Talk about money: What exactly is a school bond?
by Mark Rosenberg
Mar 13, 2014 | 916 views | 0 0 comments | 4 4 recommendations | email to a friend | print
Bonds will be the subject of much discussion over the coming months as Scotts Valley Unified School District asks voters for permission to borrow $35 million to rebuild its aging middle school.

If 55 percent of voters approve the measure on June 3, $33 million of the money will be used to replace the 70-year-old middle school and $2 million will pay for earthquake safety upgrades at Brook Knoll and Vine Hill elementary schools.

But where will the money come from, and how will it be paid back? And what, exactly, is a bond?

A bond is an IOU, a piece of paper stating that the holder is owed a certain amount of money, when that money will be paid back, how much interest the holder will receive, and who is responsible for making the payments.

In this case, the money to make the payments will come from property owners in the district. They will pay an estimated $57 a year for every $100,000 of assessed value.

Assessed value is not the same as market value. Homeowners who bought many years ago at lower prices will have assessed values that are lower than current market values.

The owner of a home that Santa Cruz County assesses at $400,000 would be billed four times $57 — about $228 — on his or her annual property tax bill.

The amount of interest the bonds will pay will be determined when they are issued, in the bond market by two competing forces.

On one side are the school district and the property owners who pay its bills; on the other side are investors who buy bonds for income. The first side wants to pay as little interest as possible; the second side wants to receive as much interest as possible.

Representatives of the two sides will settle on an interest rate based on what comparable bonds pay. Potential buyers will look at three key factors:

n Taxability: These bonds are not being sold by a for-profit business; they’re being issued by a local government entity for the public good. As such, they are considered municipal bonds, so holders of the bonds won’t pay federal taxes on interest they get, and if they live in California they won’t pay state taxes either.

n Term: Some of the bonds will mature in 25 years. Others will have shorter maturities. Generally, the longer the borrower gets use of the money, the higher the interest rate investors demand.  

n Quality: How confident are buyers that the school district will keep its promises to pay off the bonds by their maturity dates and pay the interest along the way?

Bond issuers are rated by agencies like Standard & Poor’s on how creditworthy they are. The top S&P rating is AAA, followed by AA, A, BBB, BB, all the way down to D. My understanding is that these bonds will be rated either AA or A-plus.

Currently, municipal bonds of that credit rating in California with maturities of 25 years pay an interest rate of about 4.25 percent.

If 4.25 percent were the interest rate on the 25-year maturity, an investor who buys $10,000 worth of that bond  would have an IOU from Scotts Valley Unified, paid solely from the levy of property taxes. The IOU would promise to pay them $425 of interest a year, in two payments of $212.50 every six months, and then pay off the $10,000 principal in one final payment 25 years from now.

Some bonds contain a call feature that allows the borrower to pay off the loan early. Some of the Scotts Valley bonds are likely to contain such a feature, so some bondholders would get their principal back sooner.

The annual payments from property owners pay off the interest and principal over a 25-year amortization schedule, according to David Casnocha, a lawyer for the district.

- Mark Rosenberg is a financial adviser with Financial West Group in Scotts Valley, a member of FINRA and SIPC. He can be reached at 831-439-9910 or mrosenberg@fwg.com.

 

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