FIN22 The Truth About Capital Appreciation Bonds The Good, The Bad, The Ugly

1. LONG BEACH, CA APRIL 5, 2013 FIN22 The Truth About Capital Appreciation Bonds The Good, The Bad, The Ugly These materials have been prepared by a CASBO Associate Member.  They have not been reviewed by State CASBO for approval, so therefore are not an official statement of CASBO.

2. What are Capital Appreciation Bonds? • CAPITAL APPRECIATION BOND (CAB) – A municipal security on which the investment return on an initial principal amount is reinvested at a stated compounded rate until maturity, at which time the investor receives a single payment (the “maturity value”) representing both the initial principal amount and the total investment return. CABs typically are sold at a deeply discounted price with maturity values in multiples of $5,000. CABs 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. For this reason only the initial principal amount of a CAB would be counted against a municipal issuer’s statutory debt limit, rather than the total par value, as in the case of a traditional zero coupon bond. • From the Municipal Securities Rulemaking Board’s Glossary • http://www.msrb.org/msrb1/glossary/view_def.asp?param=CAPITALAPPRECIATIONBOND 2013 CASBO ANNUAL CONFERENCE & SCHOOL BUSINESS EXPO

3. When Does a CAB Make Sense? Assume Revenue increases by 6% annually. Assume Interest Rate for Borrowing is 5% $10 ÷ 5% = $200 Present Value of Revenue Stream at 5%= $208.74

4. Recently, Much Media Attention

5. There Are Many Ways to Tell a Story

6. Let’s Look at How Taxes Are Calculated • Bonds Property Taxes • When the voters approve a general obligation bond measure, they are authorizing the School District to issue a specified amount of bonds, for specific projects and agreeing to repay those bonds through property tax. • Debt Service ÷Assessed Value = Tax Rate

7. Bonding and Taxing Capacity Limitations Education Code 15268. The total amount of bonds issued, including bonds issued pursuant to Chapter 1 (commencing with Section 15100), shall not exceed 1.25 percent of the taxable property of the district as shown by the last equalized assessment of the county or counties in which the district is located. The bonds may only be issued if the tax rate levied to meet the requirements of Section 18 of Article XVI of the California Constitution in the case of indebtedness incurred by a school district pursuant to this chapter, at a single election, would not exceed thirty dollars ($30) per year per one hundred thousand dollars ($100,000) of taxable property when assessed valuation is projected by the district to increase in accordance with Article XIII A of the California Constitution. Note: Education Code 15270, for unified districts, is the same except the bonding capacity is based on 2.5% rather than 1.25%, and the taxing capacity is based on $60 per $100,000 rather than $30.

8. Debt Service Grows Along with Tax Base

9. Optimization of the Tax Rate

10. Debt Service is Fixed, but A.V. is Variable

11. Tax Rates Will Vary Because A.V. Varies

12. Borrowing Defers Payment Above: J. Wellington Wimpy and Roughhouse

13. Let’s Look at a Desperate CAB

14. Taxing Capacity is Almost Fully Utilized

15. Most Expensive For Longest Period

16. Taxing Capacity Is Now Fully Utilized

17. Assumptions are Key

18. Recession: Projections More Wrong Than Usual CABs and BANs liabilities really increase BANs threaten fiscal solvency BANs are often used to bridge to a CAB

19. CABs are Not New

20. Where do I find information on CABs? • The ‘official statement’ of debt issuance is a great starting point • The official statement serves as the prospectus for a debt issuance (thus is geared towards the investor)

21. Example: Official Statement Important: Bonds are typically sold in $5,000 denominations

22. The Official Statement identifies the type of bonds that are being issued….. ….within the text of the Statement and in the debt service schedule:

23. The term ‘accretion’ is the big indicator…

24. CABs will present an accreted value table:

25. What Does Your Audit Report Tell You About CABs? • Your report should tell you: • Beginning and ending balances • Increases and decrease (new debt issuances, accretion and debt principal payments) • Amounts due in one year • Interest rates • Maturity dates

26. A general description of your debt, and whether you have issued CABs….

27. A summary of all general obligation debt, which should include CABs….

28. ….that should agree to the debt service schedule

29. What the audit report does not tell you? • Whether the debt issuance made sense • Financing provisions of the debt, such as how the debt was sold (negotiated sales) • For certain debt, how it’s to be repaid • The audit report recaps your debt as of a certain period

30. Which Brings us to Bond Anticipation Notes! A short-term debt instrument issued to borrow against the proceeds of an upcoming bond issue

32. So What’s The Issue With Bond Anticipation Notes? • Very short maturity period (repayment) • If you couldn’t issue GO Bonds, and GO Bonds are a source for repayment of the BANs, how do you intend to repay this debt? • Inability to repay is a huge budget issue!

33. Any Questions?