Financing with Bonds 2007 IASBO ANNUAL CONFERENCE.

Financing with Bonds

2007 IASBO ANNUAL CONFERENCE

May 2007Financing with Bonds – Overview and Procedures

GKST Public FinancePublic Education Group

Name Telephone e-mail Jamie Rachlin (312) 441-2601 [email protected]

Tim King (217) 762-4578 [email protected]

Todd McDonald (217) 762-4579 [email protected]

May 2007Financing with Bonds – Overview and Procedures

• Common reasons for issuing bonds

• Sources of bonding authority

• Referendum, backdoor referendum or non-referendum processes

• Types of school bonds

• The Property Tax Extension Limitation Act and the Debt Service Extension Base

• How much a District can borrow and repayment structures

Debt financing for schools is broad and complex. This overview has been assembled to summarize school borrowing for novice School Finance managers. This document will look at:

May 2007Financing with Bonds – Overview and Procedures

WHY DO DISTRICTS BORROW MONEY?

• Don’t have cash to pay project cost

• Tax caps limit ability to raise cash

• Reduce tax burden on current residents

• Spread project cost over its useful life

May 2007Financing with Bonds – Overview and Procedures

WHERE DOES AUTHORITY TO BORROW COME FROM?

• Federal Law

– Ability to issue tax-exempt bonds

– Legal use of proceeds

– Repayment requirements

• State Law

– Borrowing options

– Steps required to borrow

– Parameters for repayment

May 2007Financing with Bonds – Overview and Procedures

WHAT DO DISTRICTS BORROW FOR?Purpose Example

Buildings and Land Additional space to accommodate new students or new programs

Renovations and Additions Enhance or improve an aging or existing building that no longer supports the district's current curriculum or has insufficient space for new programs

Fire Prevention/Health, Life and Safety Repairs or improvements to a new building pursuant to State Order

Technology Funding of higher intial expenditures than the budget allows (and when vendor financing is too expensive)

Tort Liabilities Funding of a self-insurance program or a specific liability

Working Cash Supplement stagnant revenues, replenish fund balances, allow increased expenditures or to bond for a project rather than pay for it from current operations

Tax/Revenue/Grant Anticipation For short term needs until anticiated money becomes available

May 2007Financing with Bonds – Overview and Procedures

• Debt Certificates: a hybrid lease/installment purchase contract type of instrument that allows a school district to incur debt for tangible items.

• Alternate Revenue Bonds: these are general obligation bonds that are payable from a specified source but have a general obligation backup. The revenue source must offer debt service coverage of 1.25x. Sometimes called a “double barreled bond”.

• Non-voted General Obligation Bonds. For capped districts, these must be paid from the DSEB and are called a “Limited Tax Bond”. • Life/Safety Bonds: these are bonds that specifically fund Health/Life and

Safety to a school building pursuant to a State Order. • Working Cash. Subject to formula test to determine the maximum

authorized amount.• Funding Bonds: wide range of uses, from paying ongoing expenses of

the district to funding new construction.• Voted General Obligation Bonds: for any valid voted purpose, payable from

a property tax levy.• Notes and Warrants: Short-term to cover cash flow shortfalls.

PRIMARY TYPES OF SCHOOL BONDS

May 2007Financing with Bonds – Overview and Procedures

Backdoor Referendum

• When required by law (e.g. Working Cash Bonds, Funding Bonds, Alternate Revenue Bonds)

• Board resolution determines to commence process

• Noticed published in local paper gives residents 30 days to petition against bonds

• Petition must be signed by, in general, 10% of the district’s registered voters or bonds can be issued

Referendum

• A simple majority vote in a general election, generally used for major renovations or stand alone building projects.

Non-Referendum

• No referendum required if State Orders the sale of bonds (e.g. Fire Protection Health/Life Safety)

• No referendum required if bonds are payable from operations (e.g. Debt Certificates)

May 2007Financing with Bonds – Overview and Procedures

BORROWING OPTIONS UNIVERSE FOR ILLINOIS SCHOOLS

Backdoor Referendum No ReferendumLevy for Debt Service

Working Cash/Funding Bonds . - maximum amount determined by formula - paid from DSEB -G.O. limited as to amount

Life/Safety Bonds . - must be for approved life/safety amendment - paid from DSEB - G.O. limited as to amount

Pay from OperationsAlternate Revenue Bonds . - available revenue source pledged -1.25 times coverage requirement - G.O. unlimited as to rate or amount

Debt Certificates . - project improvements leased from Trustee - interest cost higher up to 0.25% - Not a G.O. of the District

*Note that schools can vote authority to sell bonds for a legal purpose.

May 2007Financing with Bonds – Overview and Procedures

HOW MUCH CAN THE DISTRICT BORROW?

Indebtedness limitations

Referendum/Ordinance

Debt Service Extension Base

Working cash formula (Federal restrictions, too)

May 2007Financing with Bonds – Overview and Procedures

INDEBTEDNESS LIMITATIONS

School Districts Maintaining K-8 or 9-12 Indebtedness may not exceed, for any purpose or by any amount, 6.9% of value of taxable property.

School Districts Maintaining K-12 Indebtedness may not exceed, for any purpose or by any amount, 13.8% of value of taxable property.

Exceptions: Rapidly growing districts Financially distressed districts.

May 2007Financing with Bonds – Overview and Procedures

Where a district is in a tax capped county, the Property Tax Limitation Law applies and imposes restrictions on borrowing by limiting a District’s authority to levy for non-voted general obligation bond as follows:

Debt Service Extension Base (DSEB) is the annual principal and interest allowed by law that can be levied for limited tax bonds in capped counties. It is based on the non-referendum debt levy of the district in the year in which caps were legislated or voted.

For Capped Districts Only• The annual levy for non-voted general obligation bonds is limited to the District’s

DSEB.

• In the case of Cook and Collar Counties, the DSEB is the 1994 levy, while the Downstate Counties are restricted to their levy at time cap is voted.

• Those with no non-voted general obligation bonds outstanding when capped have no DSEB.

DEBT SERVICE EXTENSION BASE (DSEB)

May 2007Financing with Bonds – Overview and Procedures

WORKING CASH FUND FORMULA

Authorized Amount: Working Cash Fund Bonds (“WCF Bonds”) are issued for the purpose of creating or increasing a working cash fund. The amount can be issued is subject to the following formula:

(.85 x Educational Fund Levy) + (.85 x Personal Property Replacement Tax Entitlement) - WCF Bonds Outstanding - or -

Balance of WCFWhichever is the greater amount.

May 2007Financing with Bonds – Overview and Procedures

HOW MUCH DO YOU NEED TO BORROW?

Start With: Needs to be funded

Add: Costs of IssuanceInsuranceCapitalized InterestContingency (discount on

bonds)

Subtract: Interest on proceeds

Equals: Total Borrowing NeedThe District must account for many expenses and revenues besides the project to be funded.

May 2007Financing with Bonds – Overview and Procedures

HOW MUCH DO YOU WANT / ARE YOU ABLE TO PAY?

Sources of funds for debt service (Unlimited Tax General Obligation versus Lease or Revenue)

Future needs

Dollar amount versus levy rate

Political considerations

Capped districts: Difference between DSEB and outstanding debt service

There are both legal and practical restrictions on how much annualdebt service the District will pay.

May 2007Financing with Bonds – Overview and Procedures

• Level levy versus level debt: If the district is expecting significant growth, it may want to shift the cost of debt service to future residents. Structuring the bonds with an estimated level levy results in increasing debt service over time, thereby shifting more of the cost of borrowing to future residents.

• Shorter versus longer repayment: Lengthening the repayment period lowers the annual debt service but raises the total interest costs. In general, a district would want to match the life of the asset it is purchasing to the repayment schedule.

• Shaping around outstanding debt: When a longer repayment period is appropriate and desirable the District can further delay repayment of principal until existing bonds are paid off. By paying interest only on bonds for a period, a district can minimize the increase in its debt levy.

COMING UP WITH A DEBT REPAYMENT STRUCTURE

Much like a mortgage, bonds are repaid over time. The District has some flexibility to decide how quickly to repay its bonds*. Some considerations would be:

May 2007Financing with Bonds – Overview and Procedures

$0

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Level Debt Service Level Levy

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Outstanding Debt Service Refunding Debt Service New Debt Service

Structuring Examples

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May 2007Financing with Bonds – Overview and Procedures

Is Borrowing

GOOD or

BAD?

May 2007Financing with Bonds – Overview and Procedures

It Depends!

• Why are you borrowing?

• Is there an ability to repay the debt?

• Does borrowing reduce or enhance future flexibility?

• How much does it cost to borrow?

May 2007Financing with Bonds – Overview and Procedures

WHAT ARE PREMIUM BONDS?

Bonds with a high coupon, sold for more than face value (par) Investor yield requirement is 4.0% Stated interest rate is 5.0% Bond has additional value due to interest rate, so investor

pays more for it.

Premium can allow fewer bonds to be issued to fund a given project, or to generate additional proceeds when bond size is capped.

May 2007Financing with Bonds – Overview and Procedures

WHY ARE PREMIUM BONDS USED?

By Investors Less sensitive to interest rate fluctuations Increased cash flow in low yield environments

By Issuers Cover cost overruns Deal with debt limitations Deal with debt limitations, cover cost overruns and defer

debt service simultaneously (Premium CABs)

Investors generally seek small amounts of premium, while issuers may require substantial amounts well in excess of market norms.

May 2007Financing with Bonds – Overview and Procedures

HOW MAY PREMIUM BONDS HURT?

Callable premium bonds – Investors only pay the premium

through the call date. If the bonds aren’t called, the yield will

be higher. If the bonds are refunded, there are additional costs

of issuance.

Super-premium bonds – If issued to accomplish a larger

project than originally planned, debt service will exceed

original projections.

Understand why premium bonds are being used and determine whether there has been proper communication to the Board and community.