Introduction to General Obligation Bonds
School & Community College Districts
General Bond Information


 

I.            Tax Exemption

There are two basic types of bonds.  One is a taxable bond and the other is a tax-exempt bond.  The individual or institution that buys a taxable bond must pay taxes on the interest received. In contrast, the interest received by the holder of a tax-exempt bond is not subject to either state or federal income taxes.  Only public agency, i.e., cities, counties, school and community college districts are permitted to issue tax-exempt bonds.  Historically, the interest rates on tax-exempt bonds are two points lower than taxable bonds.  This spread changes from time to time.  Current high quality municipal bonds are in the 4.75% range (25-year maturity as of 02/03).

II.           School District Finance

A district generally has two types of financing options available to it:  A. a financing backed by the General Fund, e.g., a lease transaction; B. a financing whose repayment source is some form of property taxes.

A.     The General Fund of the District is the primary operating fund of the District.  The primary source of income for the General Fund is the State.  The state funding is a formula determined by the State to equalize funding, on a per-student basis, for each district throughout the State.  Some districts are fortunate enough to have enough flexibility in the General Fund to be able to make ongoing debt service payments out of the General Fund.  Many districts do not have this luxury.  

B.      The second primary source of funding for district financing is property taxes.  To access this source, a district needs to muster a 2/3 vote from the voters.  Although this is a difficult task, more districts will find it necessary if they wish to access State monies for construction or modernization of their sites.  Once approved by the voters, the District can then issue general obligation bonds backed by ad valorem property taxes.

C.     With the passage of Proposition 39, the vote requirement is reduced to 55% with certain restrictions.  One of the key restrictions is the limit to the amount of the dollar tax.  The amount is limited per election to $25 per $100,000 of assessed valuation for community colleges, $30 per $100,000 for elementary as well as high school districts and $60 for a unified school district.

III.         Tax Rate & Assessed Values

The tax rate associated with the debt service on the bonds is a function of the assessed valuation of the District and the required debt repayment due in any given year.  Each August, the Auditor-Controller of the County will review the assessed value of all taxable property in the District vis-à-vis the required debt service payment for the fiscal year, and determine a tax rate.  The tax rate for each year may vary depending on what happens to the value of taxable property in the District and the structure of the debt service. 

Several assumptions are built into the forecast of future tax rates.  These factors include: 1) projections of future growth in assessed values; 2) interest rates; 3) the timing of issuance for each bond series; 4) the structure of each bond series; and 5) tax reserves and delinquencies.

The two most important factors are 1) the timing of issuance for each series of bonds and 2) projections of future growth in assessed values.  The timing of issuances is important because the bonds do not appear on the tax roll until they are issued.  The greater the amount and frequency of the bonds sold, the greater the tax rate.  The converse is also true. 

The key in projecting future assessed value growth is first analyzing historical growth rates over the last 5,10 or 20 years.  Then, conservative and defensible assumptions for future growth must be established.  Foreknowledge of future construction projects in the area, either residential or commercial, can be helpful in this regard.

IV.     The Team

The main players in a financing are referred to as the Finance Team.  The members of the Finance Team and their respective roles are as follows:

è    Bond Counsel:  Oversees the legal aspect of the transaction.  Prepares most legal documents associated with the transaction, including all resolutions.  The bond counsel provides a legal opinion that the governing board has taken all actions to legally authorize the transaction and that the transaction is in conformance with the tax code such that the interest received by the investor will be exempt from both federal and state income taxes.  The fee for bond counsel services is paid from bond proceeds.

è    Manager/Underwriter:  Oversees the financial aspects of the transaction.  Structures the bonds and guides the District through the issuance process including obtaining a credit rating.  Manages the timeline and assures that all players are in conformance.  The manager/underwriter will also buy the bonds from the District and sell them to investors.  It is the role of the manager/ underwriter to assure that the District achieves a structure consistent with its goals at a very competitive cost.  Manager/Underwriter’s fees are paid from bond proceeds.

     The County:  The Treasurer’s office in each county takes a very active role in the issuance of general obligation debt for districts in the County.  The County is the legal issuer of the bonds since the District has no ability to levy taxes.  The County’s primary activities will include passing a resolution authorizing the transaction and being intimately involved in setting the interest rates.  This is a benefit to the districts because most counties are very knowledgeable issuers of municipal debt.  There are no costs for these services.  A district may choose to bypass the County and issue bonds without county involvement.  This decision must be made at the onset of the process.

      Paying Agent:  This is usually a bank or a trust company which will be available over the life of the financing.  The Paying Agent’s role is to remind the County that debt service is due, receive the money from the County and pay the investors.  A paying agent can also serve as dissemination agent and assist the District with its ongoing disclosure requirements.  The initial year’s fee for paying agent services comes from bond proceeds.  This is the only party with an ongoing annual fee.  The ongoing annual fee must be paid by the District General Fund.

     Underwriter’s Counsel:  They serve as counsel to the underwriter.  Their primary role is to assist the District in the creation of the disclosure document, the official statement.  The official statement is the primary document used by the investor to make their decision to buy the bonds.  It describes the transaction and the credit characteristics of the District.  The underwriter pays their cost.

      County Counsel:  They will review the legal transaction from the County and the District’s point of view.  They will also provide certain opinions as to the authority of certain documents.  No charge.

V.      The Process

The process of issuing a series of bonds usually takes about 60 to 90 days.   The steps involved include:

       -Formulation of a time schedule and distribution list
       -Formulation of primary documents
              -County Resolution
              -District Resolution
              -Preliminary Official Statement
              -Passage of County Resolution
              -Passage of District Resolution
       -Completion of the Preliminary Official Statement
       -Obtaining a rating
       -Qualification for municipal bond insurance
       -Selling the bonds (setting the Interest rates)
       -Completing all relevant documentation
       -Closing and delivery of funds

The most important aspect of this process is obtaining the rating.  The rating strongly influences the cost of borrowing.  The factors that are reviewed in determining the rating are:

  1. The finances of the District.  The financial flexibility of the District is analyzed.

  2. The economics of the area.  Relative levels of wealth as well as the health and diversification of the economy is analyzed.

  3. The levels of public debt are reviewed.  The levels of debt held by the District are reviewed as well as the debt of the agencies that overlap the District.  An attempt is made to ascertain the level of public debt that the residents of the District are responsible for.

  4. Management.  The policies and practices of District management, staff and the governing board, are reviewed.  

Strength in one area can compensate for weakness in another area.  It is the role of the manager/ underwriter to guide the District through this process, such that the credit strengths of the District are highlighted.