New bonds could yield big savings for counties

• Click here for more information on the ARRA funds.

By Todd McGee
Communications Director

Given the uncertain economic situation, county commissioners are understandably hesitant to take on any significant financial obligations. Many counties have delayed capital projects, such as schools or jails, to avoid any property tax increases needed to pay off the debt service.

While the state and the nation are battling a recession, North Carolina continues to grow. The Census Bureau projects that our state's population will reach 12 million by 2030, and these additional residents will include many children who need classrooms and teachers.

Thanks to the American Recovery and Reinvestment Act, counties that need to build a new school, purchase land for a school or renovate an existing facility have two new funding opportunities that could save taxpayers potentially millions of dollars in financing costs. In addition, with more contractors looking for work, competition is driving prices down, meaning that now may be the ideal time to build, renovate or expand a school.

The Build America Bonds (BAB) program allows governments to tap into the taxable bond market. Most government-issued bonds are tax-exempt bonds. These bonds have low yields for investors but are much more stable as an investment because governments rarely default on bonds. North Carolina has some of the best local government fiscal management practices in the nation, making N.C. bond issues even more attractive to investors because of the increased certainty that the bonds will be paid.

"These are a great substitute for corporate bonds," said Bob Millikan of BB&T Asset Management in Raleigh. "They are much safer."

Millikan said that he had not heard of any North Carolina local governments attempting to sell a BAB as of mid-June. Large issues by the State of California and the New Jersey Turnpike Authority have made national headlines, and he said that many school districts and local governments in the Midwest are using the new financing mechanism for a variety of projects, such as schools or infrastructure improvements.

The taxable bond market typically pays higher rates for investors but also carries greater risk. The BAB program enables a local government to issue a taxable bond. The federal government will provide a 35 percent subsidy in the interest rate, paid directly to the bond issuer (BAB – direct payment) or given as a tax credit to the bond holder.

Investors get the benefit of the stability offered by local government-issued bonds while earning interest at corporate, taxable rates, while the interest subsidy makes the cost to local governments equal or less than that of tax-exempt rates. The BAB program may not work for counties with outstanding credit ratings, which can already earn those counties very low rates on the tax-exempt market, Millikan said.

Millikan said that most of the issues he has seen so far have been of the direct payment option, whereby the local government receives the rebate from the federal government.

Build America Bonds can be used for any purpose for which a local government can issue debt, making them a very attractive option, said Deputy State Treasurer Vance Holloman.

"They are really wide open," Holloman told the NCACC Board of Directors during a June 20 presentation. "That's going to be your greatest opportunity. Use it even if it is just for buying land."

Another new program drawing the interest of a lot of counties from around the nation is called Qualified School Construction Bonds (QSCBs). This program enables the federal government to issue bonds with a 0 percent interest rate. The ARRA included $11 billion each for 2009 and 2010, with 40 percent of the funds being assigned to the largest local education agencies around the nation, and 60 percent being assigned to states. The state allocations are determined by a formula that takes into account student population, relative wealth and other factors.

Five North Carolina counties – Mecklenburg, Wake, Guilford, Forsyth and Cumberland – received automatic allocations for 2009, ranging from $12.2 million for Forsyth to almost $26 million for Mecklenburg. The state was given an allocation of $187,167,000 for 2009. The allocations will be recalculated for 2010.

The State Department of Public Instruction has been designated as the state agency to manage the QSCB program. In late June, DPI released its guidance and funding allotments to each of the 110 LEAs that did not receive a direct authority. Each LEA was guaranteed a base of $1 million from the $187 million, and the remaining $77 million was divided up on an ADM basis, said Dr. Ben Matthews, the Director of School Support at DPI.

DPI developed an application form that must be filled out and returned to DPI with a postmark of July 31, 2009. Counties that do not respond by then will see their allotment for 2009 transferred to another county, Matthews said. A county must use its allocation by Dec. 31, 2009.

Individual counties cannot carry an allocation forward into 2010. However, states are allowed to carry any unused allotment from 2009 to 2010. Matthews said DPI would consider if a county requested to have its 2009 allocation carried forward into 2010 so they could do one larger issue, but Matthews said that would not be done automatically.

"We want it out there and we want people to use it," he said. "The intent of this was to get it out there and stimulate the economy. If we are sitting on it, that is not what the governor wants and not what we want either.

"That's the reason for the July 31 deadline is that we want to turn it back around and get it to counties that can use it. We have already had one county say that it wants $25 million."

While individual counties, including the five large ones that receive a direct allocation, cannot carry their allotments into next year, the counties can assign their allotment to the state. For instance, if Mecklenburg County decided it could not use its $26 million before Dec. 31, 2009, the county could assign its allocation to the state, which could carry it forward into 2010 or assign it to other counties to use for 2009.

The amount of savings for a 0 percent loan, compared to what a county with a good credit rating could get, are substantial. For instance, a $2 million loan for a term of 12 years with an interest rate of 4.5 percent would cost more than $592,000 in interest over the life of the loan. A 0 percent loan, then, would save the county $592,000. The same loan with a 5.0 percent interest rate would require a county to pay more than $663,000 in interest.

"You're essentially paying only principal on this," said Holloman. "That can have a significant value for you."

According to Sharon Edmondson of the Local Government Commission, there is currently not a lot of interest nationally in QSCBs, at least from investors, because of the economy. The benefit to lending institutions is paid in the form of a federal tax credit, and many of them do not need the tax credit to balance out their tax obligations.