What’s Really Exotic About Poway’s Bonds: Millions in Extra Cash
Despite a warning from the state attorney general that its tactics were illegal, the Poway Unified School District pioneered a way to pull millions of dollars in upfront cash out of its bond deals. The gambit will ultimately cost taxpayers $219 million.
There’s a good reason the Poway Unified School District’s 2011 bond deal cost so much.
The district has consistently told the public that it borrowed $105 million last year to fund the final push in its 10-year effort to modernize Poway’s schools. That deal will cost taxpayers almost $1 billion to repay, thanks to an exotic loan called a capital appreciation bond, which won’t be paid off for 40 years.
But Poway didn’t really borrow $105 million. It actually borrowed $126 million.
The district pushed the boundaries of state law to squeeze $21 million in extra upfront cash out of the deal. To get the extra money, Poway agreed to boost the interest on its bonds for investors. The result: The ultimate cost of the loan to taxpayers increased by almost $190 million.
The deal’s billion-dollar price tag made Poway famous.
While other California school districts have taken out similar capital appreciation bonds, Poway’s deal became a national flashpoint because of its sheer size and its high repayment ratio.
But what’s really unusual about Poway’s most recent deal and one that preceded it isn’t their exorbitant cost. Rather, it’s the extraordinary tactics the district used in search of extra cash.
The district hasn’t just been on the cutting edge of crafting long-term loans that push the burden for today’s borrowing onto future generations. It’s also spent the last few years figuring out how to get ever more money out of its bond deals. The district’s methods have drawn a warning from the state attorney general, who says they are illegal since they saddle taxpayers with more debt than voters approved.
The concept Poway exploited, known as “selling at premium,” has long been used by California school districts to eke a sliver of extra upfront cash or “premium” from their bonds. Districts use the extra money, typically about 1 percent of the deal, to pay attorneys’ fees and other costs of issuing bonds.
But in its last two deals, Poway didn’t just get small slivers of premium. It got big slices. Last year, instead of just getting enough premium to cover its $1.7 million in costs, the district got $21 million. Bond experts said such a high sum is unheard of.
Because the district won’t start paying off most of the debt for two decades, that premium will end up costing taxpayers $219 million.
“You’re making taxpayers pay the equivalent of bonds they didn’t authorize,” said Glenn Byers, Los Angeles County’s assistant treasurer and tax collector, whose office issued a white paper in 2011 cautioning against bond deals like Poway’s. “That’s just way over the top.”
Borrowing on Steroids
When voters allow a school district to issue bonds, they set what appears to be a strict dollar limit on how much can be borrowed.
But voters also give districts the flexibility to set the interest rates on their bonds.
That flexibility has proven controversial.
For at least a decade, California districts have taken advantage of the freedom to get premium from investors that doesn’t count towards their strict dollar limit. It’s a way for districts to borrow more money up front, while making it look like they’re staying within the limit voters set.
Byers said districts argue the extra money shouldn’t count towards the voter-imposed debt limit because they never really get it, spending it instead on their ancillary costs.
And this practice was generally accepted. Until Poway came along.
Like other districts, Poway got extra money and spent it on its costs. But the district went much further, taking the already controversial tactic and essentially injecting it with steroids.
In 2009, Poway got an additional $9.5 million upfront, equivalent to an extra 13 percent on its deal.
Then, in 2011, it upped the ante, getting $21 million extra up front — 20 percent more cash.
And Poway didn’t just use the extra money on ancillary costs, but also to pay off interest on previous loans. That pushed the district into new legal territory.
The district’s tactics caught the attention of bond lawyers across the state. Three California bond attorneys, who spoke on condition of anonymity because they didn’t want to jeopardize their ability to work on school bonds, said Poway’s two deals were extraordinary.
“Everybody was shocked by that,” one of the attorneys said. “Nobody’s ever done that before.”
The net effect: While Poway voters in 2008 approved the district selling $179 million in bonds, the district found a way to get $210 million.
A Judicial Stamp of Approval
Poway Unified officials knew they needed legal backing to do their billion-dollar deal.
So in 2010 they took the preemptive step of bringing it before a San Diego Superior Court judge.
The district filed what’s known as a validation action, calling on any interested parties to step forward and challenge its actions.
If nobody came forward, Poway could still have to make its case to the judge. Or the judge could just issue what’s called a “default judgment,” and not even hear the facts of the deal.
Poway’s validation action, notice of which was published in The San Diego Union-Tribune, a local newspaper, caught the attention of state Attorney General Kamala Harris’ office.
“It is our Office’s view that this proposed use of premium for costs of issuance as described in the complaint is not authorized by the law,” a deputy state attorney general wrote in a March 1, 2011 warning letter to the district.
“[B]y artificially inflating interest rates to generate premium, the School District is not acting consistent with statutory law, and is also incurring debt beyond what the voters authorized in violation of the California Constitution,” the letter states.
Despite the stark warning, Harris’ office never officially challenged Poway’s bond.
So on March 2, 2011 Superior Court Judge William S. Dato issued a default judgment in favor of the deal.
The bond was now, officially, legal.
Lynda Gledhill, a spokeswoman for the attorney general, would not explain why Harris’ office didn’t challenge Poway’s validation action. She said the office stands by its finding that using premium to pay for a district’s costs is illegal. But it hasn’t taken any further action.
“That’s the end of the case as far as we’re concerned,” Gledhill said.
Poway Unified school board members Todd Gutschow and Marc Davis said the attorney general’s inaction is further evidence that the district acted legally. Both board members said if the attorney general’s office was truly concerned about their deal, it would have gone to court.
Gutschow also called the letter “a politically motivated attack.”
He refused to elaborate on what he meant.
When Borrowing Isn’t Borrowing
Poway Unified officials acknowledge that they generated $31 million in extra premium out of the district’s last two bond deals.
Yet they also say the district has not borrowed more money than taxpayers approved.
“The simple fact is that [Poway Unified] did not borrow any more funds than those approved by the voters,” Superintendent John Collins wrote in an email on August 29.
Collins wouldn’t elaborate on this position. He and the Poway school board did not respond to several requests for interviews. Nor did Poway officials agree to interviews with their legal or financial staff.
District officials may choose not to define their extra $31 million as borrowing. But that money has been spent. And taxpayers will have to repay it — with interest.
When those taxpayers voted to approve Poway Unified borrowing money in 2008, they were told the district would borrow $179 million.
The bottom line is that it didn’t. It found a way to borrow millions more, by pushing the boundaries of state law.
Will Carless is an investigative reporter at Voice of San Diego currently focused on local education. You can reach him at firstname.lastname@example.org or 619.550.5670.
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