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Cash-out refinance of school bonds is illegal, says state Attorney General Jerry Brown

By Andrea Gemmet

For homeowners, cash-out refinancing is a popular way to lower monthly mortgage payments while getting a lump sum of cash in the bargain. However, when school districts use a similar practice to refinance school bonds, they're breaking the law, according to state Attorney General Jerry Brown.

In the past 10 years, Las Lomitas and Woodside elementary school districts both used this method to generate extra money for school bond-financed projects, according to the San Mateo County Civil Grand Jury.

Attorney General Brown's recently issued opinion says that school districts run the risk of having the entire bond issue invalidated if they fail to get voter approval of certain bond refunds.

At issue are so-called cash-out refunding of school bonds, in which school districts take advantage of lower interest rates to refinance a bond issuance, but agree to pay something higher than the prevailing interest rate in exchange for a cash "premium."

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For example, if a school district originally issued bonds at a 10 percent interest rate and then seeks to refinance when the prevailing rate is 8 percent, district officials could agree to pay 9 percent interest in exchange for an upfront cash premium.

In Mr. Brown's Jan. 9 opinion, he says that this runs contrary to provisions for voter approval in the California constitution. Districts may issue refunding bonds -- refinance the debt, in other words -- only if the proceeds are used to pay off the original bonds. Anything else requires a new vote.

School bonds are repaid via property tax assessments, and a cash-out refunding of bonds results in an additional debt burden on property owners, according to Mr. Brown. Such bonds "categorically result in the creation of new indebtedness … and therefore require new voter approvals," he writes in his opinion.

The attorney general's opinion also dismisses counter arguments used by school districts to justify cash-out refunding.

The legal opinion comes at the request of state Sen. Joe Simitian, and follows a 2008 San Mateo County Civil Grand Jury report questioning the practice.

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According to the grand jury report, the Woodside district added $572,000 in debt obligation to taxpayers, gaining an additional $352,000 for its bond projects. The cost of reissuing the bonds was $220,000.

For Las Lomitas, the additional debt obligation incurred is $2.6 million, adding an extra $2.25 million to its building fund at a cost of $355,000 for reissuing the bonds.

While the attorney general's opinion may end the practice in the future, it appears that cash-out refunding bonds issued in the past are safe. There is a 60-day time limit for legal challenges, starting from the date the bonds are authorized, according to Mr. Brown's opinion.

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Cash-out refinance of school bonds is illegal, says state Attorney General Jerry Brown

Uploaded: Mon, Jan 19, 2009, 5:25 pm

By Andrea Gemmet

For homeowners, cash-out refinancing is a popular way to lower monthly mortgage payments while getting a lump sum of cash in the bargain. However, when school districts use a similar practice to refinance school bonds, they're breaking the law, according to state Attorney General Jerry Brown.

In the past 10 years, Las Lomitas and Woodside elementary school districts both used this method to generate extra money for school bond-financed projects, according to the San Mateo County Civil Grand Jury.

Attorney General Brown's recently issued opinion says that school districts run the risk of having the entire bond issue invalidated if they fail to get voter approval of certain bond refunds.

At issue are so-called cash-out refunding of school bonds, in which school districts take advantage of lower interest rates to refinance a bond issuance, but agree to pay something higher than the prevailing interest rate in exchange for a cash "premium."

For example, if a school district originally issued bonds at a 10 percent interest rate and then seeks to refinance when the prevailing rate is 8 percent, district officials could agree to pay 9 percent interest in exchange for an upfront cash premium.

In Mr. Brown's Jan. 9 opinion, he says that this runs contrary to provisions for voter approval in the California constitution. Districts may issue refunding bonds -- refinance the debt, in other words -- only if the proceeds are used to pay off the original bonds. Anything else requires a new vote.

School bonds are repaid via property tax assessments, and a cash-out refunding of bonds results in an additional debt burden on property owners, according to Mr. Brown. Such bonds "categorically result in the creation of new indebtedness … and therefore require new voter approvals," he writes in his opinion.

The attorney general's opinion also dismisses counter arguments used by school districts to justify cash-out refunding.

The legal opinion comes at the request of state Sen. Joe Simitian, and follows a 2008 San Mateo County Civil Grand Jury report questioning the practice.

According to the grand jury report, the Woodside district added $572,000 in debt obligation to taxpayers, gaining an additional $352,000 for its bond projects. The cost of reissuing the bonds was $220,000.

For Las Lomitas, the additional debt obligation incurred is $2.6 million, adding an extra $2.25 million to its building fund at a cost of $355,000 for reissuing the bonds.

While the attorney general's opinion may end the practice in the future, it appears that cash-out refunding bonds issued in the past are safe. There is a 60-day time limit for legal challenges, starting from the date the bonds are authorized, according to Mr. Brown's opinion.

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