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The name is Bond. Capital Appreciation Bond

Hari Titan's picture
Submitted by Hari Titan on Mon, 10/30/2017 - 9:03pm

Call me CAB for short. Just when you thought creative financing died years ago, it got resurrected over Halloween of 2017. Refinancing a CAB with yet another CAB was put on the table by our school district from an unsolicited bid by a bond underwriter. The same bond underwriter that financed the $12 million construction of Havens with a $64 million tax liability using a compounding interest CAB. I’m glad this CAB is the subject of refinancing but only with a current interest bond (CIB) not another CAB.

As a reminder, CAB financing charges a higher interest rate because it involves deferred taxation. Bond investors are not being paid principal or interest because taxes are not being collected for a period of time. Instead unpaid interest is added to the capital outlay of the bond investors. From a bond investor’s POV their capital is growing (or appreciating) over time as taxpayers owe interest on a growing amount of debt. From a taxpayer POV, the interest due is compounding over time and their debt is growing or "negatively amortizing". As long as CIBs are an option, CABs grow debt unnecessarily.

An amortizing CIB works similar to fixed rate mortgages. This bond refinancing does not require a vote by the public as long as some savings are generated for taxpayers. At the last board meeting, 6 out of 8 emails sent to the board were against refinancing to a new CAB. A greater understanding of CABs and more emails may be required to ensure CABs are removed from the table.

Proponents of CABs in 2013 cited deferred taxes are earning some interest in taxpayer bank accounts until needed to be paid. Therefore the unpaid taxes are earning interest and have a time value of money that should be accounted for using present value (PV) analysis. For a typical Piedmonter, should we assume low short-term rates from savings accounts or higher long-term returns? Assuming lower short-term rates (e.g. ~1%) is reasonable and in this scenario CABs will become completely uncompetitive to CIBs by any metric. Unfortunately our “independent” bond advisors assume higher long-term financial instruments (Muni's @ 3.2%) in their PV calculations which are not representative of the returns for an average Piedmonter and misleadingly make CABs appear competitive with CIBs.

The earliest our CAB can be paid off is in 2023 and we have no ability to levy new taxes until then. One option is to wait and issue a CIB in 2023 to pay off the CAB. Another creative option is to fund a CIB this December for the amount needed to pay off the CAB in 2023 plus enough money to pay interest back to the bond investors until 2023. The first option has $3 to $4 million lower total tax liability than the second option but assumes interest rates stay low until 2023. Bond interest rates have been low (and trending lower) for over a decade. Refinancing this December is completely optional but may be wise if using a CIB.

References:
2017 GO Refunding Bonds (CIBs refund of Series E Bonds) - CABs to CIBs.pdf [e.g. Page 2, last column]
Government Finance Officers Association
Benefits of Total Tax Liability view

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