Oregon School Boards Association Sustainable Schools Conference. What s New in Alternative Financing

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1 Oregon School Boards Association Sustainable Schools Conference What s New in Alternative Financing January 28, 2010 Javier Fernandez Senior Vice President D.A. Davidson & Co. (503) jfernandez@dadco.com Two Centerpointe Drive, Suite 400 Lake Oswego, Oregon 97035

2 1 What s NOT so new Debt repayment sources have not changed. School districts have two sources of revenues to pay debt service: Additional property taxes Existing revenues (General Fund) General Obligation Bonds Full Faith and Credit Obligations Certificates of Participation Tax Anticipation Notes Pension Obligations

3 What s new (ARRA) Build America Bonds (BAB). Issue taxable debt at higher interest rates and receive a direct subsidy from the Federal Government equal to 35% of the taxable interest payment. A 35% tax credit to investor is also available. Generally are not available to refinance existing debt. Eligibility G.O. FFCO 2 Qualified School Construction Bonds (QSCB). Replaces taxable interest payments with tax credit to investors. Available primarily for new construction projects. Not available to refinance existing debt. Qualified Zone Academy Bonds (QZAB). Replaces taxable interest payments with tax credit to investors. Available primarily for renovation, equipping or training teachers and personnel. School district must meet qualification requirements (districts must be located in an empowerment zone or enterprise community or have a minimum of 35% of students eligible for free or reduced cost lunches). Must obtain 10% equity contribution from private partner.

4 What s new (ARRA) Clean Renewable Energy Bonds (CREB). Tax credit program similar to QSCB and QZAB. Tax credit available to investor is only 70% of the tax credit available under the QSCB and QZAB programs. Limited use for wind, biomass, geothermal, solar, solid waste, small irrigation power and hydropower capital construction projects. Eligibility G.O. FFCO 3 Qualified Energy Conservation Bonds (QECB). Tax credit program similar to QSCB and QZAB. Tax credit available to investor is only 70% of the tax credit available under the QSCB and QZAB programs. Limited use for capital construction projects aimed to reduce energy consumption by a minimum of 20% in publicly owned buildings.

5 4 Interest Rates 101 Base assumption: Interest earnings are subject to federal and state income tax. No credit differences for the following examples. This is the case for a 20-Year U.S. Treasury Bond: Source: Federal Reserve Bank of St. Louis Economic Research

6 5 Tax Exempt Interest 01/22/10 U.S. Treasury Taxable Rate: 4.38% Taxable Rate If the income tax rates for investor A are: 25% Federal 10% State 35% Total Investor A is indifferent between a tax exempt interest rate and a 4.38 taxable interest rate. = 4.38% x ( ) Equivalent Tax Exempt Rate: Tax Exempt Rate

7 6 ARRA Build America Bonds School district may issue taxable debt and Federal Government will pay a direct subsidy equal to 35% of the interest payment. 4.38% 4.38% 1.53% = 4.38% x (0.35) Taxable Rate Tax Exempt Rate BAB Taxable Rate Fed Subsidy Effective Rate paid by School District

8 7 ARRA Build America Bonds Depending on the credit quality and market conditions, the effective rate paid by a school district under the BAB program may be lower or higher than the alternative tax exempt rate. Scenario % Taxable Rate Tax Exempt Rate Scenario % BAB Taxable Rate Rate paid by SD Fed Subsidy 1.40% 2.60% 4.50% BAB Taxable Rate Rate paid by SD Fed Subsidy 1.58% 2.92%

9 8 Tax Credit Bonds (QSCB & QZAB) Maximum maturity and tax credit rate is determined daily by the Department of the U.S. Treasury (17 years and 5.97% as of January 26, 2010). 4.38% 5.97% Taxable Rate Tax Exempt Rate Tax Credit Rate (Fed Subsidy) 0.00% Paid by school district

10 9 Tax Credit Bonds (QSCB & QZAB) Source: U.S. Department of the Treasury, Bureau of the Public Debt.

11 10 Tax Credit Bonds (QSCB & QZAB) 4.38% Taxable Rate Tax Exempt Rate 7.25% Tax Credit Rate (Fed Subsidy) Supp. Cpn. Supplemental coupons have been paid by most school districts that have issued QSCB and QZABs to date. Tax credit rate has not been as expected. Demand for tax credit bonds has been exceeded by supply. 5.97% Tax Credit granted by Federal Government 1.25% Supplemental Coupon Paid by school district

12 11 Tax Credit Bonds (QSCB & QZAB) 4.38% 5.97% 5.15% Proposed legislation: Allow districts to issue QSCB as taxable interest bonds. The Federal Government could subsidize 100% of the taxable interest (similar to BABs, but at 100% level) up to the prevailing tax credit rate. Taxable Rate Tax Exempt Rate Tax Credit Rate QSCB Taxable Rate 100 % subsidized by the Federal Government 0.00% effectively paid by districts