The City of Encinitas Uses Certificates of Participation and lease-revenue bonds. They are expensive way to finance things, so why do it?

Answer: Because our elected officials don't think the voters would agree with them.

This review of how the State used Lease-Revenue bonds should explain things.

Last week's prison deal brought cheers and plaudits from virtually all political corners in California. The Legislature, threatened by a federal court takeover of the state's prison system, averted the crisis -- it is hoped -- by enacting a comprehensive bill to deal with prison overcrowding and other corrections issues. Governor Schwarzenegger hailed the agreement as another example of how California can work in a post-partisan world.

But like most political decisions made under duress, there are legitimate questions as to whether the deal reflects good public policy -- or whether it was even legal.

To recap; California has a huge and growing prison population. Those who are politically conservative were not about to let convicted felons out early. Those on the left -- who would prefer more leniency for those who are incarcerated -- were pushing for programs dealing with rehabilitation as well as a new sentencing commission. But political compromise in California is difficult and often the only way to reach that compromise is with lots of taxpayer dollars to appease both sides. It is amazing what a soothing effect buckets of taxpayer cash can have on the adversaries in a political dispute.

That is what happened here. The tough on crime Republicans got their extra beds -- 53,000 of them -- and the Democrats got their rehabilitation programs designed to reduce recidivism.

The centerpiece of the agreement was a bond proposal in the amount of $6.1 billion. That is a huge amount of indebtedness, especially considering that voters just approved the massive infrastructure proposal last fall in the amount of $42 billion.

Which brings us to the number one question posed by taxpayers: Why were these bonds not put to voters for approval?

The short answer - which is really no answer at all -- is that, as "lease revenue" bonds, they are exempt from voter approval.

There is no debate that lease revenue bonds, and their questionable cousins "certificates of participation," are instruments of indebtedness. However, because their repayment is -- in theory -- not guaranteed by the state's general fund, they are not considered "general obligation bonds" which, if the amount is over $300,000, are required by the California Constitution to be voter approved. Last time we checked, $6.1 billion is a bigger number than 300,000.

In any event, there are instances at both the state and local level where lease revenue bonds make sense. Specifically, if the improvement being financed by the indebtedness itself generates revenue, an argument can be made that voter approval should not be required because the source of the repayment does not put taxpayers at risk. The clearest example of the legitimate use of lease revenue bonds is a public parking garage. Parking garages generate revenue and that revenue can be used to repay the bond holders. Some publicly financed sports facilities, and their appurtenant retail and other business properties, might also be candidates for lease revenue financing.

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In 2000 the City of Encinitas commissioned a survey. It was titled Survey of Voters. This survey was designed to gauge the public's appetite for voting to support millions of dollars in bonds. These bonds would be expended on purchasing land. The conclusions the city council must have taken was that the super majority of voters would not want to bond for a park. The survey indicates that it would be even more difficult to pass the measure without the plans for the park being public.

The survey was reported in July 2000. About April 2001, the City of Encinitas circumvented the voters and issued lease-revenue bonds to purchase land. It takes a few months to prepare the bond issuance. In May 2001 the City purchased for $17,000,000, approximately 44 acres at the Hall property.

Lease-revenue bonds are more expensive than general obligation bonds. Although these bonds were designed for use where outside revenue is created, the park is not expected to produce much revenue and recently the city noted that they do not plan to charge user fees for sports organizations.

The Hall property remains empty and according to city staff, there is not enough money to construct Phase I. The city is planning on the park not being open for at least another six years.

Link to the survey.

Council Members like to use the size of the city's contingency reserves as evidence of the city's financial health. Indeed, the large reserves will help the city weather typical short-term blips in the economy. That stability means that the city can avoid a pointed fiscal problem due to acute economic shifts. The city now sets aside $9.3 million for reserves in the draft budget for next year. This is a good thing and the city should be commended for budgeting that reserve.

This does not mean the city has managed their funds wisely or the city's budget maintains adequate funding for the efficient maintenance of its facilities and acquisition of needed capital improvements. Indeed, it appears that the large reserve was made possible by loans the city has recently taken. The public was told that those loans would fully fund projects that are not now fully funded in the city's 6 year (draft) budget.

Excerpt from the staff report on the $20 million lease-revenue bonds.

A short history is worth reviewing.

In 2006 when the library was set to be built, the city was $6.3 million short on the library, and was $11.8 million over budget.

From a June 22, 2006 UT Article:

In January, the council foresaw the financial difficulties and prioritized its capital projects, shifting money from other projects to build the $20 million library now under construction on Cornish Drive behind City Hall.

That left projects short of money. The council had three choices: spend its reserves, borrow money or not build until the city had saved the money for construction.

In May, the council instructed the city's financial officers to draft a budget that assumes a $23 million bond issue.

From a May 25, 2006 UT report:

Financial consultants last night confirmed the City Council's worst fears over the coming year's tight capital budget: There is no easy way out.

City Finance Manager Jay Lembach indicated in a report that delaying three priority projects – three replacement fire stations, a central public works yard and the first phase of a 43-acre public park – eventually would cost the city millions of dollars more each year they are delayed because of rising construction costs.

The proposed budget falls $23 million short of estimates for those projects.

Three years ago the city was $23 million short. Then they borrowed $20 million (without a vote of the taxpayers). Here is more from the same article:

The city has decided to join the masses in coping with a small purse and big expenses. It will borrow its way out of the hole.

Council members reasoned that borrowing money would enable the city to build its priority projects – three replacement fire stations, the first phase of a 43-acre public park and a central public works yard – within the next six years.

The city purchased a public works yard and built one fire station. The current draft budget does not appear to have any funding for the other two fire stations and Hall Park operations are not budgeted in the next 6 years. The city currently does not have enough to fund Phase I of the park.

Again, from the UT article:

By moving forward, the city also would avoid the burden of escalating construction costs that would add millions of dollars each year to the projects if they were delayed because of lack of money.

If the council decides to issue bonds to cover the shortfall, Encinitas would be able to build the facilities and pay $7.3 million less than what they would have to pay if they delay the projects, Lembach said. The city would pay $1.4 million each year in interest for 30 years.

Activist Matt Walker criticized the council for developing a capital budget without a comprehensive plan, which includes moving money from other capital projects to pay for a new $20 million library at Cornish Drive behind City Hall.

“You spent it all on the library. Now you do not have enough money for fire stations, the public works yard, things we need,” Walker said. “Leaving yourself in that kind of lurch is not a plan.”

The analysis of the cost escalation was flawed at the time it was issued and the city's conclusions turned out to be incorrect. Many city watchers thought the city was using scare tactics and smokescreens to justify the bonding. Matt Walker turned out to more right than most people recognize. Not only is the city left in a lurch, the city seems to have picked up his plan to sell the Quail Gardens Drive property to fund their budget holes.

The contingency reserve in 2006 was $6 million before the city borrowed $20 million. At the same time, the city was also $23 million in deficit for its priority infrastructure projects. Now, after the $20 million loan, the city's contingency reserve is up to $9 million, but it is not clear if there is enough money for two fire stations* and city staff confirm that there is not enough money to open the Hall Property Park. Those commendable contingency reserve levels were possible because the city issued lease-revenue bonds.

It is time for more intellectually honest budgetary discussions.

Kevin Cummins

*The funding for the fire stations is not shown in the budget. Staff recently implied that there is some funding, but did not explain why it could not be incorporated into the official budget. Confirming the presence of a problem, building the fire stations is not on the list of goals for the fire department, which can be found in the Two-year Operations Budget.

Most of Encinitas' debt has grown due to the use of lease-revenue bonding. The use of lease-revenue bonding when no external revenue source is created has been considered a poor practice by the Howard Jarvis Taxpayer Association and the San Diego Tax Fighters. More on lease-revenue bonding here.

Please read. This history is worth keeping in mind.

February 13, 2005

Property taxes are increasing dramatically for most home buyers venturing into San Diego's high-priced housing market...

Today's home buyers take for granted the reforms adopted by voters in 1978 as Proposition 13. Previously, local governments set their own tax rates and annually reassessed property to reflect the rising cost of government....

Encinitas saw its property tax receipts soar 334 percent over the last decade, going from $4.1 million to $17.8 million and representing the biggest jump for any of the 18 cities in the county.

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By Jon Coupal

Even in the best of times, the three major bond proposals on the
November ballot would merit a thumbs down. Propositions 1A, 3, and
10 would put taxpayers another $16 billion in debt to fund some
dubious projects.

Proposition 1A spends $10 billion as a down payment on a massive
bullet train project. Promoters, which includes the company
responsible for Boston's infamous "Big Dig" disaster
http://tinyurl.com/big-dig-disaster, claim the project can be
completed for about $50 billion. However, a just released study by
transportations experts, which includes a former president of the
High Speed Rail Association and a former member of the Amtrak Reform
Council, show that actual costs could easily exceed $80 billion.

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