Is this how you’d borrow money?
The following article outlines what it takes to borrow money and what it can costs a community if the wrong type of funds are chosen. Let's not let this happen to us without ample debate of the options.
By Jeffrey Gaunt and Emily Krone
Daily Herald Staff Writers
A typical home loan will cost you twice what you borrowed when it’s paid off with interest.
Governments can get better deals.
Federal tax breaks keep interest rates on government loans lower than those available to homeowners — up to 30æpercent lower, according to the Congressional Budget Office.
Yet not all governments avail themselves of lower cost loans — at greater cost to taxpayers.
A Daily Herald analysis of 206 suburban school district loans reveals many taxpayers repay those loans at rates higher than they would on their homes.
Since 2000, 81 districts in our coverage area have borrowed $3.34 billion. The districts agreed taxpayers would pay back $6.03 billion.
That’s nearly the same repayment rate — $2 per dollar borrowed — as a home loan, despite the federal measures that keep government rates low.
In the most costly example, taxpayers will repay $3.09 per dollar — or three times the amount borrowed.
A total of 27 loans will require repayments of more than $2.00 per dollar borrowed.
The average of the 206 bond issues examined would ask taxpayers to pay back $1.55 for every dollar received.
On only 89 loans, fewer than half of those studied, will taxpayers repay less than $1.40 per dollar — or 30 percent less than homeowners, the standard cited by the Congressional Budget Office.
Why such a range?
Because in Illinois, taxpayers only get a say in how much a district can borrow — not how much will be paid back.
The loan structure — the length of time, the interest rates, the repayment schedule — is decided by district officials and their consultants.
With that freedom, 66 of the 81 school districts in the study took out loans using at least one of three practices that drive up costs to taxpayers:
•Many districts agreed to interest rates higher than available, and got cash bonuses from their lender for doing so.
•Many agreed to pay compounded interest rates — sometimes on the higher rates.
•Most pushed debt payments off a decade or more in order to spread the cost to tomorrow’s residents — and downplay the cost to today’s voters.
The practices are limited or outlawed in many states — but legal here.
The financial consultants hired by school districts call the practices creative solutions to financial challenges.
School officials use them to maximize revenue and better serve their children.
Many experts and state officials around the country condemn them.
The bottom line is that creative solutions aren’t cheap.
Capital appreciation
School districts borrow money by issuing bonds.
Each bond has a repayment schedule — or a list of how much taxpayers will pay back each year.
Under state law, interest rates on those payments can’t exceed 9 percent in any year.
So if a district borrows $100, interest cannot exceed 9 percent — or $9 — annually. Over 10 years, the district will have paid off $190, or $9 a year, by the end of the loan.
Some districts make it more complicated. More and more, districts borrow by issuing capital appreciation bonds.
Interest on these bonds compounds.
In other words, taxpayers pay interest on the interest.
Credit cards give you a choice. If you buy something for $100 and pay it off in a month, you’ve paid simple interest. If you buy something and don’t pay it off for six months, you’re paying interest on the $100 and the mounting interest each month.
Capital appreciation bonds are like credit cards for school districts. They allow a district to delay interest payments.
Other bonds typically require semiannual interest payments.
Because delaying interest payments makes it riskier for investors, capital appreciation bonds carry automatically higher interest rates.
District officials say they issue capital appreciation bonds — and delay interest payments — to spread some of the cost to future residents and keep current tax rates stable.
But in return, taxpayers will pay back more per dollar than they would on an average bond issue.
"It’s kind of like borrowing on your credit card and not paying — and then paying interest on interest," said Cynthia Weed, a partner in the public finance division of the Seattle-based law firm Preston Gates and Ellis, which ranks 10th nationally in volume of municipal bonds transactions. "It’s not the best policy."
Take, for example, the district that borrowed $100 for 10 years and paid $9 in simple interest each year.
If the district issued capital appreciation bonds instead, it would still owe $9 in interest the first year.
The similarities end there.
Interest would compound, costing $18.81 in the second year and $29.50 in the third.
Each year the interest mounts, and with it the interest on the interest on the interest and so forth.
When the district went to pay off the $100 in this case, it would pay a total of $236.72 — or $46.72 more than the simple interest version.
Now, imagine that the loan was for $100 million rather than $100 and for 20 years rather than 10.
Weed said she has never seen schools put that type of burden on taxpayers in her 27 years of public finance in five Western states.
"There should be an articulated rationale, as opposed to, ‘I want to prevent a levy spike this year because it’s bad for my re-election campaign.’"
Premiums
School districts sometimes can’t borrow as much money as they want because of state debt limits.
Under state law, elementary and high school districts cannot accrue debt totaling more than 6.9 percent of the equalized assessed value of property in the district. The law limits unit districts — K-12 districts — to 13.8 percent.
There also is a second restriction on borrowing. The law requires voter approval for most large loans, especially those used for construction.
If a school district is up against its debt limit, or wants to borrow more than voters approve, there is a way.
Dozens of districts have gone that route — taking premiums.
Basically, a premium is a cash bonus. Districts agree to repay loans at higher interest rates in exchange for more money up front.
These bonuses don’t count as debt — not against the state debt limit or against voter authorization.
Thus, if a district has $20 million left under its debt limit, it can borrow $20 million at high interest rates and legally collect an additional premium.
The wider the gap between prevailing interest rates and the interest rates districts agree to pay, the larger the bonus.
Taxpayers in essence are paying for the premium — by paying more in interest on the principal.
"Yes, taxpayers pay for the principal, interest and premium on the bonds," said Liz Hennessey of the Chicago financial firm William Blair & Co.
School districts can take premiums on either simple interest or capital appreciation bonds.
But the appeal of capital appreciation bonds is that they super-size interest payments — which super-sizes the premiums.
In Will County, Crete-Monee Community District 201-U agreed to pay $82.5 million in interest on $45 million worth of capital appreciation bonds.
That’s a total repayment of $127.78 million.
In exchange, the district got a $17.1 million premium.
Assistant Superintendent for Business Affairs Todd Covault said the state’s "somewhat arbitrary" debt limit forced the district to take the premium.
"We were trying to capitalize on getting the largest amount of bonds sold at that time period because we knew rates would climb," Covault said.
But the district would not have used premiums to take more than voters authorized, Covault said. "That would be wrong, fundamentally."
The use of capital appreciation bonds and premiums is not limited to big money loans.
In 2002, Winfield Elementary District 34 in DuPage County had $6 million left under its debt limit. The district issued $6 million in capital appreciation bonds, paying compounded interest at 8.5æpercent.
The district received a $2 million premium. Voters will pay back $14.3 million for that $6 million loan.
District 34 Superintendent Diane Cody said she wasn’t working in the district at the time the bonds were issued. But she believes districts need to make sure taxpayers know what they’re in for.
"I think the whole thing here is honesty and communication," Cody said. "When you’re still operating under the law, but it may not be best for the taxpayer, then the taxpayer needs to know that."
The practice of collecting premiums to get around debt limits drew fire from financial and legal authorities across the country.
"This to me looks like a clear evasion of the intent of any law that seeks to limit debt," said William Kittredge, director of the nonprofit Center for the Study of Capital Markets and Democracy in Arlington, Va., and former professor of finance at the University of Georgia.
"I think the spirit, and maybe the letter of the law, has been broken," said Mike Griffith, a policy analyst with the Education Commission of the States in Denver.
Idaho Deputy Attorney General Jim Jones also described large premiums as a ruse — and a violation of Idaho law.
"Assume a district held an election authorizing (school) bonds in the amount of $10 million to build school buildings," Jones wrote in a recent opinion sent to the Idaho Department of Education. "If a district could set artificially high interest rates on the bonds such that investors would pay $15 million for the bonds, the electors would be greatly deceived."
Back-loading
The faster you pay off your debts, the better.
The longer you wait to pay off your car loan, credit card or mortgage, the more interest you’ll pay. The same goes for school districts.
But most districts in our study chose to delay payments.
The Herald analysis shows 114 of the 206 bond issues were structured so taxpayers waited more than a decade to pay off at least half of the loans.
In the most extreme cases, districts borrow millions of dollars and don’t pay anything back — no principal, no interest — for the first 19 or 20 years.
In those examples, taxpayers end up paying more in interest alone than the district borrowed in the first place.
Take Geneva Unit District 304, which issued $2.79æmillion in simple interest bonds in 2004.
The Kane County district will make one balloon payment — in 2024 — for a total of $6.19 million.
That’s $2.06 for every dollar borrowed.
Why pay so much? So future residents can share in the cost, said Rebecca Allard, the district’s assistant superintendent for finance.
"It has been deliberate," Allard said. "Most of the bond sales deal with constructing facilities. It just seems prudent to share the cost with residents who are not here yet."
The costs speak for themselves — in 74 of the 114 cases, taxpayers will pay back more on the dollar than the average of all the loans studied.
School districts that push debt back say they’re spreading the cost to future taxpayers, who will share in the benefits of the new schools.
Some experts say that is a high-stakes gamble on the district’s future prosperity.
"That’s a real dangerous game," said Griffith, the policy analyst with the Education Commission of the States. "Most states don’t even let you play those games."
Massachusetts doesn’t — and the state’s director of accounts slammed the practice.
"It’s horrible fiscal management, and I can hardly imagine the ratings industry looking at that with anything but a jaundiced eye," James Johnson said.
Darkest before dawn
Used separately, premiums, capital appreciation bonds and back-loading magnify the cost of borrowing.
Together they maximize it.
Each technique compounds the costs of the others.
The people of Huntley School District 158 know what that’s like.
In 2000, voters in the McHenry County district authorized a $24 million bond issue to pay for a new elementary school and additions to the old middle school and high school.
Over the next three years, school officials issued the $24 million in bonds, tacked on $11.5 million in premiums and back-loaded more than a third of the payments.
All told, taxpayers are expected to pay back roughly $72 million — or three times the $24 million they authorized.
In 2002, voters — unaware of the hidden cost of the first authorization — approved another $80 million to build two middle schools, two elementary schools and a new central office. Much like before, school officials turned to premiums and capital appreciation bonds.
By 2005, the district had issued only $55 million of the $80 million. But it had collected $78 million with premiums. And officials were planing to spend more.
Then everything changed. News broke that the district hadn’t provided voters accurate information on a request for a tax-rate increase.
The community lashed out. The school board apologized. The superintendent and top business official stepped down. Voters elected three new board members.
And the new school board, with a new administration, pledged to restore voter trust.
Soon after, they halted plans to spend more than the $80 million voters authorized.
To do otherwise, they said, would further damage public confidence. And that’s something the district can ill afford.
"What the public believed was they were paying off $80 million in debt," said school board Vice President Glen Stewart, elected in the 2004 voter uprising. "Not to play games and jack it up to $105 or $110 million.
"The credibility of a board, of a school district, is incredibly important," Stewart said. "If you want to get any referendum passed, you have to tell the truth and live with it."
By Jeffrey Gaunt and Emily Krone
Daily Herald Staff Writers
A typical home loan will cost you twice what you borrowed when it’s paid off with interest.
Governments can get better deals.
Federal tax breaks keep interest rates on government loans lower than those available to homeowners — up to 30æpercent lower, according to the Congressional Budget Office.
Yet not all governments avail themselves of lower cost loans — at greater cost to taxpayers.
A Daily Herald analysis of 206 suburban school district loans reveals many taxpayers repay those loans at rates higher than they would on their homes.
Since 2000, 81 districts in our coverage area have borrowed $3.34 billion. The districts agreed taxpayers would pay back $6.03 billion.
That’s nearly the same repayment rate — $2 per dollar borrowed — as a home loan, despite the federal measures that keep government rates low.
In the most costly example, taxpayers will repay $3.09 per dollar — or three times the amount borrowed.
A total of 27 loans will require repayments of more than $2.00 per dollar borrowed.
The average of the 206 bond issues examined would ask taxpayers to pay back $1.55 for every dollar received.
On only 89 loans, fewer than half of those studied, will taxpayers repay less than $1.40 per dollar — or 30 percent less than homeowners, the standard cited by the Congressional Budget Office.
Why such a range?
Because in Illinois, taxpayers only get a say in how much a district can borrow — not how much will be paid back.
The loan structure — the length of time, the interest rates, the repayment schedule — is decided by district officials and their consultants.
With that freedom, 66 of the 81 school districts in the study took out loans using at least one of three practices that drive up costs to taxpayers:
•Many districts agreed to interest rates higher than available, and got cash bonuses from their lender for doing so.
•Many agreed to pay compounded interest rates — sometimes on the higher rates.
•Most pushed debt payments off a decade or more in order to spread the cost to tomorrow’s residents — and downplay the cost to today’s voters.
The practices are limited or outlawed in many states — but legal here.
The financial consultants hired by school districts call the practices creative solutions to financial challenges.
School officials use them to maximize revenue and better serve their children.
Many experts and state officials around the country condemn them.
The bottom line is that creative solutions aren’t cheap.
Capital appreciation
School districts borrow money by issuing bonds.
Each bond has a repayment schedule — or a list of how much taxpayers will pay back each year.
Under state law, interest rates on those payments can’t exceed 9 percent in any year.
So if a district borrows $100, interest cannot exceed 9 percent — or $9 — annually. Over 10 years, the district will have paid off $190, or $9 a year, by the end of the loan.
Some districts make it more complicated. More and more, districts borrow by issuing capital appreciation bonds.
Interest on these bonds compounds.
In other words, taxpayers pay interest on the interest.
Credit cards give you a choice. If you buy something for $100 and pay it off in a month, you’ve paid simple interest. If you buy something and don’t pay it off for six months, you’re paying interest on the $100 and the mounting interest each month.
Capital appreciation bonds are like credit cards for school districts. They allow a district to delay interest payments.
Other bonds typically require semiannual interest payments.
Because delaying interest payments makes it riskier for investors, capital appreciation bonds carry automatically higher interest rates.
District officials say they issue capital appreciation bonds — and delay interest payments — to spread some of the cost to future residents and keep current tax rates stable.
But in return, taxpayers will pay back more per dollar than they would on an average bond issue.
"It’s kind of like borrowing on your credit card and not paying — and then paying interest on interest," said Cynthia Weed, a partner in the public finance division of the Seattle-based law firm Preston Gates and Ellis, which ranks 10th nationally in volume of municipal bonds transactions. "It’s not the best policy."
Take, for example, the district that borrowed $100 for 10 years and paid $9 in simple interest each year.
If the district issued capital appreciation bonds instead, it would still owe $9 in interest the first year.
The similarities end there.
Interest would compound, costing $18.81 in the second year and $29.50 in the third.
Each year the interest mounts, and with it the interest on the interest on the interest and so forth.
When the district went to pay off the $100 in this case, it would pay a total of $236.72 — or $46.72 more than the simple interest version.
Now, imagine that the loan was for $100 million rather than $100 and for 20 years rather than 10.
Weed said she has never seen schools put that type of burden on taxpayers in her 27 years of public finance in five Western states.
"There should be an articulated rationale, as opposed to, ‘I want to prevent a levy spike this year because it’s bad for my re-election campaign.’"
Premiums
School districts sometimes can’t borrow as much money as they want because of state debt limits.
Under state law, elementary and high school districts cannot accrue debt totaling more than 6.9 percent of the equalized assessed value of property in the district. The law limits unit districts — K-12 districts — to 13.8 percent.
There also is a second restriction on borrowing. The law requires voter approval for most large loans, especially those used for construction.
If a school district is up against its debt limit, or wants to borrow more than voters approve, there is a way.
Dozens of districts have gone that route — taking premiums.
Basically, a premium is a cash bonus. Districts agree to repay loans at higher interest rates in exchange for more money up front.
These bonuses don’t count as debt — not against the state debt limit or against voter authorization.
Thus, if a district has $20 million left under its debt limit, it can borrow $20 million at high interest rates and legally collect an additional premium.
The wider the gap between prevailing interest rates and the interest rates districts agree to pay, the larger the bonus.
Taxpayers in essence are paying for the premium — by paying more in interest on the principal.
"Yes, taxpayers pay for the principal, interest and premium on the bonds," said Liz Hennessey of the Chicago financial firm William Blair & Co.
School districts can take premiums on either simple interest or capital appreciation bonds.
But the appeal of capital appreciation bonds is that they super-size interest payments — which super-sizes the premiums.
In Will County, Crete-Monee Community District 201-U agreed to pay $82.5 million in interest on $45 million worth of capital appreciation bonds.
That’s a total repayment of $127.78 million.
In exchange, the district got a $17.1 million premium.
Assistant Superintendent for Business Affairs Todd Covault said the state’s "somewhat arbitrary" debt limit forced the district to take the premium.
"We were trying to capitalize on getting the largest amount of bonds sold at that time period because we knew rates would climb," Covault said.
But the district would not have used premiums to take more than voters authorized, Covault said. "That would be wrong, fundamentally."
The use of capital appreciation bonds and premiums is not limited to big money loans.
In 2002, Winfield Elementary District 34 in DuPage County had $6 million left under its debt limit. The district issued $6 million in capital appreciation bonds, paying compounded interest at 8.5æpercent.
The district received a $2 million premium. Voters will pay back $14.3 million for that $6 million loan.
District 34 Superintendent Diane Cody said she wasn’t working in the district at the time the bonds were issued. But she believes districts need to make sure taxpayers know what they’re in for.
"I think the whole thing here is honesty and communication," Cody said. "When you’re still operating under the law, but it may not be best for the taxpayer, then the taxpayer needs to know that."
The practice of collecting premiums to get around debt limits drew fire from financial and legal authorities across the country.
"This to me looks like a clear evasion of the intent of any law that seeks to limit debt," said William Kittredge, director of the nonprofit Center for the Study of Capital Markets and Democracy in Arlington, Va., and former professor of finance at the University of Georgia.
"I think the spirit, and maybe the letter of the law, has been broken," said Mike Griffith, a policy analyst with the Education Commission of the States in Denver.
Idaho Deputy Attorney General Jim Jones also described large premiums as a ruse — and a violation of Idaho law.
"Assume a district held an election authorizing (school) bonds in the amount of $10 million to build school buildings," Jones wrote in a recent opinion sent to the Idaho Department of Education. "If a district could set artificially high interest rates on the bonds such that investors would pay $15 million for the bonds, the electors would be greatly deceived."
Back-loading
The faster you pay off your debts, the better.
The longer you wait to pay off your car loan, credit card or mortgage, the more interest you’ll pay. The same goes for school districts.
But most districts in our study chose to delay payments.
The Herald analysis shows 114 of the 206 bond issues were structured so taxpayers waited more than a decade to pay off at least half of the loans.
In the most extreme cases, districts borrow millions of dollars and don’t pay anything back — no principal, no interest — for the first 19 or 20 years.
In those examples, taxpayers end up paying more in interest alone than the district borrowed in the first place.
Take Geneva Unit District 304, which issued $2.79æmillion in simple interest bonds in 2004.
The Kane County district will make one balloon payment — in 2024 — for a total of $6.19 million.
That’s $2.06 for every dollar borrowed.
Why pay so much? So future residents can share in the cost, said Rebecca Allard, the district’s assistant superintendent for finance.
"It has been deliberate," Allard said. "Most of the bond sales deal with constructing facilities. It just seems prudent to share the cost with residents who are not here yet."
The costs speak for themselves — in 74 of the 114 cases, taxpayers will pay back more on the dollar than the average of all the loans studied.
School districts that push debt back say they’re spreading the cost to future taxpayers, who will share in the benefits of the new schools.
Some experts say that is a high-stakes gamble on the district’s future prosperity.
"That’s a real dangerous game," said Griffith, the policy analyst with the Education Commission of the States. "Most states don’t even let you play those games."
Massachusetts doesn’t — and the state’s director of accounts slammed the practice.
"It’s horrible fiscal management, and I can hardly imagine the ratings industry looking at that with anything but a jaundiced eye," James Johnson said.
Darkest before dawn
Used separately, premiums, capital appreciation bonds and back-loading magnify the cost of borrowing.
Together they maximize it.
Each technique compounds the costs of the others.
The people of Huntley School District 158 know what that’s like.
In 2000, voters in the McHenry County district authorized a $24 million bond issue to pay for a new elementary school and additions to the old middle school and high school.
Over the next three years, school officials issued the $24 million in bonds, tacked on $11.5 million in premiums and back-loaded more than a third of the payments.
All told, taxpayers are expected to pay back roughly $72 million — or three times the $24 million they authorized.
In 2002, voters — unaware of the hidden cost of the first authorization — approved another $80 million to build two middle schools, two elementary schools and a new central office. Much like before, school officials turned to premiums and capital appreciation bonds.
By 2005, the district had issued only $55 million of the $80 million. But it had collected $78 million with premiums. And officials were planing to spend more.
Then everything changed. News broke that the district hadn’t provided voters accurate information on a request for a tax-rate increase.
The community lashed out. The school board apologized. The superintendent and top business official stepped down. Voters elected three new board members.
And the new school board, with a new administration, pledged to restore voter trust.
Soon after, they halted plans to spend more than the $80 million voters authorized.
To do otherwise, they said, would further damage public confidence. And that’s something the district can ill afford.
"What the public believed was they were paying off $80 million in debt," said school board Vice President Glen Stewart, elected in the 2004 voter uprising. "Not to play games and jack it up to $105 or $110 million.
"The credibility of a board, of a school district, is incredibly important," Stewart said. "If you want to get any referendum passed, you have to tell the truth and live with it."
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