Citrus College considers issuing controversial capital appreciation bonds (link here): Citrus College is considering using a controversial type of bond financing banned in some states to fund the construction of a new fine arts building on campus.
The school’s board of trustees will vote Tuesday whether to issue capital appreciation bonds for the project, allowing construction to begin this year under a timetable that would not be possible using conventional bonds. But that immediacy comes at a cost — the $19 million project would end up costing residents in the community college district nearly $50 million by the time it is paid off, an estimated $16 million more than if traditional bond financing was used, according to an analysis provided to the board last month.
Unlike conventional bonds, which borrowers begin paying back immediately after they are issued, capital appreciation bonds allow school districts to postpone repayment for years, or decades, while interest compounds along the way. Because Citrus College has already issued multiple bonds in recent years, it has reached the maximum amount under state law it can levy taxpayers to repay its bond debt. That means it can’t use conventional bond financing until it pays down its debt.
(Mod: As you know, interest only payments on bond debt is what has gotten Sierra Madre's water department into the dicey financial straits it is today.)
San Dimas resident and open government activist Gil Aguirre says the cost of delaying the project comes nowhere close to the cost of using capital appreciation bonds, known as CABs.
“I don’t buy that argument,” Aguirre said. “They have no idea if construction costs are going to go up or not. Over the last several years, some construction costs went down. And there is evidence that they will go down more as more and more contractors return to the market.”
Aguirre has significant concerns over the use of CABs.
“The concept of compounding of interest is really insane,” he said. “They are borrowing money and paying interest on the interest as it grows. That is just bad, bad business management. Part of their duty is to the kids, but part of their duty is also to the taxpayers.”
“I try to relate it to an everyday experience. Say you want to buy a house. The lender says you qualify for a $500,000 loan based on what you can afford. The problem is you want to buy a $1 million house. So you borrow $500,000 the traditional way, then you borrow $500,000 more that will compound interest and the bank says, ‘don’t worry, you’ll be able to pay it back in 25 years when your house will be worth five times as much,’” Aguirre said. “That kind of fast and loose financing is exactly what led to the meltdown we just experienced. Wall Street got smart — they realized why lend to property owners when you can lend to school districts and municipalities.”
(Mod: Here is the letter Gil sent to the Citrus College Board of Trustees yesterday asking them to rethink this matter. Their decision on whether or not to go forward with this bond proposal could be made as soon as today. And would you believe there is a City of Bell connection?)
Citrus College District 1000 West Foothill Blvd. Glendora, CA 91741-1899
Dear Board President and Members,
At your upcoming meeting, scheduled for tomorrow, you will be asked to approve a bond proposal which is both costly and risky (agenda item H.3.). I have had the opportunity to review the materials provided to the Board, along with those provided to the public, and continue to believe the District has failed to meet the procedural and notification requirements called for under the law. It is my contention that the Board was not presented with required information including, but not limited to: an analysis containing the total overall cost of the bonds that allow for the compounding of interest; a comparison to the overall cost of current interest bonds; and a copy of the disclosure made by the underwriter in compliance with Rule G-17. Of course, I find it concerning that the District continues to struggle with these basic procedural and notification mandates.
However, putting these deficiencies aside for the moment, I would ask that each of you fully examine the substantive aspects of this speculative proposal. These costly bonds call for the compounding of interest; the District will effectively pay interest on the interest until the bonds become due. These bonds, which are both costly and risky, have been universally condemned by officials. Staff justifies the use of these bonds by claiming that the District will face a potential increase in the cost of construction and re-approval from DSA if you don’t move forward now. Despite this claim, no evidence has been provided, which substantiates such a conclusion. However, assuming a 10% increase in construction cost was to occur, the district would face a 2-3 million dollar increase in costs – yet this proposal will cost the district nearly 20 million dollars more in interest than traditional financing methods. Should the public, and each of you, really believe that spending 20 million to save 3 million is a prudent financial course of action?
This entire proposal hinges on a very risky assumption, a gamble in fact, that assessed property values in the district will double over the life of the bond. If everything goes right under this plan, taxpayers will pay some 20 million dollars more in additional interest than if traditional bonds were used. However, if things don’t go as planned the cost could be far more problematic for the district, taxpayers, and students. What are the consequences should this gamble prove to be wrong and assessed values only increase by 1 or 2% per year. After all, repayment of this 50 million dollar debt will become a liability of the district and repayment is not conditioned on these projections being accurate or coming to fruition.
If the projections for assessed values turn out to be wrong, the district will face a massive debt: one that could force the use of the school’s general fund to pay off the debt. This gamble effectively puts the District’s ability to fund future teacher salaries and student curriculum at risk. Is that really a wise course of action for you to take?
I would also suggest that each of you should be asking how the district arrived at this projected doubling of assessed values. The answer is the District didn’t. These projections were instead provided by RBC Capital Markets (RBC), the very company which stands to handsomely profit from this risky bond issuance! I would hope that each of you finds it disturbing that RBC is recommending these costly bonds while also providing you with the very analysis which is relied upon to justify this proposal.
I am not questioning the ethics of RBC, just their advice and motivations. My research appears to indicate that you should be too. A cursory check found that over the last few years, RBC has faced over 250 actions brought by state and federal regulators. As well, they have faced over 100 civil and arbitration actions. Regulators have fined RBC millions of dollars for a variety of illegal activities. One of the more troubling cases involved RBC’s work with multiple school districts in Wisconsin. The government investigation determined that RBC had acted negligently and failed to properly disclose the risks associated with the proposal they pitched to these school districts. Before federal regulators stepped in, these school districts faced losing tens of millions or worse, due to RBC’s proposal.
As well, it might be judicious for you to examine all of the District advisors who stand to profit from this costly and speculative financing deal. As I am sure you are all aware, the City of Bell recently went through an expansive investigation involving wide spread corruption at numerous levels. One of the issues examined was the possible improper issuance of bonds which failed to meet state legal requirements. State Controller John Chiang’s investigation determined in part that bond funds were mismanaged and taxes were illegally raised to cover bond costs.
I was surprised to discover that your bond counsel, Nixon Peabody, represented the City of Bell during some of their bond issuances. Furthermore I was amazed to learn that the City of Bell filed a malpractice suit against Nixon Peabody related to their representation during a 35 million dollar bond deal. At a minimum, this information should give each of you reason to pause and reflect upon this proposal before taking any action.
This scheme is little more than an ill advised gamble. The real winners are not the taxpayers or students in the District, but instead are the firms that have proposed this roll of the dice financing method. At best you will spend an additional 20 million dollars in unwarranted interest while the firms will earn increased profits. At worst you will put the financial future of the students, teachers, and taxpayers at serious risk. For all of the above reasons and more, I urge each of you to do the right thing tomorrow: do not approve this risky endeavor.
Sincerely, Gil Aguirre