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District's Bond Plan Stirs Up Fiery Controversy

By Jeff Hudson - August 23, 2012

A financial controversy is swirling around San Diego County’s Poway Unified School District.

The story took wing earlier this month, when Bloomberg News -- the highly-respected New York-based news service specializing in business and financial coverage -- carried a story on August 7 that began like this:

A California school district is shouldering $1 billion in interest on a $105 million bond in a deal intended to defer most of the payments for 35 to 40 years.

The Poway Unified School District structured its 2011 sale of capital-appreciation bonds to avoid debt service until 2033, with the largest sums – more than $300 million each – due in 2046 and 2051, according to data compiled by Bloomberg.

The district of 33,000 students, about 20 miles northeast of San Diego, issued the debt to modernize schools in July 2011. It was part of as much as $179 million in borrowing approved in a 2008 referendum that passed with 65 percent of the vote. The San Diego County Taxpayers Association now regrets that it endorsed the proposal.

Earlier this week, San Diego County Treasurer-Tax Collector Dan McAllister told a San Diego County’s North County Times that he wants the state Legislature to change the law to give county governments approval power over local school bonds, and to forbid such long repayment times. According to the newspaper:

"The county usually gets 1.5-to-1 (repayment ratio)," McAllister said. "The balloon payment that comes due at 20 years, forces 40 years of payments (into) 20 years. That's an onerous burden on the taxpayer."

McAllister and other observers don't oppose all capital appreciation bonds, just ones with such a long repayment timeline.

"They do fit within the model of financing for school districts if it's done appropriately," said Chris Cate, a vice president for the San Diego County Taxpayers Association, a nonprofit.

Cate said capital appreciation bonds with a five-year repayment work fine, but otherwise the interest rates are too high and the terms too restrictive.

The taxpayers association supported the Poway Unified bond measure in 2008, but Cate said the group didn't have the correct information when it made its endorsement.

A variety of news and broadcast media picked up on the Poway controversy – especially in Southern California. The situation also drew a quick response from tax watchdog groups, including Michael Turnipseed, executive director of the Kern County Taxpayers Association (which serves Bakersfield and surrounding areas). “This is way worse than loan sharking. And Poway is the poster child. What they have done is absolutely insane,” Turnipseed said.

For analysis, EdBrief turned to two veteran observers of California school finance – Vern Weber, senior consultant for planning and management with Total School Solutions, and Lori Raineri, longtime president of Government Financial Strategies, based in Sacramento.

Weber observed:

“Poway voters approved a $179 million Proposition 39 bond measure in 2008 (55% threshold for approval). In calling that bond, the district did not fully disclose how it intended to issue bonds or the intended use of the proceeds. In 2011, Poway issued $105 million of capital appreciation bonds (CABs) – bonds that accrue compounded interest for 22 years before principle and interest payments commence – and used most of the proceeds to retire past debt. When the $105 million bond is fully retired in 40 years (2051), the district will pay over $981 million. In addition to being a questionable practice, there are possible irregularities that are under investigation.”

“Because of assessed valuation decreases and restrictions on the sale of Proposition 39 bonds (bonding capacity limit and maximum tax rate), many school districts cannot issue traditional simple interest bonds that retire principle and interest with semi-annual payments. The Poway experience represents the latest in an unfortunate trend by school districts to incur debt with CABs that saddle taxpayers with excessive long-term obligations. The use of CABs and other expensive and risky debt instruments prompted the LA County Treasurer to issue a 2011 White Paper stating that his office would not support the issuance of CABs with maturities greater than 25 years.”

“It is imperative that school districts fully disclose to voters up front the intended bond sale method and use of bond proceeds. Under Proposition 39, a district must also have independent annual financial and performance audits which should include full disclosure of bond sales and uses of proceeds for review by its legally-mandated citizens’ oversight committee and the public. Such disclosure may not end all questionable financial practices, but it would bring awareness of the actions of governing boards and administration to the general public.”

Raineri said:

“Poway is not the only district to do this (issue capital appreciation bonds), others have done it. It’s not something we recommend. A lot of districts have done it in response to the recession . . . they can’t afford enough debt service within the limits of the tax rate projections limitations of a 55 percent voter approval bond.”

Raineri added that there are several takeaway lessons that other school districts could learn from Poway’s experience. Raineri said, “To me, my concerns begin with, well, was the plan well considered? If the plan was well considered to begin with and then something unexpected happened, well, did you consider the worst case scenario (when the bond was planned)?”

“A lot of bonds are put together without a lot of scrutiny from the school district, and instead with a lot of outside assistance from professionals,” Raineri observed.

“My concern, as a third party, was the bond plan honest? If you submit a plan that requires that your tax base grow at the highest rate it’s ever grown, I wouldn’t assume that’s an honest plan. It assumes that there has never been a downturn in real estate values (and never will be).

“We want to have integrity to the original plan, and if circumstances then drive us to point that we can’t do the original plan, we need disclosure. All along the way, we want to create a public record of the decision.”

She thinks that too often, voters (and even school board trustees) don’t fully grasp the bond plans that come before them for consideration. “You have bonds being done in a way that school districts are not really in control. Other people are making the decisions and are carrying out plan. It’s like someone saying ‘I didn’t understand my home mortgage interest rate is going to adjust.’”

Noting that California voters will be dealing with state ballot propositions that will impact education financing in the November election, Raineri said “It’s not a good situation to have this kind of bad publicity with the tax measures (on the ballot) in the fall.”

What should other school districts learn from Poway’s experience?

“Number one, administrators need to be cautious, they need to understand their deals, and take them into the board room and let the board make decisions.”

“I am working diligently to help school districts have better bond practices. There should be journalistic exposure and day lighting. But we don’t have to sensationalize things. What I hope is that people will learn to be better consumers of financial products. I don’t want people to be afraid,” Raineri said.

Editor's Note:  Jeff Hudson is the editor of EdBrief and an award-winning education reporter and writer in print, radio and television media.