How to Analyze Long Term Muni Debt: A Look at Poway School District

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.

How to Analyze Long Term Muni Debt: A Look at Poway School District

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:

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:

  1. 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.
  2. 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.
  3. Slight changes in the interest rate can make a lot of difference to the value of the debt.
  4. 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.

 

White paper from the LA Treasurer

 

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.

Yield change

By David Merkel, CFA of Aleph Blog



About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.