Bloomberg News

Texas Joins Lockyer Targeting Bonds Fueling Schools: Muni Credit

April 14, 2013

Texas Joins Lockyer Targeting Bonds Fueling Schools

Schools such as those in Leander, a city adjacent to the Texas capital, say they need these capital appreciation bonds to help the second-most-populous state handle an annual inflow of 80,000 new students. Photographer: Sam Hodgson/Bloomberg

Texas (STOTX1) lawmakers are joining the push to curb municipal bonds that push off debt payments for as long as 40 years on loans for public schools built to handle surging enrollment.

Schools such as those in Leander, a city adjacent to the Texas capital, say they need these capital appreciation bonds to help the second-most-populous state handle an annual inflow of 80,000 new students. Most of the growth is in fast-growing suburbs of Austin, Dallas, Houston and San Antonio. Bondholders such as Lin Elliott at Texas Farm Bureau Mutual Insurance Co. like the debt for yields that can be double those on regular munis.

Yet State Representative Dan Flynn is leading Texas critics who want schools to choose financial tools that don’t saddle future generations with repayment. In California, Treasurer Bill Lockyer and schools Superintendent Tom Torlakson are seeking a moratorium on such sales. California’s assembly last week passed limits on the borrowing.

“Good gracious, these are scary things,” said Flynn, a Republican from Van, 75 miles (121 kilometers) east of Dallas, and former deputy state bank commissioner. He sponsored a bill banning the bonds, similar to one the Texas Senate passed April 9. “We are mortgaging our grandchildren’s future through these bonds.”

Payment Delay

Texas schools and public agencies issued more than 700 deferred-interest bonds from 2007 to 2011, raising $2.3 billion, according to the state comptroller’s office. With no immediate payments required, the securities enable schools to avoid exceeding limits on debt-service payments.

In Texas, the focus is on Leander Independent School District (108742MF), where enrollment has doubled since 2003 to 34,000. The district bordering Austin has the fifth-highest total debt among Texas’s 1,024 school jurisdictions, or about $79,000 per student when including interest costs, according to the Texas Bond Review Board. Yet it is only the 39th-largest district.

Ellen Skoviera, an assistant superintendent, said the state board overstates Leander’s debt by not factoring in likely savings from refinancings at lower interest rates.

The district has $773 million of capital-appreciation debt, said a spokeswoman, Veronica Sopher. Its 2012 annual report shows total debt of $1.3 billion.

Yield Draw

The zero-coupon notes typically carry higher yields than coupon bonds, to compensate investors for the longer holding period before they receive any income.

Leander school bonds callable in August 2019 yield about 2.09 percent, using BVAL pricing analysis. That’s about 1.1 percentage points more than zero-coupon Treasuries with a similar duration. It’s also about the same yield spread above benchmark munis, BVAL pricing shows.

“School districts have to make it juicy enough over a non- zero bond to buy these,” said Elliott, who oversees $1 billion, including about $20 million in deferred-interest bonds at Texas Farm Bureau (0172722D)in Waco.

The risk in the bonds is that their structure gives them a longer duration than coupon-bearing debt, meaning their prices are more sensitive to swings in interest rates. That attribute is gaining focus as signs of a strengthening economy fuel bets that yields will rise this year or that the Federal Reserve will scale back its monthly bond purchases.

Appetite Curb

Ten-year Treasury yields will climb about 0.7 percentage point to 2.4 percent in the first quarter of 2014, according to the median forecast of 61 analysts in a Bloomberg survey.

“The long duration does limit our appetite in the current interest-rate environment,” said Brendan Gau, who oversees $535 million in munis as chief investment officer of Amerisafe Inc (AMSF)., a workers compensation insurer in DeRidder, Louisiana. The company holds about $5.5 million in capital-appreciation bonds from the Leander and Midlothian school districts in Texas, he said.

“But I would think that Texas school districts would benefit from locking in their long-term funding costs now, while the Fed works to keep interest rates low,” he said.

Criticism in California has centered on Poway Unified School District, north of San Diego, which borrowed $105 million in 2011 while deferring almost $1 billion in interest obligations by the time all the bonds mature in 2051.

California Critique

The California assembly unanimously approved a bill limiting the duration of capital-appreciation bonds to 25 years, prohibiting debt repayments of more than four times the principal and requiring the option of early repayment for deals maturing in more than 10 years. The measure now goes to the Senate.

Fitch Ratings lowered Leander’s rating in May to AA-, fourth-highest, partly because of its reliance on deferred- interest bonds, said Steve Murray, senior director at Fitch in Austin.

“When you issue debt that far out, it puts a significant repayment burden on future taxpayers,” Murray said.

The jurisdiction is confident that population growth will boost property taxes used to pay debt service, which it expects to rise 47 percent in the next decade to about $90 million annually, said Skoviera. Property values may rise 8 percent in 2013, after gaining about 3 percent last year, she said.

Available Tools

“We’re just using the tools we have that are necessary to put buildings on the ground that are needed for our children,” said Pam Waggoner, president of Leander’s school board.

Waggoner’s opponent in May board elections has made debt the focal point of his campaign.

“These bonds are going to crush the district,” said Jim MacKay, a sales manager for a security company.

Leander is spending $61 million on debt service this year, up from $38 million five years ago, according to district financial reports. That’s about 20 percent of its annual budget.

“We have overspent and overbuilt and now the problem becomes how we best manage the debt so we don’t implode,” said MacKay, the volunteer announcer for Friday night football games at Leander’s Vista Ridge High School.

Opposition to the bonds stems from watchdog groups such as Empower Texans, an Austin non-profit group that promotes limited government and reduced public-school spending, said Richard Litton, executive vice president of Southwest Securities Inc., a Dallas company that is Leander’s financial adviser.

Track Record

“It’s a bunch of malarkey,” he said. Texas districts have used deferred-interest bonds for years without defaults because of oversight by boards, advisers and the state attorney general’s office, which approves each issue, said Litton, who has advised municipal clients for more than 35 years.

Texas schools say they need the bonds because the state limits debt service to 50 cents per $100 of assessed valuation.

“If you go above the 50-cent cap, you effectively shut yourself out of the bond market,” said Fitch’s Murray.

Texas cut $5.4 billion in public-school funding in 2011 and 2012 to help balance the state budget, forcing districts to economize. Leander, which lost $22 million over those two years, built an elementary school in 2011 that remains vacant because of a lack of operating funds, Sopher said.

More than 80 percent of Texas’s student growth occurs in about 99 districts, mostly in suburbs of Austin, Dallas, Houston and San Antonio, said David Vroonland, superintendent of Frenship Independent School District near Lubbock and president of the Fast Growth School Coalition. The group opposes bills to restrict the use of capital-appreciation bonds, which Vroonland said his own district hasn’t used.

“If the state would address their lack of support for our schools, we wouldn’t be having this conversation,” Vroonland said.

Beating Treasuries

Local issuers led by the New Jersey Transportation Trust Fund Authority (26525MF) are set to sell about $9 billion of debt this week, down from almost $11 billion last week, the biggest wave this year, data compiled by Bloomberg show.

Municipalities will borrow as yields on benchmark 10-year munis have fallen to 1.79 percent, the lowest since January. With the federal tax filing deadline today, investor selling related to tax season is waning.

The muni rally has driven yields to almost even with those on federal debt. The ratio of local yields to those on Treasuries is about 104 percent, down from a seven-month high of 113 percent on April 5. The smaller the percentage, the more expensive munis are relative to federal securities.

Local debt has earned 0.6 percent this month, compared with about 0.5 percent on Treasuries, Bank of America Merrill Lynch data show.

To contact the reporter on this story: David Mildenberg in Austin at dmildenberg@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net


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