Capital Appreciation Bonds (CABs): Do They Have a Legitimate Role in Municipal & School Finance September 25, 2012 Capitol Public Finance Group · 1900 Point West Way, Ste. 273 · T (916) · capitolpfg.com

Introductions Managing Partner, Capitol Public Finance Group Financial advisor to public agencies throughout California Cathy Dominico Slide 2

Presentation Overview Slide 3 Questions Concerns with CABs Focusing on CABs Background

Slide 4 Background

Why Borrow? Spread Cost Over Many Budget Years –Based on useful life of project –Project of benefit to many years worth of students/citizens/taxpayers Revenues Received Over Time Conserve Cash/Cash Management Minimize Construction and Other Cost Increases Slide 5

What Does a Borrowing Pay For? Slide 6 Facility or Infrastructure Construction Land Acquisition Building Acquisition Facility or Infrastructure Renovation, Upgrade or Expansion Capital Vehicles & Equipment Purchase

Traditional Types of Long-Term Debt: Voter/Landowner Approved Debt Slide 7 Assessment BondsGeneral Obligation Bonds Mello-Roos Community Facilities District (“CFD”) Bonds

Traditional Types of Long-Term Debt: Non-Voter Approved Debt Slide 8 Lease-Purchase AgreementsCertificates of Participation (“COPs”)Revenue BondsPension Obligation BondsSales Tax BondsTax Allocation BondsMarks-Roos Bonds

Interest Payment Methods on Bonds Bonds with principal and interest repaid over the life of the bonds Current Interest Bonds (“CIBs”) Bonds with principal and interest postponed until a later date Typically more expensive than the traditional current interest bonds Capital Appreciation Bonds (“CABs”) Slide 9

Slide 10 Focusing on CABs

Recent Headlines Have Brought CABs into the Spotlight Slide 11

General Obligation Bonds (GO Bonds) Voter approved, long-term debt –Authorized under one of two voter approval methods  Traditional 2/3  Prop. 39 – 55% –Available only to schools Approval method determines rules by which bonds can be issued and proceeds can be spent –Bond proceeds can only be spent on projects explicitly identified at the time the bond measure was approved Slide 12

Issuing GO Bonds Taxpayers authorize an amount of total bonds to be issued –Issued in series over time Amount of issuance limited by legal bonding capacity Prop. 39 created additional limitations: Slide 13 Proposition 39 Tax Rate Limitations Type of District Tax Rate Limit (Per $100,000 of Assessed Value Unified School District$60 Union School District$30 Community College District$25

Understanding GO Bond Issuance Constraints Bond debt is repaid by ad valorem taxes levied on all taxable property within a district’s boundaries –Tax rates a function of annual bond debt service and total assessed value in the district Slide 14

Slide 15 Example #1

School District XYZ’s Used CABs to Issue Additional Bonds When Otherwise Could Not Have Had authorization for $15.2 million of bonds Issued $8 million of bonds –During a time when assessed value was rapidly increasing Assessed value began to decline and additional bonds were needed –Had already reached the maximum Prop. 39 tax rate for the entire term of the bonds already issued Issued an additional $5 million of bonds using CABs Slide 16

Assessed Value in Many CA Communities Slide 17

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Comments on this Overall GO Bond Structure CABs used to enable the school district to issue bonds that it otherwise would not have been able to issue under Prop. 39 –Don’t know what the communication to their governing board and community was –Don’t know what their project needs were  Were they already under contract?  Was it for a necessary facility?  Did they communicate to the community and decided this was the best decision? The answers to these questions informs us as to whether a responsible decision was made. Slide 22

Slide 23 Example #2

School District QRS Issued CABs to Maximize Bond Proceeds to Fund Necessary Projects Small elementary school district with total assessed value of $700 million –Prop. 39 tax rate cap of $30/$100,000 of a.v. limits amount that can be issued All schools at capacity and need to construct new facility costing $20 million –State funds 40%, or $8 million (50% matching program rarely provides 50% of actual school cost) –Developers fund 30%, or $6 million Used CABs to increase debt service annually to correspond to projected increases in a.v. Slide 24

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Comments on this Overall GO Bond Structure CABs used to enable the school district to fund the construction of a necessary school –Without CABs, this district would not have been able to obtain enough money Even with the expensive cost of the CABs over 40 years, a conscious decision was made to issue the bonds in this manner Slide 27

Slide 28 Example #3

School District ABC Issued CABs to Maximize Tax Rates Large unified school district issues CABs as part of overall bond plan Limits term to 25 years CABs only a small part of the district’s overall debt portfolio –Over $350 million of bonds, $26 million were CABs Layered on top of CIBs to level out debt service when combined with other bonds issued Slide 29

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Comments on this Overall GO Bond Structure CABs were issued to level out overall debt service –Did not rely on estimated increases in assessed value Overall debt repayment ratio less than 2:1 Shorter term, 25 year, CABs Slide 31

Other Uses of CABs Not only used in conjunction with GO Bonds –COPs or revenue bonds  Often to defer repayment to match a specific revenue source –Developer fees, CFD taxes, future capital contributions, etc. –Federal Government issues them  Savings bonds Have become prevalent for school GO Bonds because of the limitations of Prop. 39 Slide 32

Slide 33 Concerns with CABs

CABs Can Be Issued Responsibly Communication and education is essential –Cost information –Risks/benefits –alternatives Need to consider the overall goals of the agency Enable projects to be constructed today to avoid construction cost escalation Spread project costs over several budget years –Consider inflation Slide 34

Often Costly CABs Are Issued Without Proper Education Many board/community members do not understand the costs –Don’t know the right questions to ask Industry professionals can encourage an issuance to profit from the financing Aggressive assessed value growth projections can compound the problem and cost. Slide 35

Questions?