I am not an expert on Municipal Bonds, so if an expert reads this, and has corrections for me, please leave corrections in the comments.
In general, I am a conservative guy who avoids situations with a lot of debt. I am also an actuary and a financial analyst who has a lot of experience with long dated assets. I know how illiquid they can be, and how violent the price moves can be when they happen.
Most of the discussion here stems from this article: Where Borrowing $105 Million Will Cost $1 Billion: Poway Schools.
There are a few other notable writers who have picked up on this:
- Herb Greenberg: Are California Munis Paying Loan Shark Rates?
- Mike Shedlock: Ponzi Financing in Poway California Based on Massively Rising Property Values
But unlike them, I want to give you more data, and less opinion. For a start, here is the dense prospectus, should you want to review it.
As an aside, I looked at buying a house in Poway back in 1989, when I was considering a job in San Diego with the soon-to-be gone First Capital Holdings. Poway was what I could afford in such an expensive area.
Financial crises always come at the wrong time. In 2007, the Poway School District borrowed money to fix up the physical plant of the schools. They financed it short-term, then in early 2009 issued the “A” notes, financing much of the project, encumbering tax revenues out to 2032, and allowed the rest to float via General Obligation Anticipation Notes. The “A” series were also capital appreciation bonds, which means they are zero coupon bonds, and the interest comes from buying the bonds at a discount to the face value, and receiving the face value at maturity. The time period was shorter then the “B” notes, so they were cheaper, and hence less odious.
Given that they had already encumbered tax revenues all the way out to 2032, and had a large amount of debt that they needed to refinance, they needed to issue more permanent debt. They were already at their maximum level of what they could expect given assumed growth in the property tax base, so what could they do if they wanted to issue more general obligation debt without raising the tax rate?
After getting the assent of the voters in February 2008, to extend tax rates for an estimated additional 11 to 14 years, they issued the “A” notes, and then in 2011, the “B” notes. The “B” notes picked up where the “A” notes left off. They would make payments from 2033 through 2051.
Now, anyone who has worked with long duration fixed income (there aren’t many of us) know a few things:
- It’s illiquid because there aren’t that many that can fund it for so long. It becomes the province of strong balance sheets and speculators.
- It’s rare for people to give up current income for capital appreciation over the long haul. Most people need income over the next 20-30 years.
- Slight changes in the interest rate can make a lot of difference to the value of the debt.
- When you issue very-long-dated credit-sensitive notes, expect to pay a high yield. Poway SD is rated Aa2/AA-. That’s a high rating, but when you say you will pay nothing for 20 years, that injects a lot of uncertainty/risk into the likelihood of payment.
After all, what will the courts be like 20 years from now? What will the nation be like? What will we default on or inflate away? I know that present rules make it difficult for any entity to not repay General Obligation debt, but 20 years from now, things could be different.
The “B” notes, capital appreciatin bonds, that they offered in 2011 refinanced prior debts, and left $21 million to be used as they wished, which raised the hackles of the California Attorney General, though nothing came of that. Letter from the Attorney General Article on the topic — Second article on the topic
Take a look at the sources an uses of funds:
ESTIMATED SOURCES AND USES OF FUNDS
The proceeds of the Series B Bonds are expected to be applied as follows:
Sources of Funds
Principal Amount of Series B Bonds $105,000,149.70
Original Issue Premium 21,360,189.45
Total Sources $126,360,339.15
Uses of Funds
Deposit relating to partial payment of
Lease Revenue Bonds(1) $98,707,473.55
Deposit for full payment of 2010 Notes 26,270,000.00
Costs of Issuance(2) 569,114.44
Underwriter’s Discount 813,751.16
Total Uses $126,360,339.15
(1) Includes $98,327,473.55 for partial payment of the Lease Revenue Bonds and $380,000 for payment of costs associated with
refinancing the Lease Revenue Bonds.
(2) Includes, among other things, the fees and expenses of Bond Counsel, the fees and expenses of Disclosure Counsel, the fees and
expenses of District Counsel, the fees and expenses of the Paying Agent, the fees and expenses of School District consultants,
rating fees, the cost of printing the preliminary and final Official Statements and other costs associated with issuing, selling and
delivering the Series B Bonds, as well as costs associated with refinancing the 2010 Notes.
Disclosure data for the “B” series
Sources and Uses Table page 19
Bond payment schedule page 20
Projects should be funded over the useful life of the projects
Do without the improvements; user fees; cheaper to raise taxes
Betting on appreciation, both real estate, and the bonds
Premium — sources & uses
Right now, the district receives about $11 million a year from homeowners towards paying off its bonds.
So, to be able to afford its debt payments 20 years from now, the total assessed value of property within the taxed area would have to quadruple.
By David Merkel, CFA of Aleph Blog