Public Finance: Exploring County Options
Mission accomplished…at least the seemingly toughest leg of the mission. On May 14, 2011, Smith County voters passed the issuance of $35 million in tax bonds for the Smith County Jail and criminal justice facilities expansion/remodeling project with a vote of 3,644 for and 2,136 against. Four previous bond proposals, presented in 2006, 2007 and 2008 with price tags ranging from $59.6 million to $125 million, had failed.
Smith County Commissioner Jeff Warr was especially vigilant up to election night, considering the Smith County Jail issue was the primary reason he ran for the office of county commissioner four years ago. Warr’s experience as a Tyler City Council member and mayor pro-tem gave him a keen understanding of government budgets and a low tolerance for unnecessary spending.
“We have spent $17 million to house prisoners outside of our county,” Warr emphasized. In May 2004, the Texas Commission on Jail Standards ordered Smith County to transfer inmates to other facilities to reduce jail overcrowding. Warr spent some two years researching the county’s options for jail space before helping craft the plan that passed this year.
With facts and figures in hand, Warr attended 20 to 30 formal meetings in the six to eight months preceding the May 2011 election. He did not speculate on why previous plans had been voted down, but rather educated the citizenry on the fiscal ramifications of the bonds and the related safety issues, such as the danger shipping prisoners poses to jailers and the general public.
The $35 million plan will add 384 beds, bringing the county's occupancy level from 775 to 1,139, and end the transfer of inmates. The county also will add new kitchen and laundry facilities and an infirmary to the jail, potentially saving the county thousands of dollars, as prisoners with medical complaints must now be transported to local hospitals, Warr reported.
The bonds will add about a penny to the county's tax rate (currently at 31.39 cents per $100 of property valuation), and as soon as the bonds are paid off, that tax increase will be eliminated. In addition, the commissioners court pledged to the public that any new revenues earned by renting out spare jail beds to federal prisoners will go to pay off the bonds early.
The county issued the bonds the first week of July, Warr said. And as an added bonus, low interest rates resulted in the re-amortization of the bonds lowering the payback timeframe from 15 years to 12 years.
“We were able to save money before we even issued the bonds!” Warr declared.
Generally speaking, counties decide whether or not to hold a bond election based on what is financed. If the project is one that is large and discretionary, such as a new exhibition center, a bond election might be used, said David Mendez, bond counsel with Bickerstaff Heath Delgado Acosta LLP. If the item is not of a discretionary nature, Certificates of Obligation (COs) or Anticipation Notes may be used.
When it came to financing the Smith County Jail project, the commissioners court could have utilized COs, Warr explained.
“The Texas Legislature gives the commissioners court the authority to issue COs for things that are critical to the core of government, things we are statutorily required to do, such as maintain the jail,” he continued. However, due to the contentious nature of the jail issue, and the conservative nature of Smith County, the court decided to put the decision to the voters.
In Comal County, the county looks at three options when issuing debt for capital projects: Tax Notes, COs or bonds, said Comal County Commissioner Scott Haag. Tax Notes can only be amortized for up to seven years, “so our county uses them on smaller projects or when we are in a position to comfortably blend them into the repayment schedule of debt already issued without too much impact on the tax rate.
“COs are used on large projects of definite public necessity,” Haag continued. “Bond issues in our minds are reserved for projects which are considered discretionary (not a public necessity) or which are so large it would not be well received by our residents to not have a vote.”
Comal County most recently issued COs in 2007, with projects including restoring the old courthouse, completing a flood retarding structure, acquiring a right of way for road improvement, and making improvements to various county buildings.
“The public responded very well to this 2007 issue,” Haag maintained.
Never Assume
In order to educate the public, officials first need to educate themselves. When it comes to financing, this can be an arduous task. In some cases, the initial step is to set aside some stifling assumptions:
Ø If we can’t pay cash, it’s not worth doing.
Ø The voters will never go for it.
Ø If I obligate the county to this debt, some of the constituents will not see fit to re-elect me.
Perhaps voters deserve more credit. It’s safe to say most constituents believe their own home is worth having, even if they had to finance. No doubt many of these same taxpayers are currently financing one, or possibly two, vehicles. Some financed their own education, or that of their children. While paying cash for major purchases, such as a home, is certainly an ideal method, the majority of people simply do not have that option.
Likewise, these same constituents, if asked, may agree that projects designed to better the community are worth consideration. And, once armed with accurate facts and figures, voters can make an informed decision. For example, voters often naturally assume that the selling of bonds means an automatic tax increase. This is not always the case.
If the project does warrant an increase in the tax rate, some taxpayers automatically envision a large increase. The court needs to be sure to correct this misconception by offering taxpayers the correct equations.
For instance, last year Hockley County published and distributed a brochure listing the estimated impact of up to $15 million in general obligation bonds to fund the construction of a multipurpose center. Officials broke ground on the Mallett Event Center And Arena in June 2010.
“The committee that supported the project conducted town hall meetings, and we ran several advertisements in the local paper advising the taxpayers of the effect on the tax rate,” said Hockley County Commissioner Larry Carter.
Public Finance 101
Suppose members of the community take you up on the invitation to attend meetings. And suppose their first question is, “Just what is a bond, anyway?”
An elected official who can explain to a taxpayer the nuts and bolts of public financing will be more likely to earn that taxpayer’s confidence and support, whether for the project at hand or on a future issue.
What is a Bond?
Because a county is not authorized to go to the bank and take out a loan, it must finance long-term purchases through the issuance of bonds.
A bond is like an IOU, said Patricia Rodriguez, former senior vice president of Southwestern Capital Markets, a finance institution. In most instances, the county hires a financial adviser who assists the county in selling the bonds to buyers in the financial market.
The bond is an agreement between the county and the bondholder, whereby the county receives the money from the bondholder and then agrees to pay the money back, plus interest. The agreement includes the interest rate and the timetable of payments.
Back in the “old days,” bonds were actually printed. Today, very few bonds are printed because most bond sales are completed electronically. The Depository Trust Company keeps track of the bonds and bondholders.
Generally, bonds are issued in increments of $5,000. The Depository Trust Company tracks the maturity of the bonds using identification numbers. Counties make semiannual payments on the bond debt. In most instances, the interest money paid by the county is tax free to the bondholder.
Texas law requires that all bond issues, regardless of the type of bond, be approved by the attorney general’s office. Once approved, the legality of the bond cannot be contested, except for a constitutional challenge.
A county must choose what type of bond to issue, Rodriguez said.
v General Obligation (GO) Bonds
GO bonds are usually used to pay for major capital projects. The county must conduct an election in order to sell these bonds. The authority to conduct this election is generally provided in Texas Government Code Chapter 1251, Mendez said.
These bonds are authorized to fund specific public purposes, said Rodriguez. A public purpose is defined as a “public project or use specifically for the benefit of the county issuing the debt.” GO bond debt is paid by property taxes.
Once the voters pass a bond election, the money must be used for the initially stated purpose. In other words, if voters pass an election for courthouse improvements, the funds coming from the authorized bonds cannot be used to fund a park.
GO bonds fall into two categories.
Unlimited Tax Bonds. This type of bond tells the bondholder that regardless of circumstance (i.e., an unexpected catastrophe), the county will tax whatever amount necessary to pay the money back, Rodriguez said.
County Unlimited Tax Bonds are authorized under Article III, Section 52 of the Texas Constitution. While there is no limitation as to tax rate, the county may be limited in amount to not more than 25 percent of the assessed valuation of real property within the county or applicable county-sponsored district.
Unlimited Tax Bonds can be issued for the following purposes:
Ø Roads
Ø Flood Control
Ø Navigation
Ø Irrigation
The most common usage of the Unlimited Tax Bonds is for county road bonds.
Those working in the bond market see Unlimited Tax Bonds as the county’s most secure type of debt, usually providing the lowest possible interest rate to the county, Rodriguez said.
Limited Tax Bonds. Most GO bonds are Limited Tax Bonds. This tells the bondholder that the county must limit the amount of taxes that can be pledged to pay the debt, Mendez said. Under Article VIII, Section 9 of the Texas Constitution, a county can tax up to the $.80/$100 maximum tax rate.
Limited Tax Bonds can be issued for a variety of purposes including (but not limited to):
Ø Courthouses
Ø Jails
Ø Bridges
Ø Roads
Ø Hospitals
Ø Airports
Ø Exhibition Facilities
Limited tax bonds present more of a risk to the bondholder, Rodriguez said. In this case, the interest rate on the bonds will likely be higher to offset that risk.
However, Mendez said such risk is limited because the attorney general of Texas will not approve limited tax bonds in an amount which produces debt service requirements exceeding that which can be paid from $.40 of the foregoing $.80 maximum tax rate, calculated at 90 percent collection.
According to the law, GO bonds can be repaid over a 40-year period, Mendez said. However, the market conditions usually result in a payoff period of 15 to 20 years.
v Revenue Bonds
This type of bond tells the bondholder that the money will be paid back based on the revenue generated by the new project. Revenue bonds are not funded by tax money, Rodriguez said.
Revenue bonds are usually used more by cities than counties, as most counties do not have the type of facility to generate enough revenue to secure the bond, Mendez said.
Various statutes in the Government Code give the county the authority to issue Revenue Bonds. The bonds do not require voter approval, nor do they require the county to inform the voters prior to issue.
v Certificates of Obligation (CO)
COs are bonds that do not require authorization from the voters. However, the county must first authorize the publication of a “Notice of Intention to Issue COs.” The notice has to identify the projects to be financed, and must be published two times in a local newspaper of record at least two weeks before the date of sale of the COs, Rodriguez said.
Legal statutes limit the use of COs, Mendez said, to:
1. Pay for construction of a public work.
2. Pay for purchase of materials, supplies, equipment, machinery, buildings, lands, and rights of way for the issuer’s authorized needs and purposes.
3. Pay for professional services such as engineers, architects, attorneys and financial advisers.
If 5 percent of the registered voters submit a valid petition protesting the issuance of the COs, the issuance must go before the voters.
Last year Carson County attempted to issue COs to replace the county jail, but the voters petitioned in protest.
“Our intention, after cost analysis and much debate, was to save taxpayer dollars by putting the jail on a fast track to completion and not having the expense of an election,” explained Carson County Commissioner Kevin Howell. “The citizens decided otherwise. The county conducted a bond election, which passed in the spring of 2010.
COs can be funded by ad valorem taxes, a revenue pledge (as in revenue bonds), or a combination of the two. Like GO bonds, CO bonds can be issued for terms of up to 40 years.
Additional Public Financing Methods
v Contractual Obligations
Counties can use this type of bond to finance personal property, only. Contractual obligations are payable from a pledge of revenues, funds or taxes, and have a maximum term of 25 years.
No election is required, however the county has to adhere to applicable bidding requirements, Mendez said.
v Anticipation Notes, also known as Tax Notes or Limited Tax Notes
This financing option was made available to cities and counties by the Legislature in 1993, Mendez said. Anticipation notes can be secured by pledging either ad valorem taxes or revenue, but not both.
In the case of a revenue pledge, the county must give specific authority to permit the particular revenue source to be used for the note.
Most counties issue anticipation notes limited by the $.80/$100 tax rate and refer to the notes either as Tax Notes or Limited Tax Notes.
“The greatest advantage is that the process is streamlined,” Mendez said. “There is no election or publication requirement.”
The notes do have a short maturity that cannot exceed seven years from the date of the attorney general’s approval.
Anticipation notes can be used to:
1. Pay for construction of a public work.
2. Pay for purchase of materials, supplies, equipment, machinery, buildings, lands, and rights of way for the issuer’s authorized needs and purposes.
3. Pay for professional services such as engineers, architects, attorneys and financial advisers.
In addition, Anticipation Notes can be used to:
1. Pay for operating expenses or current expenses.
2. Fund the issuer’s cumulative cash flow deficit.
However, a county is limited to paying notes for these purposes to one year from the date of the attorney general’s approval.
Financing Step by Step
The first action a county should take in financing a project is to determine whether or not the county is fiscally able to borrow money and then pay it back, plus interest. In most cases, the county uses a financial adviser (FA) to determine whether or not it is in the position to finance.
Think of the FA as a banker and the county as a potential homeowner, Rodriguez said. The person wanting to finance a home says to the banker, “Here’s my income. Here are my expenses. How much house can I afford?” The county wanting to finance a jail says to the FA, “Here is our revenue. Here are our outstanding debts and expenses. How much jail can I afford?”
The financial adviser will develop a debt plan, Rodriguez said. Due to the complex nature of public financing, most counties hire a professional FA from the outside. Using specialized software, the FA can input the county’s taxable value and tax rate and can structure the debt to be repaid in a certain amount of time. The FA can also devise a plan based on projected growth (accompanied by an expanded tax base), or on zero growth.
The FA coordinates with other parties involved in the sale of the bonds, including the underwriter and bond counsel.
Along with using an FA, a county should consider hiring bond counsel, an attorney who specializes in bond finance, Rodriguez said.
The FA and bond counsel are two separate entities. While an FA may recommend a bond counsel, a county is not at all bound by its recommendation and can make its own choice of counsel.
“A county should insist that the bond counsel represent the issuer,” Mendez said, “so that the bond counsel is looking out for the county’s interests.”
The bond counsel’s duties are to prepare the required legal papers and take the documents through the attorney general’s office for approval. The bond counsel also researches the law with regard to financing options and renders the tax opinion that ensures that the bonds are exempt from federal income tax.
Once the county has decided to sell bonds, the FA and commissioners court will decide whether or not to use the competitive bid process or the negotiated sale process to sell the bonds. For a smaller bond issue, a private placement of the bonds may be used.
If a negotiated sale is used, the FA will assist the county in appointing an underwriter to become involved in the selling process. The underwriter does not represent the county, Mendez said.
A negotiated sale occurs when the underwriter negotiates interest rates between the issuer, the FA, and the “market,” which includes institutional buyers and ultimately the bondholders, Rodriguez said.
A competitive sale involves setting a date of sale and taking sealed bids. Whoever offers the lowest interest rate on that day will become the purchaser of the bonds. The purchaser may be an underwriter who will sell the bonds, or an institutional investor who will hold the bonds for his own account.
If a private placement is used, the FA will approach local banks and other financial institutions to try to sell the bonds. Generally, the bank will purchase the bonds to hold for its own account.
Throughout the process, the prospective bond buyers will be looking at the county’s bond rating, essentially a credit rating, which is one of the elements that will determine the interest rate at which a county can borrow, Rodriguez said.
Three major firms provide bond ratings: Fitch, Moody’s and Standard and Poor’s. Generally speaking, all three look at revenues, expenses, administration, and the ability of an issuer to repay its debt.
The rating, the highest being an “AAA” credit, tells prospective buyers what their level of risk is in terms of getting their principal and interest paid.
Keep on Asking
Public financing is not an issue commissioners courts deal with on a daily basis. Moreover, it is difficult to remain continually familiar with a myriad of financing options that may change or be amended with each legislative session.
Still, commissioners courts shouldn’t let the complexity of financing automatically deter them from taking on worthy projects or making much-needed improvements.
Courts who do decide to explore the option need to be sure to consult experts, such as financial advisers and bond counsel. Ask questions. Consult with other counties who have conducted bond elections or used COs or Anticipation Notes. You may find out that the timing is not right for your county. Or, you may learn about new options that will open new doors for your community.
If the answers you get are too complex, ask the questions again. Tell them you want the facts, plain and simple, so you can explain them to your constituents. After all, the more you understand, the more they’ll understand. H – By Julie Anderson