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Voices from the Media

'Premium' on School Bond Issues Violates Law

Melody Peterson, Orange County Register Staff Writer, April 12, 2014

The California attorney general has advised that tacking on fees for banks and lawyers is unconstitutional íV but it hasn't stopped the schools.

Despite warnings that the practice is illegal, schools across California continue to squeeze extra cash out of bond deals to pay banks and lawyers íV leaving taxpayers with an unexpected bill.

Banks and other firms have been advising the schools to use the controversial tactic, which is known on Wall Street as "selling bonds at a premium."

The companies have an interest in promoting the premium deals: They are quickly paid for their work with the extra cash and their fees face little public scrutiny.

In 2011, Attorney General Kamala Harris warned a San Diego County district that the practice was illegal because it could cause schools to borrow more for classroom construction than voters had approved.

In a letter sent to lawyers representing Poway Unified, Harris said the district's proposed premium "was not authorized by law." She added that the district was "incurring debt beyond what the voters authorized in violation of the California Constitution."

But many public school and community college districts have ignored Harris' widely circulated letter and have continued to add hefty premiums to their borrowings.

"The bankers and financial advisers have helped the districts get around the law," said Glenn Byers, assistant treasurer of Los Angeles County. "The voters are getting stuck with a higher price."

Byers said the maneuver often results in districts paying excessive fees to banks and other firms because the bills are easily paid with the extra cash. Schools often don't press the firms to lower their fees because the amounts don't come from their classroom budgets, he said.

In the end taxpayers pay more to cover the cost of the added borrowings; the money benefits banks, lawyers and financial firms rather than students.

School officials don't see what the fuss is about, pointing out that their bond lawyers review and sign off on the legality of the premium deals bonds before the bonds are sold.

"The district's bond counsel advised that the issuance of the bonds was lawful and valid," explained Mark Taylor, a spokesman for Long Beach Community College District. He called the premiums "standard industry practice."

Last year, Los Angeles County officials wrote to the attorney general, requesting a formal written opinion on whether it is legal to use premiums to pay banks and other firms. Harris announced last month that her staff was working on that opinion.


The premiums work this way: Investors agree to give the schools extra upfront cash along with the amounts borrowed through bonds if the schools agree to pay an inflated interest rate. If that extra cash is then used to pay bankers and lawyers, taxpayers end up paying the fees as well as interest on those amounts, sometimes for decades.

In an Orange County example, Santa Ana Unified announced in 2008 that it was borrowing $100 million for new classrooms. But it actually borrowed more than that, according to details in the bond documents, with investors agreeing to add a $6 million premium.

And more than $1 million of that cash was used to pay the bank and law firm that had advised the district to borrow the extra money.

Both the fees paid to George K. Baum & Co., the bank, and to Jones Hall, the law firm, were higher than published averages for such a deal.

The district paid 1.1 percent of the bonds' principal íV or $1.1 million íV to the bank. The year before those bonds were issued, the national average that schools paid to banks on similar deals was about half that amount. according to an analysis by the Bond Buyer.

Santa Ana paid $140,000 to Jones Hall. That was more than 30 percent higher than the average rate that California schools paid for legal fees on a borrowing of that size, according to a state analysis of bonds issued from 2009 to 2011.

The school district added a similar premium to a borrowing the next year, which artificially boosted the interest rate on the bonds to as high as 10 percent.

In all, the district borrowed about $13 million more than the $200 million voters authorized in an election in 2008, according to bond documents.

Lori Ranieri, the district's financial adviser, said Santa Ana Unified officials had done nothing wrong.

"There has been in some districts, and in many districts, abuse of the premium," said Ranieri, the president of Government Financial Strategies. "But not in Santa Ana."

She said the district had put about $7 million of the extra $13 million of cash into a fund to pay future debt payments. According to the attorney general's letter, that is the only appropriate use for the extra cash, since it would keep the deal from causing taxes to rise.

Ranieri confirmed that the rest of the premium íV $5.7 million íV went to pay banks, lawyers and other costs of issuing the bonds.

"We didn't know until 2011 that this was objectionable," she said. "What Santa Ana did was reasonable and conservative."

Executives at George K. Baum and lawyers from Jones Hall did not respond to phone and email messages sent last week.


Many California community college districts have also designed their bonds with hefty premiums.

In November 2012, Long Beach Community College District borrowed $237 million, and then tapped into more cash by tacking on a $24 million premium.

More than $1.4 million of that amount went to pay fees to four banks and a law firm, as well as other costs of issuing the bonds.

"The Long Beach Community College District bond issuance complied with all legal requirements," said Taylor, the district's spokesman.

He added that the college district had not borrowed more than taxpayers authorized in a 2008 election.


State legislators who authored a bill last year to curb excessive school bond costs caused by another method promoted by banks and other firms íV the use of so-called capital appreciation bonds íV also tried to limit abusive premiums. The authors had proposed that schools could issue bonds at interest rates no higher than 8 percent. The current state limit is 12 percent.

But schools, banks and other firms successfully lobbied against that proposed change.

As legislators debated the bill, financial executives gave several presentations to school officials at the Coalition for Adequate School Housing, which is also known as C.A.S.H. The group lobbies to support school construction and gets financial support from dozens of companies that work on bonds and school facilities.

In their speeches, the executives argued that the lower interest rate would reduce or eliminate the schools' ability to use premiums. The bill would take away school officials' rights "to use premium as they see fit," argued Mark Epstein, managing director of California Financial Services, an advisory firm, in a C.A.S.H. newsletter.

In an interview, Epstein explained that schools use premiums in myriad ways íV not just to pay fees. For example, he said, some investors have been willing to give schools a better deal on premium bonds.

The bill was later amended so that schools could continue to issue bonds at interest rates as high as 12 percent.


Savanna School District in northern Orange County has taken advantage of that 12 percent rate as it has frequently used premiums to pay the companies working on its bonds.

The district's bond counsel is Robert Anslow, a lawyer at Bowie, Arneson, Wiles & Giannone in Newport Beach. He is the same lawyer who worked on the Poway Unified deal and was the recipient of the attorney general's letter that detailed how the premiums were illegal.

In August 2012, Savanna sold bonds with artificially-inflated interest rates of as high as 12 percent, which resulted in a premium of $922,000.

The money went to pay an investment bank, a financial adviser, an election consultant and three law firms, including Anslow's firm, which received $38,000.

In a letter to the district detailing those costs, Anslow asked the superintendent to have the school board approve the list of fees. He wrote that the board did not need to discuss the fees, but could simply approve the list by putting it on its consent calendar. That document is an index of multiple meeting agenda items that school boards often approve with a quick vote and no questions.

Sue Johnson, Savanna's superintendent, did not respond to requests for comment last week. She told the Register last year that all funds "were used in accordance with state law."

Anslow did not respond to phone calls and emails from the Register.

Contact the writer: Contact the writer: mpetersen@ocregister.com


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