The Street Responds

I hope you read my recent piece concerning my local school district and the ridiculous bonds it issued.  To reiterate, the Poway Unified School District borrowed money at 6.8 percent tax-exempt (necessary despite its Aa2/AA- ratings due to its unusual terms) last year via a bond which provided for no debt service payments for more than two decades.   Talk about creative financing!  These so-called “capital appreciation bonds,” which raised $105 million in 2011 for needed improvements to district facilities, will require $877 million in interest payments between 2033 and 2051.  To make matters worse, the bonds are non-callable; to add call provisions would have added about $100 million in costs due to the higher coupon the bond would have been required to offer.

Barry Ritholtz of The Big Picture wrote a nice follow-up this morning linking my post and emphasizing that, once again, “a group of rubes got rolled by The Street.”  Not surprisingly, an analyst at one of The Street’s leading purveyors of municipal bond investments, Nuveen Asset Management, has rushed in to try to explain why the deal isn’t so bad after all. Let’s take a quick look at his argument.

Initially the Nuveen argument notes that “the district generated $21.36 million of premium, increasing total proceeds available to the district to $126.36 million – or an additional 20% above the stated par value of the bonds.” We get that the terms of the bond gave the district more money to work with than a typical bond offering.  The interest and repayment information in all reports (press and otherwise) all reflect it.  Moreover, the simple fact remains that $981.5 million of debt service repayment compared with $126.36 million in proceeds is a terrible deal.

The essence of the argument relates to a claim that these bonds provide for repayment more equitably by those who actually reap the benefits of the bonds:

As the district contemplates how to finance the construction of significant new capital investment in a short time frame, they are forced to consider what is the most equitable way to finance assets with expected lives of 50 or more years. In other words, should today’s residents pay for the entire cost over the next 15 or 20 years, or should future generations of residents that will also benefit from the facilities share some of the burden? The former strategy may be less expensive to the district as a singular entity but more expensive to today’s residents. By comparison, the latter strategy is more expensive to the district as a singular entity but may well be the more affordable option for residents that don’t intend to live in the community for 40 years or would rather maintain lower taxes over time. This is a tough public policy call and not all bond issuers make the same choices when faced with such a dilemma.

That’s certainly creative and perhaps even plausible sounding, but it’s wrong on its face.  This bond offering didn’t finance the building of facilities with expected useful lifespans of “50 or more years.”  It financed upgrades to facilities and those upgrades — very generously — can be expected to have a useful life of 10-15 years. Indeed, the upgrades to my local elementary school were not even completed before the money ran out (again!) and will likely be obsolete in well less than a decade. The bond also risks crippling the ability of the district to perform future upgrades — those needed before these bonds are repaid.

Moreover, “intergenerational equity” and an alleged effort to “smooth” payments over 50 years (dealt with in my earlier post) had absolutely nothing to do with the district’s actions.  It was all about political realities.  The money was needed and no bond issue requiring tax hikes could pass. With no debt service until other bonds were repaid, the district could claim that taxes were not being raised.  By “kicking the can down the road” the district thought it might get away with having its cake and eating it too (to mix metaphors but in a way you’ll no doubt understand).

Finally, the Nuveen argument focuses on the financial health of the area and optimistically hopes that on account of inflation, these bonds will be able to be repaid with ease.  That argument may turn out to be correct.  The district may well be able to repay these bonds using devalued dollars.  And since the district is part of a relatively affluent community, the money will likely be available to repay the bonds in any event. But there is no prudence in banking on such future inflation and future affluence rather than taking the “sure thing” of much lower financing costs by issuing conventional bonds. The ability to repay doesn’t turn a bad bond deal for the issuer into a good one.

Just to add a little “kicker,” note that the Nuveen argument is made using an illustration involving “a home that is worth $300,000 in 2017,” even though the median value of a home in the district today is nearly $500,000.  So the actual numbers are (of course) far worse than advertised.  But even then, the “monthly contributions to the annual levy” according to that analysis go from $5.04 to $74.49 over the life of the bond, and that’s a fifteen-fold increase.  If you think that’s a reasonable increase, you must work for the underwriter or want to buy more of these bonds.

So an obligitory defense has been offered, weak though it is.  Of course, given the substance of what was available, “The Street” (via Nuveen) did a pretty good job because there is no good defense to be made. This deal stinks to high heaven.

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One thought on “The Street Responds

  1. The inflation comment is the one I made in my comment to your original post. But you are correct — inflation was never part of the argument made to support this deal structure, and it would be foolish to rely on future inflation to make a bad deal reasonable when cheap financing was available at bond issue as long as you were willing to raise taxes and make payments.

    The inter-generational argument is a also crock — and again was not part of the rationale in the referendum — while I buy that capital improvements made and used by schoolchildren over 10-15 years could have long-term benefits to the educated children over 50 years, there is no evidence that those children will remain in Poway for the next 50 years or return after college to pay their “dues”. Probably, a fairly small percentage of people educated in Poway will remain in Poway (and those rooted there are likely trending towards the poorer end of the spectrum).

    The sad reality is that this was a poorly structured deal from the District’s perspective, and is likely to result in excessive and long-term debt burdens when compared to the benefit. The school board either poorly understood the deal, or pulled the wool over the eyes of the voters and taxpayer’s union (with the assistance of Wall Street). However, the voters have no one to blame but themselves. It is clear from the stories that the voters were unwilling to authorize any bond issuance that would lead to an increase in taxes, even though the capital spending seemed necessary. Unfortunately, the District decided to do an end-around, and the taxpayers were duped into undertaking a more costly, long-term obligation. No offense, but this is typical of California — the citizens love to vote themselves benefits, but absolutely refuse to authorize the taxes necessary to pay for them.

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