Certificates of Participation: What Are They? How Do They Work?
What Do They Mean for JeffCo?
by Joshua Sharf
Colorado is a fiscally responsible state.
At the very beginning of statehood, in 1876, Colorado’s founders sought to head off potential fiscal excesses and the bankruptcies many states had experienced earlier in the decade.
In the 1830s, easy credit induced government borrowing both for infrastructure projects like canals and to expand state banking systems. The Panic of 1837 resulted in a wave of state bankruptcies in the 1840s.
The psychological effects of these failures reverberated for generations. Just as we still fear the recurrence of inflation 40 years after the 1970s, so did Americans of the 1870s fear state fiscal instability.
To prevent Colorado from similar turmoil, the state constitution included a provision banning the state and its municipalities from issuing unsecured, general obligation debt without a vote of the people. TABOR added to this by barring certain multi-year financial obligations without a vote.
In order to get around these restrictions, local Colorado governments have used something called Certificates of Participation, or COPs. Sometimes these instruments are used to finance new assets like cars or trucks, but they can also be used to build facilities which require a much larger debt and are nominally secured by existing land or buildings.
Here’s how they work: Let’s say that a school district issues COPs to fund buildings, using existing schools as collateral. The district sets up a special-purpose authority, and transfers control of the school buildings that will be collateral to that authority. It then agrees to lease the buildings back from the authority. That lease is renewable on a yearly basis.
The special-purpose authority—not the district—issues the COPs, the payments of which are secured by the lease payments from the school district.
COPs represent a legal fiction. In theory, the lease is renewable year to year; the district could decide next year not to renew the lease, and the authority would have to default on the COPs. The action doesn’t technically represent a violation of TABOR’s restrictions on long-term obligations, and allows the school district to get around the requirement to ask citizens for permission to borrow.
But the reality is quite different. The debt is reported in the district’s Comprehensive Annual Financial Report (CAFR) as a long-term debt, not a year-to-year obligation. And since the special-purpose entity’s revenues come from the district’s lease payments, the credit rating agencies rate the debt based on the school district’s finances.
The Government Accounting Standards Board (GASB) recognizes the somewhat hybrid nature of COPs in its standards. The definition of a COP is that the investor is purchasing a portion of the revenue stream of the lease payments. As such:
- Although conduit debt obligations bear the name of the governmental issuer, the issuer has no obligation for such debt beyond the resources provided by a lease or loan with the third party on whose behalf they are issued.
- The required disclosures include a clear indication that the issuer has no obligation for the debt beyond the resources provided by related leases or loans.
Debt issued under COPs tends to be more expensive than general obligation bonds. A cursory review of interest rates shows that COPs carry up to 1 additional percentage point of annual interest more than bonds issued by the same entity.
The lease payments for school district COPs come from the operating budget, potentially pushing out needed classroom spending. In February 2015, school board members Jill Fellman and Lesley Dahlkemper proposed $80 million in COPs to fund a stadium in south Jeffco and two new schools, one in Arvada and one in Lakewood. The annual payment for the COPs would have exceeded $5 million.
In response to the growth in north Jeffco, the board majority instead asked Superintendent Dan McMinimee to look for administrative savings to fund only a new school in northwest Arvada. Through reductions and savings in overhead, the district was able to allocate $18 million for a new school. Because the school will be built without any debt, there will be no need to make ongoing budget cuts to make payments for the COPs.
Instead of using COPs, the Board has indicated its willingness to present voters with a bond package in 2016 based on additional growth projections. Projects could include those that were in the failed 2008 bond package, such as the expansion of Stein Elementary, and the completion of Sierra Elementary, as well as the potential for additional schools in north Arvada.
Bond issues are general obligation bonds, but are backed by an increase in the property tax rate. Such a tax increase has to be approved by the voters. Therefore, boards propose the projects to be included in the bond, and voters decide if they are willing to raise their taxes to fund those projects.
Caution! Numbers Ahead!
If $80 million in bonds were issued for a term of 20 years (a fairly common term for school district general obligation bonds), they would end up costing the district roughly $5 million a year in principal and interest. I base this estimate on the 2.25 percent yield that 20-year JeffCo bonds, issued in 2012, were trading earlier in the year.
In fact, the number would probably vary from year to year. Instead of using one large issue with the same maturity, districts frequently issue a series of bonds with varying maturities, in order to take advantage of the fact that it costs less to borrow for a year than to borrow for a couple of decades. The bonds issued in 2012 were structured that way.
COPs have been the subject of concern not only here in Colorado, but also in other states. North Carolina stands out as an example of COP growth, where roughly 14 percent of all outstanding state government debt is now COPs. By comparison, a little over a quarter of the $6.3 billion in long-term debt owed by Colorado and its Enterprise Funds are COPs.
Issuing COPs allows government entities to bypass the laws which have been put in place to guarantee the taxpayer has a say in the level of debt their government incurs on their behalf. After all, they are responsible for the debt through their taxes one way or another. The purpose of the law is to prevent government overspending and financial crises like in the 1800s, or more recently in Detroit.
Jeffco residents ought to ask: When going into debt, should the government ask for forgiveness or permission?