California lawmakers take aim at capital appreciation bonds

* Nearly 30 percent of appreciation bonds have been issued in California

* CAB allow issuers to postpone repayments, pass debt to next generation

* CAB are more expensive than ordinary debt

By Jim Christie

SAN FRANCISCO, Sept 19 (Reuters) - California lawmakers aim to clamp down on a type of municipal bond that has left a San Diego-area school district with a nearly $1 billion bill, 10 times the $105 million initial loan.

The effort stems from the controversy hanging over the Poway Unified School District since early August, when the Voice of San Diego website ran a report on the $981 million the district will pay for the capital appreciation bonds (CABs) it sold last year.

"In any other circumstances, it would be called usury," said Republican state Senator Joel Anderson, a San Diego-area lawmaker who wants to prevent similar debt deals.

CABs defer payments while interest compounds, which swells payments when they kick in.

CABs are not unusual and have been popular with school districts in states with fast-growing student enrollments, according to Fitch Ratings.

Nearly $92.8 billion of the debt has been issued since 1980, and $77 billion of it remains to be repaid. Around a third of the outstanding volume is on the books of issuers in California, according to Thomson Reuters data. Capital appreciation bonds have also been popular in Texas and Illinois.

The Poway district will pay off its CABs from 2033 through 2051. The bonds cannot be repaid sooner.

Like other zero-coupon bonds, CABs are more expensive to issuers than ordinary debt. The Poway districts' bonds, rated 'Aa2' by Moody's Investors Service and 'AA-minus' by Standard & Poor's Ratings Services, sold with a 6.56 percent yield on their August 2033 maturity and a 7.12 percent yield on their August 2051 maturity.

If the district sold its CABs as bonds to be repaid immediately and with a 30-year maturity, they would have had a yield in the 5 percent range, a municipal debt trader said.

HOLDING DOWN PROPERTY TAX

The $981 million bill for the Poway district's loan is a large figure even for district board member Todd Gutschow. But he said proceeds from the CABs were needed to complete a nearly decade-long campaign to renovate and build facilities at two dozen of the 34,500-student district's oldest schools and to refinance other debt.

The campaign involved five general obligation bond issuances worth a total $377 million that will cost the school district a $1.6 billion to repay.

"When you look at this one issuance in isolation, it kind of distorts everything," Gutschow said. Holding down property tax rates - as polls showed local voters wanted - played into the decision to sell capital appreciation bonds, he added.

The Poway district's debt should be manageable, given its economy and the possible increase in property values before the CABs are paid off in 2051, said Ron Bennett, chief executive of the consulting firm School Services of California.

But district officials won't easily fend off critics: "They'll look back and say 'Economically it wasn't a bad deal, but we got killed politically,'" said Bennett.

UNDERSTANDING THE IMPLICATIONS

The Poway district is commissioning an independent review of its CABs deal in the wake of negative headlines. That spurred officials of the nearby San Diego Unified School District on September 4 to rule out issuing more CABs for projects it would fund through a $2.8 billion bond measure on the November ballot.

California school districts have issued nearly $20 billion in CABs since 2000, including $5.4 billion of the debt with maturities beyond 25 years and nearly $833 million with 40-year maturity lengths, the California Debt and Investment Advisory Commission says.

San Diego County Treasurer-Tax Collector Dan McAllister wants legislation that would require prepayment and refinancing options for CABs and set a 25-year limit on their maturity. He says lawmakers should consult with Los Angeles County Treasurer and Tax Collector Mark Saladino, whose office dissuades school districts in his county from issuing CABs dated beyond 25 years.

State Treasurer Bill Lockyer, a Democrat, is warming to new rules for CABs and Republican state Senator Mark Wyland is looking to revive a bill to limit them. His bill, which has been set aside since May, would bar school districts from selling bonds at a discount deeper than 5 percent of the face value. The Poway district's CABs sold at 94 percent below par.

Wyland expects bipartisan support, given how debt service costs of CABs can swell and be pushed off to future generations: "We need to make sure property owners and taxpayers understand what the implications are."