DALLAS — Texas lawmakers are considering two bills that would ban capital appreciation bonds with the aim of reducing the risk of deferred interest costs for local governments, particularly school districts in fast-growing areas of the state.
With more than $4 billion in capital appreciation bonds issued in Texas from 2003 to 2012, about 85% came from school districts, according to the Legislative Budget Board.
“The buy-now, pay-later approach often results in crippling repayment obligations, with the repayment costs being greater than the benefits derived from the bond,” according to Sen. Juan “Chuy” Hinojosa, D-McAllen, in a statement on the intent of Senate Bill 449 that went before the Senate Intergovernmental Affairs Committee Wednesday.
CABs are typically used by school districts where immediate development is needed due to a fast-growing population, but where there are limited financing options.
Bond issuers assume that the number of taxpayers will increase and the anticipated tax-base growth will enable repayment of the obligation.
The bonds are increasingly used in districts in California and Texas, where the school-aged population is expanding faster than the current tax base can support.
CABs are usually sold at a deeply discounted price with maturities that can run up to 40 years. They are distinct from traditional zero-coupon bonds because the investment return is considered to be in the form of compounded interest rather than accreted original issue discount.
That means the initial principal amount of a CAB counts against a municipal issuer’s statutory debt limit, rather than the total par value.
Between 2007 and 2011, Texas municipalities issued over 700 CABs, receiving $2.3 billion in immediate funding, but committing future repayment obligation of over $20 billion, according to the statement on the Senate legislation.
Taxpayers in the rapidly growing Austin suburb of Leander will have to repay about nine times the amount the school district originally borrowed, according to Hinojosa.
Rep. Dan Flynn, R-Van, sponsor of the state House Bill 3416, said he introduced his version of the bill with the aim of avoiding problems that have arisen in California and other states.
In California, San Diego County Treasurer and tax collector Dan MacAllister has proposed legislation to limit the terms of CABs to 25 years and require more transparency for taxpayers.
Michigan has banned capital appreciation bonds since 1995. Legislation followed an Oakland County jury verdict that a bond counsel firm committed legal malpractice in recommending CABs to the state’s Pontiac school district.
The Texas Education Agency indicated that school districts would be hindered in their ability to issue advance refunding bonds for savings without the ability to issue premium CABs due to the state “par-to-par” requirements.
The Texas Bond Review Board reported that local governments in fiscal 2011 issued $466 million of CABs.
That included $7.8 million from cities and towns. Special districts and authorities issued $158.2 million, while water districts and authorities issued $3.8 million. Counties and health-care and hospital districts issued none.
Most bond issues for local school districts in Texas are backed by the Texas Permanent School Fund, which provides triple-A ratings and transfers the long-term risk to the state.
Gwen Santiago, executive director of the Texas Association of School Business Officials, said that school districts need the flexibility to use capital appreciation bonds, though the finance mechanism does need review.