BRADENTON, Fla. — Hoping to get more investors interested and achieve better pricing, the Pasco County School Board forged new ground in June as the first school district in Florida to sell certificates of participation without extraordinary redemption provisions. The school board’s sale of $76 million of certificates of participation with no ERPs on June 14 shaved between six and seven basis points off longer maturities, said the district’s financial adviser, Jerry Ford, president of Ford & Associates Inc. Pasco this past Tuesday sold $67.5 million of auction-rate COPs without ERPs. Historically, Florida’s school COP deals have contained language requiring the debt to be called if buildings under the master lease program are condemned, or if there are excess bond proceeds, or if a school district fails to appropriate funds to pay its lease obligations. Those provisions, Ford said, made it difficult for institutional investors to know with certainty when the COPs would be called. Although not all school districts will qualify to have ERPs removed, Ford said the Pasco deal represented a “huge” change for those that do because the COPs are more like general government bonds without prepayment requirements. In fact, the Pasco deal has already opened the door for another school district to follow suit. The Orange County School Board sold $165.4 million of COPs on June 20 and another $105 million of variable-rate COPs on June 29 — without ERPs. Both the Pasco and Orange school deals were insured by Financial Guaranty Insurance Co., which provided the critical, final approval in allowing the ERPs to be removed since the deals were originally structured with them. And the ERP related to a government’s failure to appropriate payments for the debt was the last one to be removed from the Pasco deal. “The [non-appropriation] provision wasn’t worth the penalty they were paying in the market,” said Jeffrey Fried, a senior managing director and head of FGIC’s public finance group. Fried’s past experience includes working in Florida with school districts drafting documents used today. Fried said the non-appropriation ERP was not an insurer-driven practice and future decisions about allowing them to be removed from other school deals depend on the credit quality and size of district master lease programs.
A master lease typically contains one or more school buildings with a school board agreeing to appropriate payment for all or none of the buildings under the lease. “As an insurer, we know their incentive to appropriate is very high,” Fried said. “The likelihood of non-appropriation is highly remote.” To date, FGIC is the only insurer agreeing to the removal of Florida school ERPs, but Fried said it is likely other insurers will consider following suit. FGIC, he added, did not agree to remove ERPs to bring in more business. “We did it to save our issuers money where it makes sense,” he said. “To the extent that it benefits our business partner, then that’s good business for us.” Financial Security Assurance Inc., also a large insurer of Florida school COPs, has not yet agreed to removing ERPs from a Florida school deal. However, a spokesman for FSA said it would be considered on a case-by-case basis. In 1990, some of Florida’s 67 public school districts began selling COPs due to their limited ability to sell other forms of debt, particularly general obligation debt, which required voter approval. Only four school districts have managed to get GO referendums passed since 1990, according to Ford, whose financial advisory practice tends to concentrate on public schools. Ford said removal of the ERPs became an issue as school finance teams searched for ways to broaden the investor base and get better pricing to fund the construction of new schools. Research showed that only a small number of institutional investors were holding COPs. To find out why more institutional investors weren’t investing in COPs, Ford said a series of meetings was held with key market players. The main reason they were not purchasing COPs was the extraordinary call provisions, Ford said. On the Pasco deal, Ford said the bankers and bond counsel worked to create an acceptable structure without ERPs. “By removing the extraordinary call features, the purchaser should be willing to accept a lower rate of interest,” Pasco bond counsel George Smith with Bryant Miller Olive PA said when the school district’s first deal priced. “We were able to remove some of the uncertainty on when their bonds will be prepaid.” Without ERPs, Ford said it is likely that a new tier of Florida school districts will be created in the market offering COPs that are more attractive to investors because they are more like general government bonds. One analyst following Florida’s COPs, however, questioned why investors would not want the ERPs. For example, an investor would want an ERP if the building being financed is destroyed under the assumption that its destruction removes the issuer’s incentive to appropriate for debt service.“I’ve always assured my clients that, without the ERP, you’re taking facility or project survival risk,” the analyst said. “You’d think that investors would charge a higher rate of interest for this riskier, non-ERP situation.” Fried said FGIC requires property insurance on buildings under lease. “They have an obligation to rebuild and to the extent they do not rebuild they redeem the bonds.” Tom Vander Molen, a partner in the tax and public finance groups at Dorsey & Whitney LLP, said he was surprised that investors would prefer COPs without extraordinary redemption provisions enough to accept a lower yield. “It is not surprising that investors would want to avoid an early call, because often institutional investors, particularly funds, prefer to pay premiums for higher stated rates of interest rather than to pay par for lower stated rates of interest,” Vander Molen said. “If COPs are called early, the investors have not had a chance to fully amortize their premiums, so the effective yield is less than expected.” But the trade off for eliminating ERPs is that interest paid by an insurer after a non-appropriation likely would be taxable, resulting in a lower after-tax yield, Vander Molen said. Tax exemption only applies to obligations of a state or local government, he explained. After a non-appropriation, the obligation becomes that of the insurer, which is not tax-exempt. However, the risk of taxability typically is disclosed in bond documents.
