BE EXPLOITED
Few Californians have ever heard of Capital Appreciation Bonds. An even tinier percentage of Californians could adequately explain them. As a result, the public is currently incapable of evaluating this method of bond finance and petitioning their school or college board members about it.Government does many things that the general public does not know about or understand. Accountability is inherent in the regular elections for governing boards. Candidates run for and get elected to public office based on their individual expertise and experience. Voters can subsequently choose to end the public service of those individuals based on their performance.
Educational districts have professional in-house superintendents and often have other administrators overseeing bond deals, including business officers assigned to work on bond finance.
Educational districts hire outside experts to maximize the effectiveness of their bond measures and best serve the public. Contracts for these experts include terms and conditions that provide protection for the district and accountability to the consultant.
State and county elected and appointed officials and their agencies serve as checks and balances for educational district decisions. In particular, county treasurers can and do play a role in evaluating questionable bond financing.
In the few cases in which excessive or inappropriate bond deals may have occurred, (for example, the 2011 bond issue at the Poway USD), elected county treasurers and the news media did identify the failure and publicized it. Assembly Bill 182 (now in law) is the product of research and reporting by elected government officials and the news media. The system of checks and balances worked.
Voters are not informed in election ballot material that some of the money they authorize to borrow via “general obligation bonds” ends up borrowed via Capital Appreciation Bonds and other unconventional borrowing practices.Actually, some ballot statements are now indicating that “no capital appreciation bonds shall be issued.” Inclusion of language specifying the type of General Obligation bonds to be sold should be a decision of the district board and not mandated by the state.
It’s unfair for educational districts to be forced to speculate to voters on how it might borrow money. Financing decisions are made by elected board members based on economic conditions that cannot be known at the time the bond measure is considered.
State law already imposes numerous burdensome and costly requirements on educational districts to ensure voters have a reasonable degree of information for consideration of a bond measure.
Ballot statements already are so long that few people would see any authorizations for the district to Capital Appreciation Bonds and other unconventional borrowing practices if they were included.
COST, TAXES, AND DEBT ARE FOOLHARDY
It’s foolish to borrow money and then wait for decades to start paying off the principal and accreted interest.What’s foolish are the tax and debt limitations established by state voters as Proposition 13 in 1978 and state laws (Assembly Bill 1908) enacted in conjunction with putting Proposition 39 on the statewide ballot in 2000. If those limits were set at a higher threshold or eliminated altogether, Capital Appreciation Bonds and other unconventional financing schemes would become rare.
Property taxes may increase substantially many years in the future when the district begins paying off the debt.It’s unlikely the taxes will end up being particularly noteworthy or burdensome after decades of increased property value and inflation.
The amount to be paid back under Capital Appreciation Bonds is too high.Just because there is a high number for aggregate accreted interest in 40 years doesn’t necessary mean that amount will ever be paid. Many Capital Appreciation Bonds are “callable” and can be redeemed (and are being redeemed) with a new issue of refunding bonds that have lower rates and can be issued as traditional Current Interest Bonds.
Because of the consistent increasing value of property in California over several generations, an amount that seems high to taxpayers now will not be so daunting decades from now.
Routine inflation will reduce the “real” cost of paying back Capital Appreciation Bonds decades from now.
Focusing on the amount of debt service generated by Capital Appreciation Bonds ignores the intangible benefits of high-quality schools with environments conducive to teaching and learning
Capital Appreciation Bonds are used too often.For most educational districts, Capital Appreciation Bonds comprise a small percentage of the total amount of bonds issued. Capital Appreciation Bonds are a legitimate and beneficial option for educational districts that want to obtain a bit more of the money that voters authorized to borrow for needed school construction.
Capital Appreciation Bonds allow educational districts to fund contracts with local contractors and vendors, thus encouraging economic growth and job creation in the community. Capital Appreciation Bonds pay for themselves by generating increased economic activity.
There are no legal or commonly accepted definitions of “too often.” The authority to issue Capital Appreciation Bonds is granted to the educational district’s board of trustees, who are elected by the people. Each educational district has its own comfort for Capital Appreciation Bonds, and this comfort usually reflected in the decision of the board. Trust our representative democracy.
Capital Appreciation Bonds assume an ability to pay based on projections of increased value of taxable property that may extend as many as 40 years into the future.Granted, no one can perfectly predict the future. But California remains a desirable place to live because of its climate, natural beauty, economic prosperity, and culture. It’s reasonable to assume that people with ability and ambition will always come to California, a beacon for the world, and thus increase demand for housing.
The best way to ensure increased property values in the future is to build a foundation of high-quality schools with environments conducive to teaching and learning. Funding for new construction - sometimes obtained through Capital Appreciation Bonds - allow these schools to be provided and fulfills the expectation for increased property values.
Without any sort of representation, future generations of taxpayers (children and grandchildren) are bound to repaying debts accumulated by unconventional borrowing practices of current generations.Schools built using Capital Appreciation Bonds are for the benefit of our children and grandchildren. Shouldn’t they contribute to paying for the system that helped to make them successful?
This is an unfortunate distortion of the concept of “taxation without representation” that applies to people who are deprived of their right for full participation in their current governance. Many of the important and transformational social programs in the United States and in California were adopted before the people now benefiting and paying for them were even born. Generations work together cooperatively to advance progress.

Sources

“Text – SB 872 Local Agencies: General Obligation Bonds,” California Legislative Information, October 6, 1993, accessed June 28, 2015, www.leginfo.ca.gov/pub/93-94/bill/sen/sb_0851-0900/sb_872_bill_931006_chaptered

“Market Place; Zero-Coupon Municipals,” New York Times, March 21, 1982, accessed June 28, 2015, www.nytimes.com/1982/03/31/business/market-place-zero-coupon-municipals.html

“Capital Appreciation Bonds: The Creation of a Toxic Waste Dump in Our Schools,” Alpha Wealth Management, April 11, 2013, accessed June 28, 2015, www.alpha-wealth.com/resources/publications/CAB-Paper.pdf

Kevin Dayton @DaytonPubPolicy, May 9, 2015, accessed June 28, 2015 https://twitter.com/daytonpubpolicy/status/596934260381978624

Dale Scott & Company www.dalescott.com

“Questions & Answers from Capital Appreciation Bond (CAB) Public Forums,” Poway Unified School District, August 20, 2014, accessed June 28, 2015, https://www.powayusd.com/doc_library/2014-15/CommunityForumFAQs.pdf

“Plan Pitched to Lower Poway Bond Debt,” San Diego Union-Tribune, August 20, 2014, accessed June 28, 2015, www.utsandiego.com/news/2014/aug/20/poway-plan-bond-debt/

“Text – AB 182 Bonds: School Districts and Community College Districts,” California Legislative Information, October 2, 2013, accessed June 28, 2015, leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201320140AB182&search_keywords=

“Treasury: Capital Appreciation Bonds,” San Diego County Treasurer-Tax Collector, accessed June 28, 2015, www.sdtreastax.com/capital-appreciation-bonds.html

“AB 182 Bill Analysis – Concurrence in Senate Amendments,” Official California Legislative Information, September 5, 2013, accessed June 28, 2015, www.leginfo.ca.gov/pub/13-14/bill/asm/ab_0151-0200/ab_182_cfa_20130905_163723_asm_floor.html

“AB 182 Bill Analysis – Assembly Committee on Education,” Official California Legislative Information, March 20, 2013, accessed June 28, 2015, www.leginfo.ca.gov/pub/13-14/bill/asm/ab_0151-0200/ab_182_cfa_20130318_154906_asm_comm.html

“Citrus College OKs Capital Appreciation Bond Issuance,” San Gabriel Valley Tribune, May 6, 2014, accessed June 28, 2015, www.sgvtribune.com/social-affairs/20140506/citrus-college-oks-capital-appreciation-bond-issuance

“Re: Poway Unified School District v. All Persons Interested – Superior Court of California, County of San Diego, Case No. 37-2010-00106255-CU- MC-CTLAG,” California Attorney General letter to Poway Unified School District, Orange County Government, March 1, 2011, accessed June 28, 2015, http://cams.ocgov.com/Web_Publisher/Agenda11_05_2013_files/images/ATTORNEY%20GENERAL%20OPINION%20-%20POWAY%20BOND%20PREMIUM_9843497.PDF

“Muni Bomb Ticks in California,” Joel On the Road, April 27, 2012, accessed June 28, 2015, www.joelontheroad.com/muni-bomb-ticks-in-california/

“Find High-Interest School Bonds in Your District: A Five-Step Guide,” Voice of San Diego, August 8, 2012, accessed June 28, 2015, http://www.voiceofsandiego.org/investigations/find-high-interest-school-bonds-in-your-district-a-five-step-guide/

“Spreadsheet: Capital Appreciation Bonds,” Los Angeles Times, November 28, 2012, accessed June 28, 2015, spreadsheets.latimes.com/capital-appreciation-bonds/

###

More Trouble with Bond Finance for Educational Construction (Section 8 of 9)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
You are here: More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
Guide to all Tables and Appendices – Comprehensive Reference for Researchers


More Troubling Issues with Bond Finance for Educational Construction

While compiling the comprehensive information provided in this study, California Policy Center researchers identified numerous other troubling aspects of bond finance. School and college districts are evading compliance with the law and making irresponsible decisions. Ordinary voters lack enough data to make an informed vote. Community activists who seek deeper understanding find themselves stymied.

Bad Government Behavior

1. Some School and College Districts Don’t Comply with Proposition 39

Two examples of investigative reports on educational district compliance with Proposition 39 are the San Diego County Taxpayers Association 2015 School Bond Transparency Scorecard and a 2010 San Mateo County Civil Grand Jury report entitled “School Bond Citizens’ Oversight Committees, Prop 39.” These reports show some districts are close to full compliance while others don’t seem to be complying at all. It appears that two types of districts are broadly failing to comply: (1) small school districts, which may have limited capability to comply, and (2) large school districts routinely accused of fiscal irresponsibility and mismanagement.

2. Spend It Or Lose It? Districts Can Sell Bonds Decades After Voter Approval

Some school and college districts ask voters to approve new authority to borrow additional money for facilities construction even though much of the authority from previous bond measures to borrow money has not been used. This is a strategy to circumvent tax and debt limits imposed by state law on individual bond measures, and it leaves millions (and sometimes billions) of dollars in borrowing authority dangling for future school boards to exercise long after voters have forgotten the election.

3. Districts Sell Bonds at a Premium and Use the Extra Money to Pay Fees Related to Selling the Bonds

The California Attorney General’s office is preparing a legal opinion (14-202) on whether school and college districts can use a premium to pay bond issuance fees. The question asked is “May the ‘premium’ generated from a school district bond sale be used to pay for expenses of issuance and other transaction costs?” (See Table 8 for a list of such fees.)

In 2011, the California Attorney General warned the Poway Unified School District that “artificially inflating the interest rate to generate premium” to pay for costs of issuance would be illegal.

The California State Treasurer or a state agency needs to compile a list of bond issues for which buyers paid a premium that the district then used to pay bond issuance fees. How rampant is the practice and how much has it cost California taxpayers?

4. Firms Get Contracts to Prepare a Bond Measure Before the Election and Then Get Contracts to Implement the Bond Measure After the Election

The California Attorney General’s office is preparing a legal opinion (13-304) on whether a party that gets a contract with a school or college district for surveying voters and preparing a bond measure can then get a contract as the bond underwriter (bond broker) for issuances approved by that same bond measure. The question asked is “In connection with a school or community college bond measure, does a district violate state law by contracting with a bond underwriter for both pre-election campaign services and post-election underwriting services?”

5. Is There Exaggeration, Deception, or Outright Fraud When Districts Assess Needs for Another Bond Measure?

Some school and college districts seek to borrow more money for school construction even when their enrollment has been substantially declining for years and is projected to continue declining. Overcrowding would not seem to be a problem in such districts. Is the need legitimate?

A state agency should conduct random audits for several school or college districts to determine the credibility of their facilities plan based on their evaluations of safety, class size reduction and information technology needs. Numerous bond measures include the words “safety” and “security” in the ballot question and statement, insinuating to voters that students and teachers may be physically harmed unless the district can borrow money via bond sales for construction projects. Are there truly legitimate threats to safety and security in schools throughout the state?

6. A Handful of Voters in Future Development Areas Have Given School Districts Massive Authority to Sell Bonds and Put the Bills on Future Residents

When researchers for the California Policy Center developed preliminary charts now in the appendix to this report and began circulating them publicly early in 2015, two bond measures received unexpected attention on the list of 1,147 considered since enactment of Proposition 39.

In both of these cases, a school district created the boundaries of a School Facilities Improvement District — carved out of the entire district — in a sparsely-populated where future development will occur and future schools will be built.

Apparently the Folsom-Cordova Unified School District compared this option to the establishment of a Community Facilities District funded by Mello-Roos fees and chose this financing option. Its Improvement District had a population in 2006 of about 330 persons.

Table 17: Bond Measures Approved by a Handful of Voters for Huge Amounts
Educational DistrictFolsom Cordova Unified School District SFID No. 3Roseville Joint Union High School District SFID No. 1
Amount Authorized to Borrow$750,000,000$115,000,000
Date of Election2007-03-272007-04-24
CountiesSacramentoPlacer
MeasureMA
Needed to Pass66.7%66.7%
Yes6011
No141
Total7412
Passage81.1%91.7%
Amount Per Vote$12,500,000$10,454,545

Shortcomings That Hinder Voters

The California legislature recognizes that some ballot statements for bond measures do not contain enough relevant information for voters. In 2014, Governor Brown signed into law Assembly Bill 2551, introduced by Assemblyman Scott Wilk, which requires each bond issue proposed by a local government to include estimates from official sources of tax rates for certain years, the maximum annual tax rate, and total debt service (the principal and interest that would be required to be repaid if all the bonds are issued and sold). The bill never received a vote in opposition. In 2015, Assemblyman Jay Obernolte introduced Assembly Bill 809, which requires the ballot statement for local tax measures to include information on the amount of money to be raised annually and the rate and duration of the tax to be levied. As of July 13, 2015, the bill was moving through Senate committees after passing the Assembly 57-8 (with 15 not voting).

1. Ballot Questions and Statements Aren’t Useful to the Ordinary Voter

A 2009 Little Hoover Commission report on bond measures noticed the lack of “fundamental criteria for ballot measures” and recommended a “simple, easy-to-understand report card in the voter guide for all bond measures placed on the ballot.” The problem continues unabated today.

Bond measures tend to be presented to voters in a vacuum, with minimal context about the past history of the district’s bond measures and construction programs. Voters can misinterpret proposed bond measures as a desperate response to a long-standing unaddressed crisis of unsafe, decrepit, and overcrowded classrooms, laboratories, and athletic facilities.

Voters need a chance to consider whether they should approve millions or even billions in new bond authority, even if millions or even billions of money has already been borrowed and millions or billions in existing authority still remains to be spent. This would reveal any history of foolish bond issues or debt acquisition.

2. Information Provided to Voters Needs More Pictures, Charts, and Tables

As mentioned in Section 5 of this report, a possible reason why the public finally discovered the extreme Capital Appreciation Bond financing arrangements of the Poway Unified School District was the simple and colorful graphics in the Voice of San Diego articles about it. More than ever, American society depends on imagery, charts, and tables for information instead of prose.

3. Voters Need to See the Importance of Assessed Property Valuation and District Enrollment Projections

Projections of the rate of change for assessed property valuation in the district should be among the most important elements in decisions concerning bond issues. Voters need to consider a history of wild swings in assessed property valuation in the district and decide whether projections are realistic or exaggerated.

A report on Capital Appreciation Bonds from the 2013-2014 Orange County Grand Jury recognized “there has been virtually no publicity concerning the implications of debt service repayment for CABs, specifically the magnitude of potentially higher taxes. There is potential for some school districts, through the County, to increase property taxes well beyond what was presented when the bonds were issued in order to repay the CABs.” Results of the Grand Jury’s investigation were depicted in tables. At least three school districts in Orange County predicted assessed property valuation to grow at unrealistically high rates when they asked voters to approve bond measures. As a result, these districts will have to levy tax rates far beyond what was portrayed to voters in order to pay off the Capital Appreciation Bonds.

In addition, voters need to be aware if the school or college district asking to borrow money for construction is experiencing a long-term trend up or down in student enrollment. There are arguments for borrowing a lot of money for facilities construction during a time of dropping enrollment (Wiseburn Unified School District is an example of this deliberate strategy), but the message to voters needs to reflect actual circumstances.

4. Ballot Questions for Bond Measures Deceive and Manipulate Voters

Several ballot questions for proposed community college bond measures have specifically singled out veterans as beneficiaries. As noted in Section 2, polling shows that voters respond positively to the idea that a bond measure will help veterans. As a result, the possibility that veterans will be using facilities funded by bond proceeds gets prominent mention in ballot language.

On June 29, 2015, the Solano County Grand Jury issued a report highly critical of the ballot title and ballot statement for Measure Q, a November 2012 ballot measure that authorized the Solano Community College District to borrow $348 million for construction by selling bonds to investors. The Grand Jury asserted that voters were duped into thinking that proceeds from selling bonds would directly provide classroom instruction and job training for veterans and other students. It suggested that future bond measures conform narrowly to Proposition 39 language and focus on construction of educational facilities:

Finding 1

The language of Measure Q was misleading. While Proposition 39 generally authorizes funding of buildings and land purchases even the name of the measure, “The Solano Community College District Student/Veterans’ Affordable Education Job Training, Classroom Repair Measure,” suggests otherwise.

Recommendation 1

Language used in future school bond proposals be limited to that which is stated in the authorizing statute.

References to veterans is an example of how campaign consultants have developed ballot titles, questions, and summaries that manipulate the emotions of uninformed voters who are looking at a ballot and deciding how to vote. Another example is the claim that “all funds stay local” or “all funds benefit neighborhood schools.” This statement ignores how taxpayers will pay the financial services industry for issuance fees and may end up providing more funds for interest payments to wealthy bond investors than for principal spent on design and construction of neighborhood schools.

These clever campaign tactics would probably withstand legal challenges based on California Elections Code Section 9509, which establishes a standard for a legitimate challenge to a title, question, or statement of a school or college district ballot measure. A complaint must have “clear and convincing proof that the material in question is false, misleading, or inconsistent” with state law.

Grassroots Activism on Bond Measures Is Difficult

1. Municipal Finance Is Confusing, Even for People Motivated to Understand It

As stated in a 2013-14 Orange County Civil Grand Jury report on Capital Appreciation Bonds, “This topic required extensive research. Numerous newspaper articles were reviewed…An extensive Internet search was conducted to learn about the mechanics of bond financing and the related mathematics.” An ordinary person may have difficulty understanding concepts and jargon of municipal finance. It’s also a challenge for anyone without education or experience in accounting to identify and extract relevant information from financial audits and official statements.

In particular, Capital Appreciation Bonds are difficult to comprehend. To complicate matters, accreted interest for this type of debt instrument is portrayed differently depending on whether accounting is done on a “cash basis” or on an “accrual basis.” In the generally accepted accounting principles developed by the Financial Accounting Standards Board, each year’s interest payment is included as an expenditure for the year. This is accounting done on a cash basis. But in the generally accepted accounting standards for state and local governments developed by the Governmental Accounting Standards Board, accreted interest on Capital Appreciation Bonds is not recorded as a current expenditure until the bond matures. This is accounting done on an accrual basis.

Translating these concepts into something easy to understand is critical for the public to evaluate the wisdom of proposed bond issues.

2. Centralized Data Isn’t Available to Compare Debt Finance Conditions of School and College Districts

Where does the public go to find out how a school or college district funds facility construction and how it compares to other educational districts in the county or state?

In most cases, state law has not assigned any state or local agency with the responsibility to collect such information and provide it to the public in an accessible format. Even for information that state law requires to be collected and published — such as waivers from tax and debt limits — agencies are not providing the information in a way that alerts the public to existing or potential problems.

The California State Treasurer’s office has a “California Debt Issuance Database” administered by the California Debt and Investment Advisory Commission that allows the public to search for certain information about individual bond issues. School boards are required to submit certain information and reports regarding the sale or planned sale of bonds to the California Debt and Investment Advisory Commission. This database is better than nothing, but realistically it is not a useful tool for the ordinary citizen.

3. Basic Financial Information Is Inaccessible, Especially at Smaller School Districts

Many school districts are not posting their state-mandated financial reports on their websites for public access. Useful documents that the public should be able to readily access include PDF versions of annual financial audits and bond program audits.

For cases in which financial reports are not available on the web, adequate response to public records requests is often elusive. E-mailed requests to educational districts to get these reports do not always result in a prompt response. In particular, officials in small rural school districts do not seem responsive to an outside individual or organization requesting the district’s financial information. Researchers for this project struggled to obtain financial audits that would reveal details of Capital Appreciation Bond sales with ratios of debt service to principal that are much worse than the Poway Unified School District.

4. “Private Placements” Sometimes Eliminate Official Statements as a Source of Data

The Municipal Securities Rulemaking Board (MSRB) Electronic Municipal Market Access (EMMA) database was created and is maintained for the benefit of potential buyers of municipal bonds. Nevertheless, the Official Statements posted on the database are a valuable source of information for members of the general public who are interested in the debt finance and financial status of a state or local government agency.

Some school districts use “private placement” to sell bonds rather than using a more traditional method of selling bonds in the primary market to many investors. This is supposed to allow for lower interest rates on the bonds and save money for taxpayers. Because the individual private investors are considered qualified to do their own research into the credit and financial status of a district, “private placements” for bond sales by educational districts are exempt from the federal requirement to post Official Statements.

Researchers were unable to determine current debt service for several small school districts for which Official Statements were not posted on EMMA. At least two of them (Exeter Union High School District and Columbia Union School District) used private placements for their most recent bond sales. It is likely that every school district missing an Official Statement on EMMA for its most recent bond issue used private placement.

5. Public Information About General Obligation Bonds Varies in Formats and Completeness

In the annual Financial Audits for educational districts, information about general obligation bonds are presented in different ways. Some reports give details about each series of bonds that are issued, while some do not.

The same problem applies to the Official Statements on the EMMA database. Charts that indicate outstanding debt service are presented in different formats. Some charts provide details about principal and interest for each bond measure and some do not. A few Official Statements for educational districts that have substantial bond debt did not even add up the columns.

Official Statements are only produced when bonds are issued, so the most recent information available on the EMMA database can be more than a decade out of date. EMMA only became operational in the late 2000s, so information from the mid-1990s and earlier is often not available.

6. Refunding Bonds and Reauthorization Bonds Complicate Matters

When a school district refunds some of its bonds with a new bond issue, the record becomes fuzzy about how much principal is still owed for each bond measure and bond issue. Some districts have repeatedly issued refunding bonds, thus creating confusion about what bond measures are responsible for creating current debt. Taxpayers in some educational districts are still paying for bond measures approved in the late 1980s and early 1990s, but that fact is now hidden behind more recent refunded bond issues.

Since 2000, sixteen school districts have asked voters to reauthorize previously-approved bond authority, thus complicating the reporting of bond authority and bond debt. When voters reauthorize bond authority in a new election, they trigger new capacity for the district to levy taxes and accumulate debt. GO Reauthorization Bonds®, developed by the municipal debt financial advisory firm Dale Scott & Company, are marketed to districts that have reached their tax and debt limits, want to borrow more money for construction, but also want to avoid extensive sales of Capital Appreciation Bonds as the scheme to circumvent the tax and debt limits.

7. Critical Information Often Can Only Be Found in Old Board Meeting Packets Not Available for Easy Public Access

Perhaps the most important information to evaluate when considering bond issues are the projections of assessed valuation. If such projections are even recorded, they are often only found in presentations that financial advisors make to the board of trustees. Those presentations might or might not be included in old board meeting packets that might or might not be posted on a district website.

Sources

“2015 School Bond Transparency Scorecard,” San Diego County Taxpayers Association, www.sdcta.org/policy/policy-detail.html?id=1727

“School Bond Citizens’ Oversight Committees, Prop 39,” San Mateo County Grand Jury, https://www.sanmateocourt.org/documents/grand_jury/2009/prop39.pdf

“Re: Poway Unified School District v. All Persons Interested – Superior Court of California, County of San Diego, Case No. 37-2010-00106255-CU- MC-CTLAG,” California Attorney General letter to Poway Unified School District, Orange County Government, March 1, 2011, accessed June 28, 2015, http://cams.ocgov.com/Web_Publisher/Agenda11_05_2013_files/images/ATTORNEY%20GENERAL%20OPINION%20-%20POWAY%20BOND%20PREMIUM_9843497.PDF

“Resource Center,” California’s Coalition for Adequate School Housing, accessed June 28, 2015, https://www.cashnet.org/resource-center/resourcefiles/651.pdf

Text – AB 2551 “Local ballot measures: bond issues,” California Legislative Information, accessed June 28, 2015, http://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201320140AB2551

Text – AB 809 “Local initiative measures: ballot printing specifications,” California Legislative Information, accessed June 28, 2015, http://leginfo.legislature.ca.gov/faces/billTextClient.xhtml?bill_id=201520160AB809

“Bond Spending: Expanding and Enhancing Oversight,” California Little Hoover Commission, June 24, 2009, accessed June 28, 2015, http://www.lhc.ca.gov/studies/197/report197.pdf

“School Bonds: The Untold Story of Assessed Values,” Orange County Grand Jury 2013-14, accessed June 28, 2014, http://www.ocgrandjury.org/pdfs/2013_2014_GJreport/BondsReport.pdf

“Former Wiseburn Schools Chief Don Brann Will Take Reins of Troublec Inglewood Unified,” Daily Breeze, June 28, 2013, accessed June 28, 2015, www.dailybreeze.com/general-news/20130628/former-wiseburn-schools-chief-don-brann-will-take-reins-of-troubled-inglewood-unified

“We Have Your Money, Now What?” Solano County Grand Jury 2014-15, accessed June 30, 2015, http://solano.courts.ca.gov/materials/Measure%20Q.pdf

California Elections Code Sections 9500-9509, accessed June 28, 2015, http://www.leginfo.ca.gov/cgi-bin/displaycode?section=elec&group=09001-10000&file=9500-9509

California State Treasurer’s Office – “California Debt Issuance Database” administered by the California Debt and Investment Advisory Commission www.treasurer.ca.gov/cdiac/debtdata/database_text.asp

“How to Kick-Start a Stalled G.O. Bond Program,” Association of Chief Business Officials, May 21, 2013, accessed June 28, 2015, www.acbo.org/files/Conference/2013 Spring/GOReauthorizationBonds.pdf

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Table A-5 Arguments for Capital Appreciation Bonds

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
You are in this section: Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Table A-5 is meant to provide a resource for policymakers and the public to organize arguments about Capital Appreciation Bonds for issue briefs, letters, speeches, public comments, etc

Table A-5
Arguments for Capital Appreciation Bonds
ArgumentRebuttal
URGENCY
School facilities are desperately needed now: schools are overcrowded, deteriorating, outdated, and unsafe. These claims are rarely quantified. There needs to be an objective way to determine that need overwhelms the risk of massive tax and debt burdens for future generations.
Despite 14 years of Proposition 39, educational districts continue to increase the number of bond measures on the ballot and the total amount authorized to borrow. It seems that spending between $100-$200 billion on construction since 2000 has only increased the need for more.
It’s possible that educational districts are preparing for a population boom that may never occur. Average Daily Attendance for California K-12 school districts has dropped from 5,927,951 in 2003-04 to 5,631,709 in 2008-09 to 5,501,603 in 2013-14. Actual California population growth is lagging behind projections made in the 1990s.
When the bond measure was before voters for consideration, the educational district made promises to residents about what was going to be built and what the tax rate would be. Those promises must be fulfilled. Voters want the projects now.Anecdotally, it appears that voters aren’t necessarily keen on immediately proceeding with construction projects listed in bond measure ballot statements if it requires borrowing money under outlandish terms via sales of Capital Appreciation Bonds or other unconventional methods of debt finance. Taxpayers would rather give their money to their local educational district than to bond investors.
Who actually applies the most pressure on the educational district to proceed with borrowing money? Are educational districts selling Capital Appreciation Bonds or other unconventional methods of debt finance because parents and teachers are demanding it? Or is the political pressure coming from the various interests that contributed to the bond measure campaign and now want to reap the rewards of contracts for this construction program?
Interest rates are low. This is a good time to borrow money, perhaps with a mix of Current Interest Bonds and Capital Appreciation Bonds. Rates may not be so favorable when assessed valuation of property in the district goes up.Interest rates are low and provide an advantage for educational districts issuing Current Interest Bonds, but the outrageous nature of Capital Appreciation Bond negates the benefit of lower rates. The ratio of debt service to principal should not exceed 3 or 4 (at the most) for an individual bond issue.
Educational districts will jeopardize the quality of education for students if they don’t get funding for construction now.Is it true that new and modernized facilities significantly improve academic performance and life preparation for students? Is the impact of bond measures on test scores proportionate to the amount of tax revenue spent on debt service for those bond measures? Or are bond measures simply an easy method to get more money flowing into the district?
Ongoing construction programs would have to stop if funding isn’t obtained now, causing inconvenience, stopping momentum, and risking a higher cost of construction in the future.A realistic projection for assessed valuation of property would allow for better planning of construction-related contracts. Future generations should not have to pay for the risky borrowing practices of this generation’s leaders.
STINGY STATE LAWS COMPEL USE
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because of unreasonably low tax and debt limits established in state law.The California legislature established these limits in state law in 2000 as part of a strategy to boost voter support for Proposition 39, a statewide measure on the November 2000 ballot to modify Proposition 46 enacted in 1986 - an initiative that modified the high-profile Proposition 13 enacted in 1978. Without limits and other additional taxpayer protections, Proposition 39 might have failed, as Proposition 26 failed in March 2000.
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because assessed valuation of property in the districts unexpectedly declined, thus forcing districts to confront tax and debt limits.It’s important to obtain an independent projection of assessed property valuation that does not extend a current exceptional rate of growth for 40 years.
THESE BOND FINANCE DEALS ARE MISUNDERSTOOD
It’s wrong to consider Capital Appreciation Bonds in isolation. They are usually just a piece of a package of bond issues. When considered in conjunction with other bond issues, the debt to principal ratio is usually reasonable.This doesn’t eliminate the reality that bonds are issued that will need to be paid back decades later with compounded interest. Why include them at all?
Focusing on long-term debt service is misleading. Just because there is a high number for aggregate accreted interest in 40 years doesn’t necessary mean that amount will ever be paid. Many Capital Appreciation Bonds are “callable” and can be redeemed (and are being redeemed) with a new issue of refunding bonds that have lower rates and can be issued as traditional Current Interest Bonds. Because of the consistent increasing value of property in California over several generations, an amount that seems high to taxpayers now will not be so daunting decades from now. Routine inflation will reduce the “real” cost of paying back Capital Appreciation Bonds decades from now. This is public money. The decision to borrow money via Capital Appreciation Bonds assumes that assessed valuation of property and the rate of inflation will increase substantially over decades. And some districts (such as Poway Unified School District) have sold Capital Appreciation Bonds that are not callable.
Contrary to claims made after the fact, plenty of information is provided to educational district administrators and elected board members about bond sales. There isn’t an excuse for not understanding the proposal.Information is not presented in a standardized way that is easy to understand. Most school board members do not have a background in accounting, finance, or bonds. In addition, school board members may be hesitant to publicly acknowledge their lack of understanding, especially if everyone else in the room is nodding heads during the bond consultant presentation.
Critics have self-interested motivations to criticize. Traditional and consistent ideological detractors of government schools want to take advantage of yet another opportunity to undermine the system. Cynical politicians want to exploit bad news in order to build a reputation. News media wants to improve reader and viewer ratings through sensational and misleading coverage.Most people would acknowledge that criticism of at least a few bond issues by California educational districts has merit. In addition, there are self-interested motivations for people denying that Capital Appreciation Bonds and other unconventional bond financing are unusual or unwise. Community college and K-12 school district elected officials wanted to stay in office. District administrators wanted to keep their jobs. And of course professionals in the financial industry wanted to continue making a living from the transaction fees generated by bond sales.
Assembly Bill 182 (2013) wasn’t really needed, but it is now law and there are no valid arguments to impose more restrictions on this valuable tool for educational districts.Educational districts are still selling Capital Appreciation Bonds (and also Bond Anticipation Notes) under the assumption that assessed valuation will continue to rise for decades. The bond financing industry will continue to use these schemes to bloat borrowing and collect more transaction fees.
Table A-5
Arguments for Capital Appreciation Bonds
ArgumentRebuttal
URGENCY
School facilities are desperately needed now: schools are overcrowded, deteriorating, outdated, and unsafe. These claims are rarely quantified. There needs to be an objective way to determine that need overwhelms the risk of massive tax and debt burdens for future generations.
Despite 14 years of Proposition 39, educational districts continue to increase the number of bond measures on the ballot and the total amount authorized to borrow. It seems that spending between $100-$200 billion on construction since 2000 has only increased the need for more.
It’s possible that educational districts are preparing for a population boom that may never occur. Average Daily Attendance for California K-12 school districts has dropped from 5,927,951 in 2003-04 to 5,631,709 in 2008-09 to 5,501,603 in 2013-14. Actual California population growth is lagging behind projections made in the 1990s.
When the bond measure was before voters for consideration, the educational district made promises to residents about what was going to be built and what the tax rate would be. Those promises must be fulfilled. Voters want the projects now.Anecdotally, it appears that voters aren’t necessarily keen on immediately proceeding with construction projects listed in bond measure ballot statements if it requires borrowing money under outlandish terms via sales of Capital Appreciation Bonds or other unconventional methods of debt finance. Taxpayers would rather give their money to their local educational district than to bond investors.
Who actually applies the most pressure on the educational district to proceed with borrowing money? Are educational districts selling Capital Appreciation Bonds or other unconventional methods of debt finance because parents and teachers are demanding it? Or is the political pressure coming from the various interests that contributed to the bond measure campaign and now want to reap the rewards of contracts for this construction program?
Interest rates are low. This is a good time to borrow money, perhaps with a mix of Current Interest Bonds and Capital Appreciation Bonds. Rates may not be so favorable when assessed valuation of property in the district goes up.Interest rates are low and provide an advantage for educational districts issuing Current Interest Bonds, but the outrageous nature of Capital Appreciation Bond negates the benefit of lower rates. The ratio of debt service to principal should not exceed 3 or 4 (at the most) for an individual bond issue.
Educational districts will jeopardize the quality of education for students if they don’t get funding for construction now.Is it true that new and modernized facilities significantly improve academic performance and life preparation for students? Is the impact of bond measures on test scores proportionate to the amount of tax revenue spent on debt service for those bond measures? Or are bond measures simply an easy method to get more money flowing into the district?
Ongoing construction programs would have to stop if funding isn’t obtained now, causing inconvenience, stopping momentum, and risking a higher cost of construction in the future.A realistic projection for assessed valuation of property would allow for better planning of construction-related contracts. Future generations should not have to pay for the risky borrowing practices of this generation’s leaders.
STINGY STATE LAWS COMPEL USE
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because of unreasonably low tax and debt limits established in state law.The California legislature established these limits in state law in 2000 as part of a strategy to boost voter support for Proposition 39, a statewide measure on the November 2000 ballot to modify Proposition 46 enacted in 1986 - an initiative that modified the high-profile Proposition 13 enacted in 1978. Without limits and other additional taxpayer protections, Proposition 39 might have failed, as Proposition 26 failed in March 2000.
Educational districts have to sell Capital Appreciation Bonds or other unconventional methods of debt finance because assessed valuation of property in the districts unexpectedly declined, thus forcing districts to confront tax and debt limits.It’s important to obtain an independent projection of assessed property valuation that does not extend a current exceptional rate of growth for 40 years.
THESE BOND FINANCE DEALS ARE MISUNDERSTOOD
It’s wrong to consider Capital Appreciation Bonds in isolation. They are usually just a piece of a package of bond issues. When considered in conjunction with other bond issues, the debt to principal ratio is usually reasonable.This doesn’t eliminate the reality that bonds are issued that will need to be paid back decades later with compounded interest. Why include them at all?
Focusing on long-term debt service is misleading. Just because there is a high number for aggregate accreted interest in 40 years doesn’t necessary mean that amount will ever be paid. Many Capital Appreciation Bonds are “callable” and can be redeemed (and are being redeemed) with a new issue of refunding bonds that have lower rates and can be issued as traditional Current Interest Bonds. Because of the consistent increasing value of property in California over several generations, an amount that seems high to taxpayers now will not be so daunting decades from now. Routine inflation will reduce the “real” cost of paying back Capital Appreciation Bonds decades from now. This is public money. The decision to borrow money via Capital Appreciation Bonds assumes that assessed valuation of property and the rate of inflation will increase substantially over decades. And some districts (such as Poway Unified School District) have sold Capital Appreciation Bonds that are not callable.
Contrary to claims made after the fact, plenty of information is provided to educational district administrators and elected board members about bond sales. There isn’t an excuse for not understanding the proposal.Information is not presented in a standardized way that is easy to understand. Most school board members do not have a background in accounting, finance, or bonds. In addition, school board members may be hesitant to publicly acknowledge their lack of understanding, especially if everyone else in the room is nodding heads during the bond consultant presentation.
Critics have self-interested motivations to criticize. Traditional and consistent ideological detractors of government schools want to take advantage of yet another opportunity to undermine the system. Cynical politicians want to exploit bad news in order to build a reputation. News media wants to improve reader and viewer ratings through sensational and misleading coverage.Most people would acknowledge that criticism of at least a few bond issues by California educational districts has merit. In addition, there are self-interested motivations for people denying that Capital Appreciation Bonds and other unconventional bond financing are unusual or unwise. Community college and K-12 school district elected officials wanted to stay in office. District administrators wanted to keep their jobs. And of course professionals in the financial industry wanted to continue making a living from the transaction fees generated by bond sales.
Assembly Bill 182 (2013) wasn’t really needed, but it is now law and there are no valid arguments to impose more restrictions on this valuable tool for educational districts.Educational districts are still selling Capital Appreciation Bonds (and also Bond Anticipation Notes) under the assumption that assessed valuation will continue to rise for decades. The bond financing industry will continue to use these schemes to bloat borrowing and collect more transaction fees.

Table A-6 Arguments Against Capital Appreciation Bonds

See the complete California Policy Center report For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction (complete, printable PDF Version, 4 MB, 361 pages)

Links to all sections of this study readable online:
Executive Summary: “For the Kids” – Comprehensive Review of California School Bonds (1 of 9)
More Borrowing for California Educational Construction in 2016 (2 of 9)
Quantifying and Explaining California’s Educational Construction Debt (3 of 9)
How California School and College Districts Acquire and Manage Debt (4 of 9)
Capital Appreciation Bonds: Disturbing Repayment Terms (5 of 9)
Tricks of the Trade: Questionable Behavior with Bonds (6 of 9)
The System Is Skewed to Pass Bond Measures (7 of 9)
More Trouble with Bond Finance for Educational Construction (8 of 9)
Improving Oversight, Accountability, and Fiscal Responsibility (9 of 9)
You are in this section: Guide to all Tables and Appendices – Comprehensive Reference for Researchers


Table A-6 is meant to provide a resource for policymakers and the public to organize arguments about Capital Appreciation Bonds for issue briefs, letters, speeches, public comments, etc.

Table A-6
Arguments Against Capital Appreciation Bonds
ArgumentRebuttal
THE BOND FINANCE INDUSTRY IS NOT TRUSTWORTHY
Promoters of bond deals are motivated by transaction fees and tend to advance funding proposals in their own interest but harmful to the public interest.Borrowing money for long-term investment is a well-accepted practice in the United States and a fundamental part of our economic system.
Most people involved with bond finance are ethical and enjoy being in a professional financial vocation that helps students and society.
The few bond finance professionals who are alleged to advise decisions not in the interest of their clients earn a bad reputation and can’t stay in the business.
Companies and individuals who work in the business of assisting with capital transfer and earn fees on those transactions are an easy target to malign, but they are essential to a prosperous economy.
Proving their lack of responsibility to the public, the California Public Securities Association in 2009 sponsored Assembly Bill 1388, a self-interested bill that repealed a law requiring that the maximum annual payment of principal and interest on a bond issue cannot exceed the minimum annual payment of principal and interest by more than 10 percent.Actually, this bill helped educational districts by allowing them greater opportunity to borrow money despite reaching state tax and debt limits or despite reaching tax and debt limits indicated in the bond measure.
Excessive competition in the market to win contracts from educational districts for bond finance services has compelled some companies to overstate benefits and understate risks of unconventional bond finance.Increased competition in municipal bond finance gives educational districts the opportunity to compare numerous potential contractors and chose the one that best suits its needs. Districts concerned about debt accumulated through Capital Appreciation Bonds can award contracts to professional service firms that adopt a conservative approach to bond finance.
Increased competition in municipal bond finance has encouraged the development and promotion of more creative and effective options to help educational districts in bond finance, such as Reauthorization Bonds and Ed-Tech Bonds.
Corruption is rampant in the municipal bond finance business, as proven by apparent “pay to play” practices between educational districts and bond underwriters.Many parties in the bond financial industry resent how their reputation is tainted by a few companies that make substantial contributions to bond measure campaigns and/or consult for those campaigns and then obtain no-bid contracts and/or higher transaction fees. They have asked the Municipal Securities Rulemaking Board (MSRB) to restrict parties in the financial services industry from contributing to bond campaigns. They have also collectively adopted a voluntary internal moratorium on the practice.
Some county treasurers, for example in Los Angeles County, have ended business with securities brokers that contribute to campaigns for bond measures. The problem is being addressed.
The Municipal Securities Rulemaking Board already has a regulation requiring brokers, dealers, and municipal securities deals to disclose their campaign contributions to allow public scrutiny of such political activity.
Political campaigns are expensive. Parents and students are unlikely to be major sources of contributions to a campaign to pass a bond measure. There is nothing wrong with companies contributing to a campaign and expressing their First Amendment constitutional right to free speech.
No one has ever proven this practice actually happens.
Claims about this practice come from firms that want to stifle competition from other firms that work harder for educational districts.
Educational districts are no different than victims of loan sharks, payday lenders, mortgage scammers, and other unsavory usurers.Comparisons of professional, certified financial service providers to criminals is unjust. Boards elected by the people consider and vote on proposals for bond issues at public meetings regulated by open meetings laws. The process is highly regulated by the US Securities and Exchange Commission and the Municipal Securities Rulemaking Board. The news media has the opportunity to follow and report on the issue to the public.
LACK OF PUBLIC KNOWLEDGE COMPROMISES ACCOUNTABILITY AND ALLOWS TAXPAYERS TO BE EXPLOITED
Few Californians have ever heard of Capital Appreciation Bonds. An even tinier percentage of Californians could adequately explain them. As a result, the public is currently incapable of evaluating this method of bond finance and petitioning their school or college board members about it.Government does many things that the general public does not know about or understand. Accountability is inherent in the regular elections for governing boards. Candidates run for and get elected to public office based on their individual expertise and experience. Voters can subsequently choose to end the public service of those individuals based on their performance.
Educational districts have professional in-house superintendents and often have other administrators overseeing bond deals, including business officers assigned to work on bond finance.
Educational districts hire outside experts to maximize the effectiveness of their bond measures and best serve the public. Contracts for these experts include terms and conditions that provide protection for the district and accountability to the consultant.
State and county elected and appointed officials and their agencies serve as checks and balances for educational district decisions. In particular, county treasurers can and do play a role in evaluating questionable bond financing.
In the few cases in which excessive or inappropriate bond deals may have occurred, (for example, the 2011 bond issue at the Poway USD), elected county treasurers and the news media did identify the failure and publicized it. Assembly Bill 182 (now in law) is the product of research and reporting by elected government officials and the news media. The system of checks and balances worked.
Voters are not informed in election ballot material that some of the money they authorize to borrow via “general obligation bonds” ends up borrowed via Capital Appreciation Bonds and other unconventional borrowing practices.Actually, some ballot statements are now indicating that “no capital appreciation bonds shall be issued.” Inclusion of language specifying the type of General Obligation bonds to be sold should be a decision of the district board and not mandated by the state.
It’s unfair for educational districts to be forced to speculate to voters on how it might borrow money. Financing decisions are made by elected board members based on economic conditions that cannot be known at the time the bond measure is considered.
State law already imposes numerous burdensome and costly requirements on educational districts to ensure voters have a reasonable degree of information for consideration of a bond measure.
Ballot statements already are so long that few people would see any authorizations for the district to Capital Appreciation Bonds and other unconventional borrowing practices if they were included.
COST, TAXES, AND DEBT ARE FOOLHARDY
It’s foolish to borrow money and then wait for decades to start paying off the principal and accreted interest.What’s foolish are the tax and debt limitations established by state voters as Proposition 13 in 1978 and state laws (Assembly Bill 1908) enacted in conjunction with putting Proposition 39 on the statewide ballot in 2000. If those limits were set at a higher threshold or eliminated altogether, Capital Appreciation Bonds and other unconventional financing schemes would become rare.
Property taxes may increase substantially many years in the future when the district begins paying off the debt.It’s unlikely the taxes will end up being particularly noteworthy or burdensome after decades of increased property value and inflation.
The amount to be paid back under Capital Appreciation Bonds is too high.Just because there is a high number for aggregate accreted interest in 40 years doesn’t necessary mean that amount will ever be paid. Many Capital Appreciation Bonds are “callable” and can be redeemed (and are being redeemed) with a new issue of refunding bonds that have lower rates and can be issued as traditional Current Interest Bonds.
Because of the consistent increasing value of property in California over several generations, an amount that seems high to taxpayers now will not be so daunting decades from now.
Routine inflation will reduce the “real” cost of paying back Capital Appreciation Bonds decades from now.
Focusing on the amount of debt service generated by Capital Appreciation Bonds ignores the intangible benefits of high-quality schools with environments conducive to teaching and learning
Capital Appreciation Bonds are used too often.For most educational districts, Capital Appreciation Bonds comprise a small percentage of the total amount of bonds issued. Capital Appreciation Bonds are a legitimate and beneficial option for educational districts that want to obtain a bit more of the money that voters authorized to borrow for needed school construction.
Capital Appreciation Bonds allow educational districts to fund contracts with local contractors and vendors, thus encouraging economic growth and job creation in the community. Capital Appreciation Bonds pay for themselves by generating increased economic activity.
There are no legal or commonly accepted definitions of “too often.” The authority to issue Capital Appreciation Bonds is granted to the educational district’s board of trustees, who are elected by the people. Each educational district has its own comfort for Capital Appreciation Bonds, and this comfort usually reflected in the decision of the board. Trust our representative democracy.
Capital Appreciation Bonds assume an ability to pay based on projections of increased value of taxable property that may extend as many as 40 years into the future.Granted, no one can perfectly predict the future. But California remains a desirable place to live because of its climate, natural beauty, economic prosperity, and culture. It’s reasonable to assume that people with ability and ambition will always come to California, a beacon for the world, and thus increase demand for housing.
The best way to ensure increased property values in the future is to build a foundation of high-quality schools with environments conducive to teaching and learning. Funding for new construction - sometimes obtained through Capital Appreciation Bonds - allow these schools to be provided and fulfills the expectation for increased property values.
Without any sort of representation, future generations of taxpayers (children and grandchildren) are bound to repaying debts accumulated by unconventional borrowing practices of current generations.Schools built using Capital Appreciation Bonds are for the benefit of our children and grandchildren. Shouldn’t they contribute to paying for the system that helped to make them successful?
This is an unfortunate distortion of the concept of “taxation without representation” that applies to people who are deprived of their right for full participation in their current governance. Many of the important and transformational social programs in the United States and in California were adopted before the people now benefiting and paying for them were even born. Generations work together cooperatively to advance progress.

The Looming Bipartisan Backlash Against Unionized Government

Whenever discussing politically viable policy proposals to improve the quality of life in California, the imperative is to come up with ideas that strongly appeal to moderate centrists, since that is how most Californians would describe themselves. And there are two compelling issues that offer that appeal: making California’s system of K-12 education the best in the world, and restoring financial sustainability to California’s state and local governments.

While these two objectives have broad conceptual appeal, there is a clear choice between two very different sets of policies that claim to accomplish them. The first choice, promoted by public sector unions, is to spend more money. And to do that, their solution is to raise taxes, especially on corporations and wealthy individuals. The problem with that option, of course, is that California already has the highest taxes and most inhospitable business climate in the U.S.

The alternative to throwing more money at California’s troubled system of K-12 education and financially precarious cities and counties is to enact fundamental reforms. And these reforms, despite the fact that each of them arouses relentless, heavily funded opposition from government worker unions, are utterly bipartisan in character. They are practical, they are fair, and they are not ideologically driven.

Education Reforms:

  • Faithfully implement the Vergara Ruling – abolish the union work rules that (1) grant teacher tenure well before new teachers can be properly trained and evaluated, (2) protect incompetent teachers from dismissal, and (3) favor seniority over merit when implementing workforce reductions.
  • Streamline permitting for charter schools. These independent enterprises allow far greater flexibility to teachers and principals, creating laboratories where new best practices can rapidly evolve. Poorly performing charter schools can be shut down, successful ones can be emulated.
  • Enable school choice, so parents can move their students out of bad schools. Start by aggressively promoting and supporting California’s 2010 Open Enrollment Act, that empowers any parent whose child attends one of the state’s 1,000 lowest performing schools to move them to the school of their choice.

Financial Sustainability Reforms:

  • Roll back defined benefit pension formulas to restore viable funding and protect taxpayers. Adopting “triggers” that prospectively lower pension benefit accruals for existing workers and suspend COLAs for retirees, will preserve the defined benefit. One more market downturn will make this choice unavoidable – the sooner this reform is accepted, the more moderate its impact.
  • Reform public employee compensation. The average total compensation for California’s state and local government workers (taking into account all employer paid benefits including retirement benefits and annual paid vacations/holidays) is now more than twice the median compensation for private sector workers. Typically, approximately 70% (or more) of local government budgets are for personnel costs. Public sector compensation needs to be frozen – or even reduced – until the private sector can catch up.
  • Modernize and streamline public agencies. Introduce flexibility to job descriptions and eliminate unnecessary positions. Upgrade and automate information systems.
  • Improve financial management and accountability. The public sector needs to adhere to the same accounting standards that govern the private sector. If anything, public sector reporting should be more standardized, and faster, than what is required in private industry – currently the opposite applies.
  • Eliminate exploitative financing mechanisms: Outlaw capital appreciation bonds, revenue anticipation bonds, and pension obligation bonds, for starters. Nearly all of the “creative” financing instruments being foisted onto relatively unsophisticated city councils are short-term solutions that create long-term financial nightmares.

There are many other fundamental reforms that could rescue California’s K-12 educational system and rescue California’s state and local finances. But the ones listed here would be a very good start. And while there is plenty of room for debate over the particulars of each of these proposed reforms, there is only one powerful interest group that vigorously opposes all of them – public sector unions.

The reality of California’s unacceptable educational results and insolvent cities and counties will compel concerned citizens of all political persuasions to examine these issues over the next several years. And in that process, the inherent conflict between public sector unions and the public interest will become increasingly obvious. To survive, public sector unions will have to accept reforms that challenge their agenda. They will have to accept meaningful pension and compensation reform. They will have to accept smaller, more efficient workforces. They will have to embrace individual accountability and reward individual merit in public education and throughout public agencies. They will have to abandon their symbiotic relationship with financial predators that pump cash into bloated, unionized public agencies on terms that are usurious to taxpayers.

To the extent public sector unions are not willing to attenuate their power and adapt their agenda to the public interest, their recalcitrance will invite a bipartisan fury from a betrayed people. Even in California.

*   *   *

Ed Ring is the executive director of the California Policy Center.

The Misleading and Incomplete Financial Disclosures of Public Institutions

Last week the California Public Policy Center published a study assessing the impact of new regulations issued by the Government Accounting Standards Board. The new ruling will require public entities to recognize unfunded pension liabilities on their balance sheets. This is a major reform. But it points to a larger issue. California’s state and local government entities and their closest financial collaborators – public sector unions, bond underwriters and pension funds – have an incentive to overstate their financial health, and understate the significance of many of the root causes of their financial distress. Here are a few examples, with links to reports that provide more detail:

(1) They mislead voters into believing government workers are underpaid, when in fact they now earn total pay and benefits that are well over twice the average for private sector workers.
“Work in Progress” Government Employee Pay Tracker Still Grossly Inaccurate
December 3, 2013, UnionWatch

(2) They claim personnel costs are only a small fraction of state and local government budgets, when in fact they usually comprise 65% to 80% of total government spending.
What Percent of California’s State and Local Budgets are Employee Compensation?
February 11, 2011, UnionWatch

(3) They campaign for tax increases to “save our schools,” then instead give the money to their pension funds.
Editorial: Prop. 30’s pension boost
November 28, 2012, Orange County Register

(4) They fail to recognize unfunded pension and retirement health care liabilities on their balance sheets.
Accounting Standards, Not Elections or Litigation, Will Finally Enable Reform
February 19, 2013, UnionWatch

(5) They mislead voters into thinking the average government pension is only $25,000 per year, when in fact, a government worker who puts in a 30 year career and retires today can expect a pension that averages over $60,000 per year.
CSEA Understates Average State Pension
May 31, 2011, UnionWatch

(6) They issue “pension obligation bonds,” borrowing money in order to make their annual pension fund contributions.
Pension Obligation Bonds: Borrowing Our Way to Prosperity?
February 9, 2010, Mackinac Center

(7) They issue “capital appreciation bonds,” deferred payment, “negative amortization” scams that should be illegal.
School bond terms more like payday loans
February 1, 2013, Orange County Register

(8) They fail to disclose total outstanding state and local government debt.
State Treasurer Doesn’t Know How Much California Owes in Bond Debt
December 4, 2012, UnionWatch
How Big is California’s “Wall of Debt”?
January 15, 2012, UnionWatch

The primary impact of all of these examples is the same; more deficit spending, and more outstanding debt. In each of them, by misleading the public and by failing to disclose clear summaries of financial realities, the beneficiaries are public sector unions and financial firms. The irony is staggering. At the same time as public sector unions relentlessly accuse “Wall Street” of enriching themselves through financial chicanery, they collude with financial interests to drag America’s public institutions deeper into a mire of debt. And they get away with it because cities, counties, government agencies, government employee pension funds, and public sector unions – are not held to the same disclosure rules or accounting standards as the private sector, nor subject to the same financial reforms.

The irony runs even deeper. Because it is debt formation itself that enables stratification of wealth and privatization. The only sector of the economy that reaps perennial benefit from government debt issuances and outstanding government debt are the Wall Street brokerages who collect the fees and their wealthy clients who collect the interest. The more encumbered local government entities are with debt, the more they are compelled to pass new regulations and attendant fees, as well as raise taxes, in order to pay the bankers. This undermines the prospects of the upwardly mobile, the emerging companies, the middle class private sector taxpayers, at the same time as it empowers established wealthy elites and corporate monopolies.

The connection between government insolvency and the destruction of public institutions cannot be overstated. When governments can’t afford to maintain basic services because too much of their revenues are used to service bond debt and feed pension funds – i.e., wealthy financial interests – the only solution left is privatization. Isn’t that anathema to the agenda of public sector unions?

California’s total state and local government debt is approaching a trillion dollars. But nobody, not the State Controller, the State Treasurer, the California Dept. of Finance, or the Office of Legislative Analyst, knows exactly how much is owed. Yet as long as borrowing can cover deficits, spending cuts can be deferred. This is a powerful incentive indeed to anyone who works for the government or contracts with the government to remain optimistic, and back up their optimism with misleading, incomplete financial disclosures.

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UnionWatch.org is edited by Ed Ring, who can be reached at editor@unionwatch.org

State Treasurer Doesn’t Know How Much California Owes in Bond Debt

One would think that Californians would know by now that bonds are nothing more than taxes plus interest. After all, when people were borrowing against their home equity to pay off bills and buy things, didn’t they learn the hard way that the money had to be paid back with interest? Borrowing IS spending. Bonds ARE taxes.

Now a clever way for governments to borrow money has become popular in California that even Democratic Treasurer Bill Lockyer has compared to the deceptive home loans of the last decade. Remember those? The too-good-to-be-true loan packages, where interest payments were deferred for a few years, or “locked in” at lower than market rates until five years into the loan, wherein they would reset at market rates, raising the monthly payment to unsustainable levels? But while consumers started to learn tough financial lessons back in 2008, government is heading for a tough financial lesson today. And the same financial sharks who fled town when the real estate bubble popped five years ago are having a feeding frenzy on the municipal bond market.

We’re talking about Capital Appreciation Bonds. These are loans that, typically, require no payments of principal or interest for between 10 and 20 years, then once this grace period expires, payment of principal plus interest must be paid in full. Other variants of these loans require no payments for the first 10-20 years, then the loan must start getting repaid over the next 10-20 years, with payments based on the new balance which includes compounded interest. What a temptation for politicians who not only can’t raise taxes, but can’t even afford interest payments! Talk about kicking the can down the road.

There is a legitimate justification for issuing bonds that are paid off over decades. It applies when the project that the bond proceeds will fund is a long-term investment in capital and infrastructure that will have a useful life that meets or exceeds the term of the bond. Thus the borrower pays the cost of paying for an asset during the time they are using the asset. But capital appreciation bonds violate this justification, because since they require zero payments during most of the presumed useful life of whatever asset they are financing.

The financial hole that capital appreciations bonds are getting our cities into, as if they didn’t have enough financial challenges meeting current obligations or funding future retirement pension and healthcare obligations for current workers, has been covered fairly well already. On November 29, 2012, the Los Angeles Times published an article by Dan Weikel entitled “Risky bonds tie schools to huge debt,” where they reported on capital appreciation bonds used to finance school construction and maintenance, and had this to say:

“Most school bonds, like home mortgages, require roughly $2 to $3 to be paid back for every $1 borrowed. But CABs compound interest for much longer periods, meaning repayment costs are often many times that of traditional school bonds.

CABs, as the bonds are known, allow schools to borrow large sums without violating state or locally imposed caps on property taxes, at least in the short term. But the lengthy delays in repayment increase interest expenses, in some cases to as much as 10 or 20 times the amount borrowed.”

The LA Times also published a companion article where they provided a spreadsheet that tracked Capital Appreciation Bonds (spreadsheet) just for school districts in California. This spreadsheet showed that $5.6 billion in capital appreciation bonds have been issued to fund education to-date, and that the payments, most of which will not come due for another 20 years, will total $24.0 billion. But the borrowing disclosed on this spreadsheet is just for education, and it is just those borrowings that took the form of capital appreciation bonds. It is only a small portion of the debt.

So how deep is the hole? How much do California’s state and local governments owe? How much of that borrowing is via conventional bond financing, and how much of it is via capital appreciation bonds?

If you think the California State Treasurer’s office would know the answer to this question, you would be wrong. UnionWatch inquiries to that office yielded helpful suggestions to refer to the California Debt and Investment Advisory Commission’s webpage that discloses California Public Debt Issuance – Yearly Totals 1985-2012. From this table you can see both state and local borrowing per year. The biggest borrowing year was 2009, with $95 billion in debt issuance. The average since 2000 is well over $50 billion per year. But how much of this debt was reissuance of old debt? How much of it is new debt? What is the cumulative outstanding debt of state and local governments in California? How much of that outstanding debt takes the form of Capital Appreciation Bonds?

We asked. Nobody knows. They’re working on it. The spokesperson suggested we consult someone with a subscription to Bloomberg online, wherein we suggested they get one for their office. Why isn’t this information a click away, clear for every journalist and policymaker in California to immediately apprehend? The reader may imagine what would happen to any treasurer in any large corporation if their department was unable to instantly produce this data. Such is the state of California’s public finance. This isn’t an unfunded liability for future obligations, such as pensions, where countless variables – including average lifespan, spiking impacts, and rates of return on investments – make precise estimates impossible. This is money borrowed, spent, and owed. It is a number that can be known to the penny. And in California, right now, we don’t know.