partnerships FINANCING OPTIONS USING BONDS FOR ILLINOIS SCHOOL DISTRICTS
want to issue a bond? B onds are a form of debt. In the public sector, “borrowers” or “issuers” of bonds are states, cities, villages, school districts and other local government entities that need money for a variety of reasons. Typically, a school district will want to issue a bond and pay principal and interest over time to spread out the burden of paying for new schools, improvements and other capital needs over the period of expected useful life of the financed assets, as opposed to increasing taxes or impacting its budget over a shorter term. Borrowing by a school district is highly restricted and must be done in accordance with Illinois law. Use of bond proceeds by a school district Municipal bonds can be issued by school districts for a variety of purposes, provided that their issuance accords with Illinois law. Commonly, school districts issue municipal bonds for capital projects, working capital needs or refinancing of prior debt. A. New Projects. Generally, a school district compiles an annual capital improvement budget or prepares a “needs list,” which consists of projects the school district considers to be important by means of its impact on the safety, resources and general wellbeing of the students and community served by the school district. Capital projects can be funded by federal or state grants and other miscellaneous revenue available for general purpose use. However, the primary sources of district funding to pay for capital projects are generally derived from the proceeds of municipal bonds. Projects involving the acquisition of school sites and buildings, construction of new school buildings and additions, and equipping, altering, repairing and reconstructing existing facilities, are examples of school district projects that are commonly financed with bonds. Thus, generally speaking, if a school district is building a new capital project, it is likely that the proceeds of a municipal bond issuance are financing all or a portion of the project. a “Typically, to schooladistrict will want issue bond and pay principal and interest over time to spread out the burden of paying for public infrastructure over the period of expected useful life of the financed assets, as opposed to increasing taxes or impacting their budget over a shorter term. Borrowing by a school district is highly restricted and must be done in accordance with Illinois law. ” Often times capital projects are of long term value to current and future students, as well as residents of the school district (such as new school buildings, maintenance of older facilities, expanding or updating current facilities, etc.). Hence, issuing bonds to fund a capital project allows current and future taxpayers within the district to pay related costs over the life of the project as they avail themselves of the benefits it bestows upon the district. 1
can issue bonds to fund working capital expenditures that arise from a variety of circumstances. Traditionally, working capital bonds have been issued as short-term obligations where the proceeds are used to cover a district’s temporary cash flow, or operating, deficit. Short-term budgetary deficits can arise from a mismatch between the receipt of annual revenues (property taxes or other) and the timing of annual expenditures of the issuer within a year. Tax anticipation warrants (“TAWs”) are often issued in anticipation of taxes levied but not yet collected. TAWs may be issued in an amount up to 85% of the total amount levied for the particular fund against which the TAWs are issued. Longer-term working capital bonds have become more commonplace in recent times due to financial difficulties stemming from the recent economic crisis, which caused significant declines in property values. School districts use these longer-term working capital bonds to address structural deficits that are not the result of a mismatch of revenues and expenses. Tax anticipation notes allow a school district flexibility to balance out its revenue collections from anticipated levies with anticipated expenditures. A school district is permitted to incur debt by issuing a tax anticipation note in an amount not exceeding 85% of the taxes levied for the particular fund against which the notes are issued. Further, a tax anticipation note is required to mature within two years and may not be issued if there is an unpaid note from any prior year. Although tax anticipation notes are generally a means of balancing a school districts operating expenses with revenue collections, these notes may sometimes be used as a bridge to fund a pending capital project while the school district structures more permanent funding by the end of the year. Insurance reserve bonds, funding bonds, tort judgment funding bonds, interfund loans, interfund transfers, state aid anticipation certificates and working cash fund bonds are permitted under Illinois law assuming certain requirements are satisfied. Certain federal income tax issues exist in connection with working capital financings. C. Refundings/Refinancings. Like a homeowner who refinances their mortgage when interest rates drop, a school district with outstanding debt can issue refunding bonds in order to take advantage of lower rates. Refunding bonds can also be issued to avoid default or restrictive debt burden. A refinancing can be done as a current refunding, which means the old bonds are called or mature within 90 days of the issuance of the refunding bonds, or an advance refunding (limited to one occurrence) where the old bonds are called on a specified call date and proceeds of the new refunding bonds are typically held in an escrow account until such later call date at least 90 days after the issuance of the refunding bonds. Refundings generally do not need to satisfy direct or backdoor referendum requirements. 2
a school district may issue include general obligation bonds (i.e. building bonds, life safety bonds or funding bonds), alternate revenue source bonds, debt certificates/ installment contracts, leases, tax anticipation warrants, tax anticipation notes and revenue anticipation notes. ” Types of bonds There are a number of different forms of bonds/debt that a school district may issue to meet its financing needs. Types of Obligations that a school district may issue include general obligation bonds (i.e. building bonds, life safety bonds or funding bonds), alternate revenue source bonds, debt certificates/ installment contracts, leases, tax anticipation warrants, tax anticipation notes and revenue anticipation notes. Refunding bonds have been issued more frequently in recent years due to the lower interest rate environment. A. General Obligation Bonds. General obligation bonds or “G.O.’s” are debt issued by a school district representing its full faith and credit and backed by its ad valorem taxing power. A general obligation can be issued for any lawful purpose for which ad valorem taxes may be levied subject to constitutional, statutory, or other limitations (such as debt limitations discussed further below) and pursuant to proper constitutional, statutory, or other procedures. The School Code of the State of Illinois, as amended (the “Code”) contains the guidelines for bond issuance by school districts. Generally, the Code limits the amount of bonds that a school district may issue for a particular purpose. The Code also establishes the debt limit, or maximum amount of money a school district can borrow. For elementary and high school districts, the debt limit is 6.9% of the equalized assessed valuation of the district and for unit school districts, the debt limit is 13.8% of the equalized assessed valuation of the district. There are exceptions to the debt limit as outlined in the Code. For instance, if either (i) student enrollment increases or is projected to increase to certain levels and the majority of the electors approve the bond issue or (ii) a school board determines that additional facilities are required to provide a quality educational program and two-thirds of the electors approve the bond issue, a school districts debt limit can increase to 15%. The Code also allows for situations in which the debt limit can exceed 6.9%, 13.8%, or 15%. Bonds, as well as installment contracts, leases, debt certificates, judgments, tax anticipation notes, and teachers’ orders, are among the borrowing options which count against a school district’s debt limit. Generally, however, alternate bonds do not count against the debt limit. 3
bonds issued to pay the cost of acquiring school sites and buildings, equipping, altering, repairing and reconstructing new and existing school buildings and additions secured by an ad valorem tax on all property in the district without limitation as to rate or amount must be approved by voters of the issuer by referendum held at a regularly scheduled election. 2. Life Safety Bonds. School districts can issue life safety bonds in order to alter, reconstruct and repair school buildings and permanent, fixed equipment and purchase and install equipment purchased for purposes of meeting requirements that are set forth in the building code promulgated by the State Board of Education of the State of Illinois for existing facilities that house students. In accordance with statutory procedures an architect or engineer conducts a survey of a school districts buildings and issues findings of such survey in a “safety survey report.” The school board approves the safety survey report and submits it to the regional superintendent. The regional superintendent approves (or denies) the safety survey report and submits it to the state superintendent. The state superintendent approves (or denies) the report and issues a certificate of approval. Once approved, the regional superintendent issues an order to begin the project. Assuming the school district follows the procedures discussed above, life safety bonds are not subject to direct or backdoor referendum and are secured by an ad valorem tax on all the taxable property within the school district without limitation as to rate or amount, unless the school district is subject to the Limitation Law (discussed herein), in which case the ad valorem taxing power of the school district would still apply, however the amount of the levy would be limited by the school district’s extension base. “Bonds, as well as installment contracts, leases, debt certificates, judgment, tax anticipation notes, and teachers orders, are among the borrowing options which count against a school district’s debt limit. Generally, however, alternate bonds do not count against the debt limit. ” 3. Funding Bonds. Funding bonds may be issued in order to pay teachers’ orders or claims including lease obligations that a school district cannot meet from current revenues. In order to issue funding bonds, a school district follows a procedure similar to other backdoor referendum processes: (i) the school board adopts a resolution declaring the district’s intent to issue bonds for a qualifying purpose; (ii) notice of intent to issue the funding bonds is published in a newspaper within the district and if there is no newspaper within the district then a newspaper having general circulation within district; (iii) the notice must inform voters of the district’s intent to issue bonds and that the bonds shall be issued unless a requisite number of voters1 sign a petition and present such petition to the board secretary within 30 days of publication of the notice. 1 The petition must be signed by voters of the district equal to 10% or more of the registered voters of the district requesting that the proposed funding bonds be submitted to all of the voters of the district at the next prospective referendum date. 4
requirements, alternate bonds are subject to a backdoor referendum. ” B. Alternate Revenue Bonds. Alternate revenue bonds or “double-barreled” bonds are essentially revenue bonds issued under the Local Government Debt Reform Act (the “Debt Reform Act”) with the general obligation of the school district serving as backup security for the bonds. School districts are authorized to use any lawfully available revenue source as a pledge of security for the payment of principal and interest on alternate bonds. The intent of the Debt Reform Act is to permit the issuance of the alternate revenue bonds assuming the pledged revenue source is sufficient so that the tax levy relating to the debt service on the alternate bonds does not need to be extended. The coverage requirements provide that the school district must demonstrate that such pledged revenue source be sufficient in each year the bonds remain outstanding to provide not less than 1.25 times (1.10 times if the revenue source is either (i) federal or state funds that the school district has received in some amount during each of the three fiscal years preceding the issuance of the alternate bonds or (ii) revenues to be received from another governmental unit under an intergovernmental cooperation agreement) debt service on all outstanding alternate bonds payable from such revenue source and on the alternate bonds proposed to be issued. Apart from coverage requirements, alternate bonds are subject to a backdoor referendum. The backdoor referendum gives registered voters the opportunity to petition the school district to submit the question of issuing the alternate bonds to referendum. However, the petition must be submitted within thirty days after publication of the authorizing resolution and be signed by the greater of (i) 7.5% of the registered voters of the district or (ii) the lesser of 200 of the registered voters or 15% of the registered voters.2 County School Facility Occupation Taxes. In 2007, the Illinois General Assembly enacted the County School Facility Occupation Tax Law (P.A. 95 0675) (the “School Sales Tax Law”) which authorizes the county board of any county, other than Cook County, to impose a county sales tax to be used exclusively for school facility purposes (the “School Sales Taxes”). “School facility purposes” is defined in the School Sales Tax Law and includes the acquisition, development, construction, reconstruction, rehabilitation, improvement and financing of land, buildings, structures and equipment. The tax may be imposed only in .25% increments and may not exceed 1%. Numerous counties in Illinois have imposed the School Sales Taxes. 2 In school districts with fewer than 500,000 inhabitants, other than most public infrastructure projects such as public school projects, the necessary number of necessary petition signers for a school district with more than 4,000 registered voters is the lessor of (i) 5% of the registered voters or (ii) 5,000 registered voters; and the necessary number of electors for a school district with 4,000 or fewer registered voters is the lesser of (i) 15% of the registered voters or (ii) 200 registered voters. 5
imposing the tax has been submitted to the electors of the county at a regular election and approved by a majority of the electors voting on the question. Once implemented, Sales Taxes are collected and distributed by the county to school districts within the county on an enrollment basis. Sales Taxes are a common revenue source that is pledged by school districts when issuing alternate revenue bonds. No referendum is required for a new or replacement school if financed with alternate revenue bonds with School Sales Taxes as a pledged revenue. C. Leases. School districts are empowered to enter into multi-year lease, purchase and lease-purchase contracts for equipment and property to be acquired. There are a number of conditions imposed upon such lease agreements. Leases related to buildings, rooms, grounds and appurtenances for district related purposes may be entered into for a term not exceeding 99 years if certain requirements are met. The principal amount of the borrowing and the interest related under any such lease agreement must be repaid within 40 years. Leases related to real or personal property such as a school site, building or equipment, may be entered into for term not exceeding 20 years. A form of lease that may be offered to the public is known as a Certificate of Participation (“COPs”), which is a repayment obligation governed pursuant to an installment contract or lease agreement. Under the Debt Reform Act, a school district’s ability to issue debt certificates, as described below, make the issuance of COPs unnecessary. “The Debt Reform Act authorizes school districts to purchase or lease either real or personal property through the use of installment contracts not exceeding 20 years in length. ” D. Debt Certificates/Installment Contracts. School districts are authorized to borrow money by entering into installment finance agreements. There are statutory specifications as to what constitutes an installment contract. The Debt Reform Act authorizes school districts to purchase or lease either real or personal property through the use of installment contracts not exceeding 20 years in length. Debt certificates may be issued by a governmental unit to evidence the payment obligations of the governmental unit under a lease or installment contract subject to statutory debt limit. There is generally, however, no separate tax levy available for the purpose of making such payments lease or installment payments, it is considered a promise to pay by way of budgetary appropriation. However, a school district not subject to the Limitation Law may enter into an installment contract payable from the levy of a direct, unlimited ad valorem property tax sufficient to pay the installments if certain backdoor referendum requirements are satisfied. The debt certificates are valid regardless of whether an annual appropriation is included in any annual or supplemental budget adopted by the district. E. Limited Bonds. These bonds are issued in lieu of G.O.’s that have otherwise been authorized by applicable law as described herein. These bonds are payable from a separate property tax levy with no limit on the rate, but the Limitation Law restricts the amount of taxes that can be used to pay the bonds. These bonds are payable from a school district’s debt service extension base. 6
If a petition with signatures of at least 10% of the registered voters in the district is filed with the secretary of the school board within 30 days of the school district’s publication of the intent to issue the bonds, then the issuance is subject to approval of the electorate. The principal amount of these bonds cannot exceed 85% of the taxes allowed to be levied for educational purposes for the current year plus 85% of the last known personal property replacement tax entitlement minus the greater of (i) the principal amount of the school district’s working cash fund bonds outstanding or (ii) the amount to the credit of the district’s working cash fund. TABLE OF FINANCING OPTIONS USING BONDS FOR ILLINOIS SCHOOL DISTRICTS Type of Debt Security General Requirements General Obligation Building Bonds Full faith and credit and backed Referendum. Statutory Debt Limit by the ad valorem taxing power of applies. the district. General Obligation Life Safety Bonds Full faith and credit and backed Meet Life Safety rules with by the ad valorem taxing power of architect report, regional and the district. state superintendent approval. Statutory Debt Limit applies. BINA required for certain Life Safety Bonds. General Obligation Funding Bonds Full faith and credit and backed Notice of intention resolution, by the ad valorem taxing power of backdoor referendum procedures the district. and BINA. Statutory Debt Limit applies. Alternate Revenue Bonds “Double-barreled” – payable from a specific revenue source with the general obligation of the district serving as backup security. Pledged revenues must meet 1.25 times debt service coverage requirement. Backdoor referendum procedures and BINA required. Generally, no Statutory Debt Limit. Debt Certificate No separate tax levy backing, obligation is a promise to pay by means of budgetary appropriation (no annual appropriation risk). Borrow money by entering into installment contract agreement. Statutory Debt Limit applies. Limited Bonds Full faith and credit and backed Bonds otherwise authorized by the ad valorem taxing power of pursuant to applicable law the District. and payable from debt service extension base unlimited as to rate but limited as to amount. Working Cash Fund Bonds Full faith and credit and backed Backdoor referendum by the ad valorem taxing power of procedures, Statutory Debt Limit the District. applies. BINA required. 7
O nce the school district makes a decision to raise capital by means of bonding, it must next consider which method of finding a “lender” or buyer of the bonds works best. Illinois school districts have flexibility as to the method of sale. A competitive sale of school district bonds is not required. The method by which to attract potential investors of bonds can be a critical component to the resulting interest rate the school district will pay to service its bonds. A credit rating is not legally required to be obtained by the school district in order to issue bonds. However, a credit rating may help lower interest costs, particularly in the case of public bond issuances. The following parts of this section discuss different forms of offering bonds to investors or “lenders” that are typically used. A. Negotiated sale. In a negotiated sale, the process begins with the issuer choosing an underwriter (or managing underwriter if more than one underwriter). The issuer and the underwriter then negotiate the terms of the offering. Once terms of the offering and assuming all procedural issuance requirements are met by the issuer, the underwriter will buy the bonds from the issuer and remarket the bonds to its investors accordingly. B. Competitive sale. In a competitive sale, bonds are advertised for sale. The announcement, by way of a notice of sale, includes both the terms of the sale and the terms of the bond issue. Any investment bank, broker-dealer or dealer bank may bid on the bonds at the designated date and time in a “blind” fashion, meaning each bidder does not have knowledge of the other bids. The bidder with the lowest interest cost is awarded the bonds. “Illinois school districts have flexibility as to the method of sale. A competitive sale of school district bonds is not required. The method by which to attract potential investors of bonds can be a critical component to the resulting interest rate the school district will pay to service its bonds. ” C. Direct placement. Direct placement or direct lending in the context of municipal bonds refers to any arrangement in which a single lender/buyer, such as a bank, pension fund, mutual fund, etc., purchases the bonds of the school district directly. This form of sale may also be described as a private placement, a direct purchase or a bank loan. Advantages such as avoiding instability in public markets, avoiding continuing disclosure requirements, and avoiding the rating process make direct placements an attractive option for issuers. D. Bank qualified or non-bank qualified. Pursuant to Section 265(b)(3) of the Tax Code, banks and savings and loans are not permitted to deduct interest expenses attributable to taxexempt bonds acquired after the passage of the Tax Reform Act of 1986, or August 1, 1986, unless the “small issuer exemption” applies. If a school district anticipates that it will not issue more than $10,000,000 of tax-exempt debt during the calendar year and the debt is designated as a “qualified tax-exempt obligation” pursuant to Section 265(b)(3), the restriction on the deduction for interest expense does not apply. Issuing so called bank qualified bonds or “BQ” bonds can reduce the interest rate on the bonds since banks that purchase bank qualified bonds do not have a restriction on its interest expense deduction. 8
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