DALLAS — A new Texas law that limits issuance of capital appreciation bonds is a positive credit factor for local governments, especially school districts, according to Moody's Investors Service.
House Bill 114 by state Rep. Dan Flynn, R-Canton, went into effect Sept. 1.
The bill limits the use of CABs to 25% of an issuer's overall debt and shortens principal maturities by 20 years. The bonds, which accrue interest until they reach maturity, were allowed to extend 40 years under the old law.
"The bill is credit positive because it will deter school districts in particular from issuing debt based on uncertain future taxable value growth projections," according to a report by Moody's analysts Ray Ousley, Michael J. Ross, and Gera McGuire.
"Although the bill will lead to more conservative debt structures, it also will inhibit high growth school districts' ability to finance new school facilities to keep pace with rapidly growing student populations," the analysts wrote.
Texas lawmakers considered banning the use of CABs altogether, but proponents of the finance measure argued that the bonds are needed in some cases.
The school district with the most CABs is the Houston Independent School District, the state's largest, with $2.4 billion.
However, the district seen as the most worrisome CAB issuer is the Leander Independent School District in Austin's northern suburbs. The fast-growing district has more than $1 billion of CABs, which puts it in second place in the state, according to Moody's.
While CABs make up only 1.9% of Houston ISD's outstanding principal, they account for nearly 55% of Leander ISD's.
The booming Cypress-Fairbanks ISD's $751 million of CABs make up only 7.5% of its outstanding debt. Cy-Fair in the Houston suburbs is one of the state's largest districts.
Under Chapter 45 of the Texas Education code, school districts can use a projected taxable value of the final year that bonds would mature as a proxy to illustrate repayment. The Texas Attorney General's so-called 50-cent test requires that school districts show that they can service additional debt at or below a debt service property tax rate of 50 cents per $100 of assessed value.
Districts will still be allowed to use projections of assessed values when seeking approval for a new bond issuance, analysts said. For example, a school district using a 3% annual growth projection could show 217% taxable value growth at the end of a 40-year CAB, but a smaller 75% taxable value growth at the end of a 20-year CAB.
"Shortening the maturity will reduce the bond amount that districts will be able to sell, limiting exposure to outsize projections," analysts wrote. "Historically, Texas school districts have used CABs to manage their tax rates and budgets by deferring the costs of current infrastructure projects until future assessed value growth is realized."
In 2014, CAB issuances by school districts accounted for 99% of the local government CAB issued in the state.
The new law also prohibits school districts from using CABs to purchase assets with a useful life shorter than 20 years, ensuring that districts use CABs only for long-term infrastructure projects. Issuers cannot use CAB proceeds for operational, maintenance or transportation costs.
