Introduction to General Obligation Bonds
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:
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
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:
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.