SAN FRANCISCO — The California attorney general’s office has been asked to weigh in on a school-bond refinancing practice that has drawn some criticism.
The “cash out” refundings of school general obligation bonds allow districts to defease outstanding bonds while generating additional cash to spend on capital projects, using, for example, a premium bond structure to generate proceeds beyond the par amount.
Critics of the practice say it is deceptive toward the voters who approve local school GO bonds in California, and of questionable legality under state law.
School and local GO bonds in California must be authorized by voters and are secured by a special ad valorem property tax. But refunding bonds, because they are not considered new debt, do not require voter approval. Critics of the cash out practice say savings opportunities from a refunding ought to be passed on to taxpayers.
“My personal take on it is that it’s inappropriate,” said Michael Smith, treasurer and tax collector for Marin County. “It really is an affront and a violation of the trust that voters have given with their support of the bond measure to begin with.”
In November, Sen. Joe Simitian, D-Palo Alto, made a formal request to the attorney general’s office for an opinion on the practice, asking for answers to seven questions. It typically takes four to six months to produce such an opinion, according to the AG’s office. Simitian’s office did not return phone calls.
Only certain state and local public officials may request the opinion of the attorney general, who is currently Jerry Brown. They are not binding, but they “have been accorded ‘great respect’ and ‘great weight’ by the courts,” according to the attorney general’s Web site.
The leader of a watchdog group in San Jose says she is waiting for the attorney general’s opinion before
filing a lawsuit challenging a San Jose Unified School District transaction from 2005. The district illegally pulled $20 million of cash out of a 2005 deal to refund bonds authorized by voters in a 1997 ballot measure, said Jill Escher, chairwoman of Citizens for School Bond Accountability, the group planning the suit.
The attorney general typically does not issue an opinion on an issue that is the subject of ongoing litigation. The December 2005 bond issue was for a par amount of $148.1 million, according to its official statement. In addition to the principal amount of the bonds, the issuance generated an original issue premium of $20.4 million, deposited into a building fund for the prior bonds, according to the OS.
UBS Securities LLC underwrote the issue. Stradling Yocca Carlson & Rauth was bond counsel.
Escher said the savings generated in a refunding should have been passed to the SJUSD’s taxpayers, instead of generating extra cash.
Opponents of the cash out practice say the California Government Code prohibits issuers from doing a refunding that generates principal in excess of what is needed to retire the refunded bonds and pay issuing costs.
“The proceeds of any sale of refunding bonds for cash shall be placed in the treasury of the local agency to the credit of a fund to be established for the purpose of refunding the bonds to be refunded,” the code says in part.
“I don’t get what loopholes they see that I’m not seeing,” said Escher, a Berkeley law graduate who is currently raising children instead of practicing law. She began following the district’s finances as a member of a citizens bond oversight committee created for another school district bond measure, the 2002 Measure F, which authorized $429 million.
When the $20 million in new capital funds appeared, Escher said, she was skeptical.
“How does the district get cash out of a refinancing of a bond where they’ve already spent all the money?” she said. “I knew what their accounts look like. Did it fall from the sky? Where did it come from?”
Eventually, she said, that led her to the cash out refinancing arrangement, despite stonewalling from the school district.
“Some bond counsel may argue that the premium generated by issuing higher than market-rate bonds does not count as ‘proceeds,’ but how is that possible when we taxpayers are paying higher taxes to provide the district with this very pot of excess cash?” Escher wrote in a letter submitted to the attorney general’s office for consideration in the opinion process. “Calling the premium anything other than ‘proceeds’ is just an attempt to linguistically dance a way around the rules.”
Issuers should think carefully about any cash out refunding, according to an article written by Jeffrey Small and Cathleen Dominico of financial advisory firm Capitol Public Finance Group LLC in late 2005.
“When school districts attempt to capture the savings up front to pay for additional school facilities, they should proceed with caution, as this transaction is complex and controversial,” the article said.
Small said the impetus for the article came from a client school district that was solicited by an investment banking firm with a proposal to generate cash through a refunding by amortizing debt more quickly and taking advantage of a run-up in assessed property valuations.
“We found that it was not appropriate because of the way it was structured,” he said.
The article describes two basic variations of “cash out” deal. One is a direct issuance of refunding bonds that generates proceeds for the district — which brings up the question of the state’s government code restrictions. Another variation appears to get around that limit by using a joint powers authority that directly buys the district’s refunding bonds but issues a higher amount of revenue bonds to the public, money the district can then use for capital needs.
“Some deals are better than others,” Small said. “Even if structured correctly, you need to have the community’s support. At the end of the day, if taxpayers in your community feel there’s been a stealth transaction generated to serve some financial people and to provide some other benefits, our feeling is the school district or community college district is going to lose credibility.”
San Jose USD’s chief business officer, Ann Jones, said it conducted its business openly.
“All resolutions referenced were part of the regular posted agenda. Action was taken in open public session,” she said in an e-mail.
The refunding bonds provided additional funds for capital projects, decreased total debt service, and reduced the term of the bonds while maintaining the estimated tax rates promised to the voters during the 1997 election, Jones said.
Small said he believes school district issuers should obtain a legal opinion for cash out refundings endorsing the use of the proceeds, preferably from general counsel rather than bond counsel.
“It’s one thing to opine that it’s a tax-exempt borrowing,” he said. “It’s a completely separate issue to opine that the proceeds are being used properly.”
Smith said that cash out deals often occur with little public discussion.
“County treasurers can all of a sudden look at themselves receiving funds at the eleventh hour,” he said.
Escher said she needed to file public records act requests with the SJUSD to learn anything about the deal, even months later.
Bond counsel did not responded to requests for comment by press time.
Escher said her group has retained the firm McManis, Faulkner & Morgan to represent it. She said the group wants the $20.4 million returned to taxpayers, plus the $1.6 million cost of issuance. The cost of any litigation is exponentially more than the additional property tax Escher’s family is paying, but that’s not the point, she said.
“What else can we do, just let it happen, let it slide? I’m not just going to let it slide. What I’m doing makes no economic sense for me. I’m pissed. I see taxpayer abuse going on,” she said, adding that she would expect to recover attorney’s fees.
