AP Enterprise: Schools use controversial practice for extra cash (cash-out refunding)

AP on Bakersfield Californian ^ | 4/29/06 | Bob Porterfield - ap

[NormsRevenge]

A growing number of schools and community colleges in California are refinancing voter-approved bonds to raise extra cash, a practice many financial experts say puts an additional burden on taxpayers and may violate state law.

The process, known as cash-out refunding, is similar to refinancing a home mortgage to lower monthly payments and take out equity in cash. It's popular because the school districts get extra money - frequently millions of dollars - without going back to the voters.

Most use the money to cover construction cost overruns, but critics say California law limits the use of refunded bonds for anything other than repaying old debt. Without voter approval, they say, there is no clear legal authority for the leftover cash.

"This is something that should be thoroughly investigated," said Jonathan Coupal, president of the Howard Jarvis Taxpayers Association, a Sacramento-based watchdog group. "It appears to be contrary to the intent and spirit of the law."

But the legality of cash-out refunding is an open question. The California courts have not been asked to weigh in, and Attorney General Bill Lockyer hasn't issued a formal opinion.

"We're aware of the issue and are looking into it," Lockyer spokesman Nathan Barankin said. "There have been a few informal opinion requests."

With the number of cash-outs increasing yearly, both sides in the debate say there is a need for clarity.

"When legal opinions diverge, as they have here, legislative clarification is essential in order for school districts to move ahead operating on a level playing field," said John O'Sullivan, senior vice president of Kelling, Northcross & Nobriga, an Oakland financial adviser whose clients include school districts. "We'd just like to know what the rules are."

Of the 248 bonds refinanced by California school and community college districts since 2003, at least 80 were cash-outs, according to an Associated Press review of data provided by the California Debt and Investment Advisory Commission, or CDIAC, and documents obtained from districts under the state's public records act.

Their frequency increased in each of those years, from 15 in 2003, to 25 in 2004, to 40 in 2005.

Some municipal finance experts say the actual number may be much higher, but it's difficult to separate cash-outs from other types of refundings because public disclosure is ambiguous.

In March 2004, voters in the San Joaquin Valley's Manteca Unified School District narrowly approved a bond measure for the construction of new schools and some rehabilitation work. The district sold bonds totaling nearly $42.5 million.

Fifteen months later, it refinanced, selling new bonds to pay off its existing debt and reaping an extra $4 million in cash to cover cost overruns on the projects.

"They decided it was better to refinance the existing bonds, get the extra money to cover cost overruns on existing projects, and keep the second series of bonds in reserve for the remaining projects," said Mark Epstein, the district's Santa Rosa-based financial adviser, who recommended the move.

Michael Dodge, Manteca's assistant superintendent for business affairs, said school officials were led to believe that a cash-out refunding would save taxpayers money over the long haul.

But experts say the practice usually ends up costing taxpayers more because any savings from the refunding are taken by the district in cash. Lawyers and financial advisers also claim a fee.

In Manteca's case, the refunding did save the district about $500,000 over the 18-year life of the bonds, but the $718,000 in fees and other related costs more than wiped out the savings. That led to an increased tax bill of $22.40 per year on a $400,000 home.

Cathleen Dominico, a financial consultant with Sacramento's Capitol Public Financial Group and a leading critic of the practice, said the savings should have been passed on to taxpayers.

"These refundings should not be designed so that taxpayers pay more," she said.

California law requires school construction to be financed with general obligation bonds that are repaid by property taxes. The district's voters must approve bond measures by a 55 percent majority, and school officials can sell bonds up to the approved debt limit.

Once bonds are sold, they can be refinanced at any time without further voter input. New bonds are sold, ostensibly at a lower interest rate, and the proceeds are used to pay off the existing debt.

But the law says the refinanced amount may not exceed "the principal amount of the bonds to be refunded plus the costs of issuing the refunding bonds."

That's where critics of cash-outs say the practice crosses the line.

"School districts are subject to the debt limit approved by voters," said Jeffrey Smith, Dominico's colleague at Capitol Public Financial Group. "We've told our clients you can't do that because it circumvents the restrictions of the debt limit."

School officials are not necessarily to blame, says Smith, "because these refundings are presented to them as being legal" by their advisers.

So far, the debate has been confined mostly to law firms and financial institutions. But the growing number of cash-outs has begun to draw attention from public officials responsible for managing the money from bond sales.

"So much of this is under the radar," said San Mateo County Treasurer Lee Buffington. "If this is such a good deal and such a legal deal, why aren't they out there beating the drum?"

Like Manteca, most districts use the extra cash to cover construction shortfalls.

Hartnell Community College in Salinas raised $4 million from its 2005 refunding; the Southwest Community College District in San Diego County got $5.2 million; and the Anaheim City School District pulled out $8.6 million in cash from its bond refunding.

The largest 2005 cash-out was made by the San Jose Unified School District, which netted $20.4 million.

For the districts, the temptation has never been greater. Most have seen construction costs skyrocket in recent years. The pricetags presented to voters for new school buildings may increase by 30 percent or more by the time projects are completed a few years later.

"Districts can't deliver the projects they promised," says Tom Duffy of the Coalition for Adequate School Housing in Sacramento, a lobbying group. "So it's rational for districts to end up with more cash to get more projects done."

Law firms and financial institutions can make millions in fees by helping districts refinance debt and take money out, and some aggressively market cash-outs.

One of the biggest champions is San Francisco Attorney David Casnocha. His firm, Stradling Yocca Carlson & Rauth, has participated in many of the refundings, including Manteca's.

Casnocha said in an e-mail that he believes there are several approaches to cash-out refunding that "constitute legal means to issue refunding general obligation bonds," but he has declined to comment further.

Piper Jaffray and UBS Financial Services were the lead underwriters in many of last year's cash-outs.

Piper Jaffray declined to discuss refundings, while UBS said in a statement: "Schools and colleges have worked on these refinancings with many of the leading law firms, financial advisory firms and bond underwriters specializing in this area. UBS obtains and relies upon the legal opinion of nationally recognized bond counsel when it acts as the lead underwriter in any issuance of bonds."

Other California law firms, financial advisers and underwriters advise their clients to steer clear of taking cash out when refinancing their bonds.

"It would take a lot for somebody to convince me this is ethical," said Lori Raneri, president of Government Financial Services, a Sacramento consulting firm that counts more than 200 California school districts as clients. "If this is legitimate, why didn't we do it originally?"

[calcowgirl]

What a bunch of crooks!