Refinancing

To fund the $4.7 million in capital needs projects, the board voted to refinace the district’s $308 million in debt, generating a savings of $3.25 million a year. I supported refinancing the bonds, but not the way it was done, so I didn’t vote for that. (More on that another time.)

The school district borrowed $354 million in 2007 to fund the building of 7 new schools and the renovation of the other 20 schools. Since then, taxpayers have paid down some of that debt, so the balance on the loan is now $308 million. The loan has a 4.85% interest rate.

On January 26^th the board voted to “refinance” those bonds because interest rates have dropped. It passed 5 to 1 and I voted against the resolution. I support refinancing the loan at some point; interest rates have fallen. There is a lot of saving to be had, either to the district or the taxpayers or a combination of both.

I disagreed with the timing of this “refinancing” decision and the method of the “refinancing”. The bonds are not callable until December 2016, and it was quite costly get around that. Also I disagreed with the way the refunding was implemented, in particular the mechanism used to do this.

I listened to the 20 minute presentation by the bond analyst, and it was very heavy on the numbers, but short on the actual process. Watching the audience, I came away thinking most got lost in the numbers, and didn’t understand the process of how this “refinancing” was going to work. I put “refinancing” in quotes, because it really wasn’t a typical refinancing.

First let me explain how a refinancing works. The school district has $308 million in bonds outstanding at 4.85%. If it was a simple refinancing, the district would have borrowed $308 million at current interest rates of 2.91%, and immediately used the $308 million to pay off the old $308 million loan at 4.85%.

Day x the district would have a $308 million loan of 4.85%. The next day the district would have a $308 million loan at 2.91%. The savings would be immediate because the next annual payment would be millions lower, and the costs would only be the fee paid to issue the bonds.

The district did something much different. The district had $308 million in bonds outstanding at 4.85%, however, those bonds were not callable and couldn’t be retired until December 2016.

To get around that, the district borrowed $308 million at current rates of 2.91%, and set aside that new $308 million in an escrow account. Remember the district can not recall or pay off the old $308 million loan, because those bonds are not callable until December 2016. It is now carrying that new or second $308 million loan until December 2016. So it will continue to pay on the 4.85% $308 million old loan, PLUS pay 2.91% on the new or second $308 million loan (less the half of percent it earns on the new loan in escrow) until December 2016. In December 2016, when the bonds are callable, the funds in escrow account will be used to pay off the old loan and then the refinancing will be complete.

Let’s look at the cash flow. Refinancing from the $308 million loan at 4.85% to the $308 million loan at 2.91% will generate $35.4 million in savings over the remaining life of the loan until 2032. The next 20 months (from April 1, 2015 to December 2016), however, it is quite expensive to carry that second $308 million loan. That extra cost is $10.9 million in total, $550,000 a month, or nearly $20,000 a day.

I don’t think most understood how much of the saving was being given back. I saw the look of amazement on peoples faces as I explained all of this. Things are always explained to the public and the board in a way to persuade them to support it. Sometimes the rest of the story needs to be told.

The risk of not refinancing like this and locking in the new loan at 2.91% is that interest rates rise between now and December 2016. I understood that, but I just didn’t see rates rising any time soon. The world economy is very weak. Interest rates in Europe are negative in some countries. Since the refinancing rate of 2.91% was set, interest rates have come down a bit.

The driving force in the timing was the district needed the cash now. When you build too many buildings, all at once, spend most all of the money on new construction and put little aside for future maintenance, you are going to be short on cash when roofs and HVAC’s have to be replaced.

The second reason I opposed this, was the use of the dummy corporation. To explain this, we have to go back to the original loan when the building program was first passed.

In the state constitution, it says a school board has the power to borrow up to 8% of the assessed value of all property in the school district. If the board wants to borrow more than the 8% limit, the additional borrowing must be approved by a referendum vote of the people.

In 2005 the citizens of Pickens County voted down a $197 million plan. The board knew the public would never pass a $350 million plan, so it came up with a scheme that was first used in Greenville. Under the Greenville Plan, the school board creates a dummy company. This is done because the dummy company is not limited by the constitution, so it could borrow an unlimited amount of money on behalf of the school board without voter approval.

The dummy company has no assets, no employees and no home office. It is a shell company created with the sole purpose to borrow and hold the $350 million. Working with the school board it renovates and builds the new schools. To get the money to make the bond payments, the school district arranges a lease-purchase agreement with the dummy company. The students will use the new/ renovated schools and the school district will make lease payments to the dummy company. The payments will pass through the dummy company and come out the other side as bond payments to the lenders. After the leases expire and the debt is paid off, ownership of the schools will revert to the school board. Hence the term, lease-purchase.

It is a scheme to get around the borrowing limit in the constitution. The school board of 2006 voted for this (Shirley Jones, Jim Brice, Kevin Kay, BJ Skelton, Herb Cooper and June Hay voted for, Alex Saitta and Oscar Thorsland voted against, Jim Shelton abstained).

With this refinancing the dummy corporation was ordered to borrow another $308 million and carry both loans for 20 months. That is, the total debt of the dummy corporation will be more than $600 million for the next 20 months, against a $308 million asset in the escrow account. I didn’t support the creation of the dummy corporation; I voted against the Greenville Plan and that entire scheme. I surely wasn’t going to approve using the dummy corporation this time around either.

I fully understand why the district administration recommended refinancing now and using this mechanism. It wanted to lock in the current interest rate (like I said, rates could go up). Also, the district needs to pull forward to this year, the savings of the refinancing starting in December 2016. It needed the cash now and can’t wait until then.

Going back to 2006, there was a series of bad decisions on the building program. One decision was, $374 million of the $387 million was spent on construction and renovation. Only $13 million was put aside for roof and HVAC replacement. (And that $13 million really wasn’t put aside either. $13 million of interest was later discovered. First it was put in an escrow account to pay down debt. Then when Ben Trotter resigned, the escrow account was wiped out and the money was spent on replacements of HVAC’s and roofs, repaving and painting.)

The district added 750,000 square feet, and maintenance needs were growing, so it needed the cash pronto, so waiting on the refinancing really wasn't an option for the district.

To me, doing this refinancing and paying so much to carry that second loan was like going to one of those pay-day lenders, because the person unwisely managed his finances that he just couldn’t wait until pay day because he needed the money so badly now. When a person overspends and doesn’t properly think ahead, the choices are usually only fair, bad and worse.