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Risky bonds tie schools to huge debt

About 200 districts in California may have to pay as much as 10 to 20 times the amount borrowed.

November 29, 2012|Dan Weikel
  • Newport Harbor High School in Newport Beach is part of the Newport Mesa School District, which issued $83 million in long-term notes in May 2011.
Newport Harbor High School in Newport Beach is part of the Newport Mesa School… (Mark Boster / Los Angeles…)

Two hundred school districts across California have borrowed billions of dollars using a costly and risky form of financing that has saddled them with staggering debt, according to a Times analysis.

Schools and community colleges have turned increasingly to so-called capital appreciation bonds in the economic downturn, which depressed property values and made it harder for districts to raise money for new classrooms, auditoriums and sports facilities.

Unlike conventional shorter-term bonds that require payments to begin immediately, this type of borrowing lets districts postpone the start of payments for decades. Some districts are gambling the economic picture will improve in the decades ahead, with local tax collections increasingly enough to repay the notes.

CABs, as the bonds are known, allow schools to borrow large sums without violating state or locally imposed caps on property taxes, at least in the short term. But the lengthy delays in repayment increase interest expenses, in some cases to as much as 10 or 20 times the amount borrowed.

For The Record
Los Angeles Times Wednesday, December 05, 2012 Home Edition Main News Part A Page 4 News Desk 2 inches; 73 words Type of Material: Correction
School bonds: An article in the Nov. 29 Section A about a risky type of construction financing used by school districts said that news of one bond issued by the Poway district was first reported by the Voice of San Diego website. That website has acknowledged that its work was assisted by Joel Thurtell, a retired reporter for the Detroit Free Press who had previously written about the bonds in a blog post.

The practice is controversial and has been banned in at least one state. In California, prominent government officials charged with watching the public purse are warning school districts to avoid the transactions.

One sounding the alarm is California Treasurer Bill Lockyer, who compares CABs to the sort of creative Wall Street financing that contributed to the housing bubble, the subsequent debt crisis and the nation's lingering economic malaise.

"They are terrible deals," Lockyer said. "The school boards and staffs that approved of these bonds should be voted out of office and fired."

Most school bonds, like home mortgages, require roughly $2 to $3 to be paid back for every $1 borrowed. But CABs compound interest for much longer periods, meaning repayment costs are often many times that of traditional school bonds.

And property owners -- not the school system -- are likely to be on the hook for bigger tax bills if the agency's revenues can't cover future bond payments, Lockyer and other critics say.

Several financial consultants who advise school districts on CABs declined to comment, as did the chairman of their trade group. Education officials acknowledge some drawbacks with CABs, but argue that the bonds are funding vital educational projects.

The Newport Mesa Unified School District in Orange County issued $83 million in long-term notes in May 2011. Principal and interest will total about $548 million, but officials say they are confident they can pay off the debt.

The bonds "have allowed us to provide for facilities that are needed now," said the district's business manager, Paul Reed. "We could not afford to wait another 10 years."

Overall, 200 school systems, roughly a fifth of the districts statewide, have borrowed more than $2.8 billion since 2007 using CABs with maturities longer than 25 years. They will have to pay back about $16.3 billion in principal and interest, or an average of 5.8 times the amount they borrowed.

Nearly 70% of the money borrowed involves extended 30- to 40-year notes, which will cost district taxpayers $13.1 billion, or about 6.6 times the amount borrowed on average.

State and county treasurers say debt payments of no more than four times principal are considered reasonable, though some recommend a more conservative limit of three times.

"This is part of the 'new' Wall Street," Lockyer said. "It has done this kind of thing on the private investor side for years, then the housing market and now its public entities."

The Poway Unified School District, which serves middle-class communities in north San Diego County, is one of the school systems faced with massive CAB debt payments. In 2011, it issued $105 million in capital appreciation bonds to complete a school rebuilding program.

Because the recession had depressed property values and tax revenue, Poway district officials realized that using conventional bonds might jeopardize a promise to district voters to limit the tax rate.

So on the advice of an Irvine-based financial consulting firm, they turned to the long-term notes. Under the deal, the school board could keep construction moving, avoid reneging on its pledge to voters and stay within the legal limits. And it would not have to repay the bonds for decades.

By the maturity date of 2051, however, the $105 million in Poway notes will cost district taxpayers almost $1 billion in principal and interest -- more than $9 for every $1 borrowed.

That deal, first reported by the Voice of San Diego news website, raised alarms. But some Poway officials defend it as necessary to complete much-needed projects.

"It was well worth it," said Jennifer Zaheer, president of the Palomar Council Parent Teachers Assn., which serves Poway Unified. "In my son's experience, there's a big difference between using a trailer and having a new classroom."

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