Municipal securities are important financial instruments utilized by California school and community college districts to finance their long-term capital projects and operations. Given the diverse educational and funding needs of these districts, understanding the various financial instruments is crucial to determine which municipal security best fits a district’s financing needs. Chet Wang, a public finance professional from Keygent LLC, takes the time to give us an overview of the various types of municipal securities utilized by California school and community college districts.
What Are Municipal Securities?
Municipal securities, sometimes referred to as “munis”, are debt obligations issued by states, cities, counties, and other governmental entities, including California school and community college districts, to finance public facilities and other expenditures. These securities are crucial in supporting a vast array of infrastructure and public service projects, such as building new educational facilities. Municipal securities are typically tax-exempt, meaning that investors are not required to pay federal income tax, and in some cases, state income tax, on interest received. This tax advantage allows local governments, such as school and community college districts, to borrow at lower interest rates than other financing instruments. Municipal securities come in various forms. The most common form is general obligation bonds. California school and community college districts may also consider issuing Mello-Roos bonds, certificates of participation, bond anticipation notes, and tax and revenue anticipation notes. Municipal securities play a crucial role in facilitating the development and maintenance of school facilities and modernization of infrastructure. They also provide a critical tool for districts to manage their finances in the form of short-term financing.
Keygent Discusses General Obligation Bonds, The Most Issued Municipal Security by California School & Community College Districts
General obligation bonds are the most commonly issued municipal security by California school and community college districts when raising capital for the construction or modernization of their facilities. Municipal bonds are repaid through an ad valorem tax based on the assessed value of properties within a district’s boundaries. A district’s overlapping county has the ability to set a tax rate annually to generate the necessary revenue to meet the debt obligations.
Chet Wang noted, “Investors consider general obligation bonds a lower-risk investment compared to other types of municipal securities utilized by California school and community college districts because they are backed by the unlimited taxing power of the district.” With general obligation bonds being considered a potentially safer investment, this often results in districts receiving higher credit ratings and lower interest rates on their municipal bonds, resulting in a lower overall borrowing cost.
California’s Mello-Roos Bonds
Mello-Roos bonds are a type of municipal security that leverages the value of land in a portion of a school or community college district. These bonds are commonly used by local governments in California to finance infrastructure for new developments. California school and community college districts can utilize these bonds to finance the construction or acquisition of their facilities. Unlike general obligation bonds, Mello-Roos bonds are repaid through special taxes that are calculated using a special tax formula. Taxes may be levied on developed and undeveloped property but cannot be based on the value of a home. Districts will typically hire a special tax consultant to perform special tax calculations based on the proposed development. To issue Mello-Roos bonds, a district must sponsor the formation of a community facilities district, which becomes the issuing entity for the bonds. The passage of a community facilities district requires two-thirds voter-approval of registered voters within the district. If there are less than 12 registered voters, the vote is by landowner and weighted by acreage.
Bond Anticipation Notes: A Type of Bridge Financing
Bond anticipation notes, or BANs, are another type of municipal security that can be issued by California school and community college districts. BANs are typically issued by districts to generate immediate funding for capital projects that will eventually be repaid through long-term municipal bonds. Essentially, BANs are bridge loans that are repaid with the proceeds from future bond issuances. Districts may consider issuing BANs if they have tax rate capacity issues but require funding immediately for pending capital projects.
The appeal of BANs lies in their flexibility in managing funding timelines. By issuing BANs, a California school or community college district can align its cash flow with project demands, while effectively managing their tax rate. The use of BANs also has some risks for districts. Districts should be mindful of future market conditions and their ability to issue long-term municipal bonds to repay the BANs before their maturity. If a long-term financing cannot be secured due to a downturn in the interest rate environment or tax rate capacity did not become available as projected, the district may face challenges in being able to repay the BANs. Chet Wang noted, “The strategic use of a short-term financing can support uninterrupted project execution but it must be managed carefully to ensure districts can repay it.” Additionally, districts may have higher total issuance costs from issuing two different municipal securities. Therefore, while bond anticipation notes provide essential flexibility, they require meticulous planning to mitigate associated risks effectively.
Keygent Provides an Overview on Certificates of Participation
California school or community college districts also have the ability to issue municipal securities that do not rely on a district’s ability to levy property taxes as a source of repayment. Certificates of participation, or COPs, are a type of municipal security that involves a lease-purchase agreement between the issuing district and a financing entity. The lease payments are made by the district from its general fund, or other allowable source of funds. Unlike general obligation bonds, districts do not require voter-approval to issue COPs. As a result, certificates of participation are typically used by districts when voter-approval for a general obligation bond authorization is challenging or the timing of the project needs cannot support an extended timeline associated with a bond election.
Due to the source of repayment for the municipal security, COPs are considered riskier than traditional general obligation bonds. Since a California school or community college district is making payments directly from their internal funds rather than ad valorem property taxes, their options are limited to raise additional funds to repay the COPs if needed, unlike an ad valorem tax. Chet Wang explained, “When planning to issue certificates of participation, it is important that districts work closely with their financing team to ensure the structure of the COPs results in a total debt service that can be comfortably repaid.”
Due to the riskier source of repayment, credit rating agencies generally assign a lower rating for a certificate of participation. Investors in turn typically demand higher interest rates to compensate for the perceived additional risk associated with COPs. Generally, certificates of participation have a higher overall borrowing cost than general obligation bonds.
Tax and Revenue Anticipation Notes: Short-Term Cash Flow Funding
Tax and revenue anticipation notes, sometimes referred to as TRANs, are short-term municipal securities issued by school or community college districts to manage cash flow issues. These notes are typically repaid within one fiscal year with a maximum financing term of 13 months. TRANs are repaid by anticipated future funding. To address deficits in their projected cash flows, districts may elect to issue TRANs to “bridge” the gap until they receive their expected revenue. Tax and revenue anticipation notes help districts cover operational costs and maintain liquidity until revenues are received. This type of financing is crucial for districts that experience significant timing differences between their expenditures and the receipt of tax revenues. Issuing TRANs helps districts stabilize their budget and promote continuity in educational services. Similar to COPs, tax and revenue anticipation notes do not require voter approval.
Keygent Discusses Shared Traits Between Municipal Securities
Although all the previously mentioned municipal securities have their differences, the process of issuing them is similar. Once a California school or community college district has identified their project needs, the district then works with their municipal advisor to determine which municipal security best suits their needs. The district, with the help of their municipal advisor, bond counsel and underwriters, prepares various legal documents authorizing the issuance for Board approval. Once approved, an updated credit rating is typically required from one of the major credit rating agencies. The financing team and District then typically publish an official statement and other necessary financing documents to market the municipal security to investors. The financing is then sold via a competitive bidding process or a negotiated sale, where the interest rates and terms are finalized. Once the municipal security is finalized, the district receives its funds for their project or operational needs.
Additionally, municipal securities share the responsibility for ongoing continuing disclosure. In the context of municipal securities, this refers to the ongoing obligation of issuers to provide updated financial information and material event notifications to investors until the securities have matured. This requirement is critical for maintaining transparency and ensuring that the investors have access to current data to assess the creditworthiness and potential risks associated with their investments. Continuing disclosure agreements are typically executed at the time of the financing issuance and usually can be found as an appendix in the Official Statement. The agreement stipulates the specific types of information and deadline for reporting the information. Key information often included in the requirements are annual financial statements, operating data relevant to the issued securities, and demographic data such as assessed value. The agreement also outlines what is considered a material event and is often required to be publicly disclosed within 10 business days of the event occurrence. These events may include bond calls, rating changes, and defaults. Reporting requirements are unique to each municipal security even if
each financing is issued by the same entity. It is important that districts carefully review each of their continuing disclosure requirements to ensure that nothing is missed. These reports are filed on the Electronic Municipal Market Access, or EMMA, system, a centralized online platform managed by the Municipal Securities Rulemaking Board. EMMA serves as a comprehensive source for free public access to municipal disclosures, bond ratings, and other important data.
Effective continuing disclosure not only fulfills regulatory requirements but also bolsters investor confidence and the overall integrity of the municipal bond market. For issuers, maintaining a strong track record in disclosure practices is important for future bond issuances. Some California school and community college districts may elect to utilize a dissemination agent to assist with navigating the many requirements of their ongoing continuing disclosure.
California school and community college districts have a diverse array of municipal securities at their disposal for raising funds for their capital or operational needs. Ranging from long-term financings such as general obligation bonds or certificates of participation, to short-term financings such as tax and revenue anticipation notes. Each type of security comes with its own set of benefits and risks that every district should carefully consider. By working closely with their financing team, districts can identify which municipal security best fits their project and economical needs. The issuance of municipal securities by school and community college districts is a complex but essential area of public finance in California, reflecting a sophisticated relationship between educational needs, public policy, and financial markets.
Keygent LLC is a municipal advisor firm based in El Segundo, California that provides strategic and technical municipal advisory services and dissemination agent services solely to California school and community college districts. Their public finance professionals have experience advising districts on the issuance of various types of municipal securities. For more information, please visit www.keygentcorp.com.
