The Poway deal gets fishier

By Felix Salmon
September 26, 2012

Remember Poway, and the exorbitant interest costs it was paying on its debt? At first glance, those costs were so huge because of the way the deal was structured: there were no interest or principal payments before 2033, and the final payments weren’t due until 2051.

In reality, however, there was something else going on as well: while Poway claimed to have only borrowed $105 million, they were lying about that: in fact, they borrowed $126 million, taking a $21 million kickback on top of the $105 million they were ostensibly borrowing.

As such, in reality they’re “only” paying $855 million of interest on a $126 million principal amount, rather than the $876 million of interest on $105 million in principal that we originally thought. But this is not a good thing. In fact, Will Carless — who’s been pushing this story hard, and has done a huge amount of work in reporting and explaining it — makes a very persuasive case that it’s illegal.

After all, the whole point of pushing the repayment dates back to 2033 and beyond was that Poway had already maxed out everything it was allowed to borrow before that. “When voters allow a school district to issue bonds,” Carless explains, “they set what appears to be a strict dollar limit on how much can be borrowed”. But somehow, that cap on the amount the district can borrow does not seem to be well defined. Somewhere along the way, definitions got fuzzy.

It should be pretty simple, this question of how much someone has borrowed: you just look at how much money they received when they did the borrowing. And to determine how much interest they’re paying, you take all the money they repay, and subtract that initial amount.

But Poway isn’t doing that. Instead, it’s defining the amount that it’s borrowing as the face value on the bonds. Set a bond with a low face value, and you get to borrow much more than face value, without going over the borrowing limit set by voters.

And that’s exactly what Poway did. By artificially jacking up the interest rate on the bonds — and the longest-dated bond, remember, had an interest rate of a whopping 7.2% — Poway managed sell the bonds at a substantial premium to par. That action, according to a formal letter filed by the California attorney general’s office, was not legal. The AG’s office didn’t prosecute Poway, on the grounds that doing so would cause Poway to incur substantial litigation costs. But it explicitly said that Poway’s behavior was unlawful, and that if this kind of thing became a habit, then it might indeed end up being prosecuted.

What’s more, if Poway sold these bonds at 120 cents on the dollar, there’s no way it could buy them back at 105 cents or less, as I suggested a few weeks ago: unwinding this deal is going to be expensive. Not $850 million expensive, of course, but tens of millions of dollars all the same. I was going on the fact that Bondview shows the bonds trading at about 101 cents on the dollar, but there might be something weird going on there.

In any case, the more we learn about this Poway bond, the smellier it gets. And of course officials aren’t talking:

“The simple fact is that [Poway Unified] did not borrow any more funds than those approved by the voters,” Superintendent John Collins wrote in an email on August 29.

Collins wouldn’t elaborate on this position. He and the Poway school board did not respond to several requests for interviews. Nor did Poway officials agree to interviews with their legal or financial staff.

Well done to Carless for pushing on this; I hope his piece causes enough of a stir that Poway is going to be forced to answer for its actions in some forum. But in the meantime, it would be great to get some clarity on which bonds in particular ended up selling at well above par, and where those bonds are trading today. If, that is, they’re trading at all.

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Comments
4 comments so far

You’re right, FS – this Poway thing is unethical, but not IMO because of the rate or the amount. It’s the duration and the deferred-interest methodology that is corrupting.

The district is collecting cash now – and spending it. Future generations get stuck with the bill for both the principal and all the deferred interest. How do we morally justify doing this to them?

When we die our personal heirs can’t be compelled to assume our debts beyond the value of our estates – except when it comes to government debt. There, ‘the sins of the fathers’ truly are visited on the sons and daughters – not to mention the grandchildren.

IMO, this is yet another shameful example of Boomer self-indulgence. There is no way out of this debt-trap we have set except for sustained inflation to erode the real value of these obligations. So sad. Who the hell would buy one of these things anyway?

Posted by MrRFox | Report as abusive

You’re right on, but your bond pricing data is not so great. The 2042 issue you mentioned was partially called at 103, but Bloomberg shows it bid at 86 today. The other zero coupon bonds are well below 100 from the beginning.

Posted by loudnotes | Report as abusive

Check out emma.msrb.org and search under Poway Unified.

Issues you want are Cap Apprec Tranche A & B, Cap Apprec Elec 08, and School Facilities Improvement District No. 2007-1.

Confusion arises because the original principal differs from the final accreted value amount.

The underwriter paid an original premium on the original principal. Some of the original premium was used to pay issuance costs but most was for something called the Bond Advancement Program, which is explained in some School Board Resolution from 2008 and not in the offering dcuments.

When the underwriter sells these to the public, as with all CABS, they are sold at a discount, but the discount is to the final accreted value (principal plus compounded interest payments). Some of the discounts are as great as 6% of par for the Series B 2051, but they range from 60% to 6% of par. Each issue has a maturity schedule that outlines the accretion rates on the various maturities

Posted by Ghoghogol | Report as abusive

I agree with MrRFox, and I don’t know why a state legislature would/should allow any local or municipal government to issue long-term, zero coupon bonds. The temptation is too great for politicians to promise something today while pushing payment into the distant future.

The taxpayers of this school district several decades out – a group whose overlap with people currently living there I would expect to be limited – will be saddled with the full cost of building and expanding schools today, including both principal and accrued interest. As an extra “bonus” for these future taxpayers, by then the buildings built today ought to be in need of replacement or major renovation, so they will get to pay for that also.

Posted by realist50 | Report as abusive
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