"Evanston/Skokie District 65 is paying for the new neighborhood, kindergarten through eighth grade school in the Fifth Ward by selling lease certificates.
But what exactly are lease certificates? Through an analysis of district filings with the Municipal Securities Rulemaking Board, a recent district financial audit and interviews with accounting experts and the district’s finance officials, the RoundTable obtained essential information about this funding mechanism.
Lease certificates are a common source of funding used by school districts and other public entities for the purpose of raising money to complete capital projects, and they represent an alternative to traditional bonds, according to experts with the nonprofit Truth in Accounting. A school district can sell off lease certificates to investors in order to fund a new building, for example, and then those investors make a profit when the district pays back the money it owes on the building, plus the interest accrued on the certificates.
According to the 160-page official statement submitted by the district to the Municipal Securities Rulemaking Board, District 65 awarded the lease certificates to Mesirow Financial Inc. of New York on March 29 for a price of $38.3 million, plus a single-time premium payment to the district of $6.3 million, for a total of $44.3 million. Mesirow received a discount of $277,017.
In terms of interest, the district received a coupon rate of 5% on the original sticker price of $38.3 million, Chief Financial Officer Raphael Obafemi said. But the $6.3 million premium paid by Mesirow for the rights to the certificates is exempt from interest, essentially providing a discount to District 65 on the interest it will owe.
As a result, the district will actually pay an interest rate of 3.48% accrued on top of the $44.3 million raised for the new school from the lease certificates, according to Obafemi. As shown in the screenshot below from the district financial audit, the district will pay about $3.2 million per year through 2042, including interest to service its debt on the lease certificates.
In 2042, District 65 will become the owner of the Fifth Ward school. At that point, it will have paid more than $58 million for the school.
Why lease certificates?
Because of state and federal laws, school districts have a cap on the amount of debt they can take on by issuing bonds, according to Obafemi and Christine Kuglin, director of the Truth in Accounting program at the University of Denver.
If a district wants to exceed that cap, it would have to hold a referendum where voters get to decide if they want to pay higher taxes to cover the additional debt from more bonds. District 65 is already at its cap for bond debt through 2036, Obafemi said.
Lease certificates, on the other hand, are subject to fewer restrictions because they do not require a tax hike.
“Ordinarily, when you issue your traditional bonds, what you do is you use property taxes to pay for that, especially tax assessment that then goes to the taxpayer. That’s how you do it,” Obafemi said. “With a lease certificate, we actually are paying it back with operational savings from transportation cost.”
The district is currently paying more than $5 million annually for transportation costs, which primarily go toward busing kids from the Fifth Ward to other schools around the city. By building a neighborhood school that hundreds of students in the Fifth Ward can walk to every day, the district will “conservatively” save at least the $3.2 million required to pay for the lease certificate debt each year, Obafemi said.
Alternatively, the district could have chosen to hold a referendum and then pay for the school by issuing bonds, but that path would legally require raising property taxes to service the bond debt. The district still would have saved money on busing costs in that scenario, but it would have had to issue tax abatements to individual taxpayers in order to take away the burden of funding the bond repayments.
“Instead of doing that, we just said we’ll look at operations, we’ll cut the cost of transportation, and we’ll repurpose that money to pay for the lease certificates without having to do all that – the referendum, we need to increase your taxes, and once your taxes increase, we need to abate it back to you every year for the next 20 years,” Obafemi said.
Risks and drawbacks
Lease certificates tend to be slightly more unstable than bonds, so they often feature higher interest rates, according to Kuglin.
Plus, the avoidance of a voter referendum by issuing lease certificates instead of bonds can often create distrust among voters about the motivations for choosing a different funding method, according to a 2002 study published by the Mackinac Center for Public Policy in Michigan.
“The government makes lease payments as a first budgetary obligation and no additional tax is imposed to secure the obligation,” the study said. “Therefore voter approval is unnecessary. But avoidance of voter approval creates suspicion, which is the main source of controversy for capital leases.”
Although bonds traditionally are more secure than lease certificates, the cost of borrowing money in general has skyrocketed recently because of inflation. Most neighboring school districts that have issued bonds this year, including Evanston Township High School, are paying 4% or 5% in interest on those bonds.
For ETHS, the only difference is that the interest drops from 5% down to 3% after a decade of debt payments.
“At the end of the day, the biggest issue with this is that you are in a situation that you don’t want voter approval, you don’t want to have that debt bearing down on your financial statements, so you just go ahead and make this unilateral decision,” Kuglin said. “Because you’re not getting this approval, you’re having to pay higher interest rates, you’re spending more money, but you do have some flexibility to it.”
But thanks to the $6.3 million premium payment made by the investment firm to acquire the certificates from District 65, the interest rate and total amount that will eventually be paid by the district is “pretty damn good,” Obafemi said.
“I really believe, at the end of the day, the decision to fund the Fifth Ward School by issuing a lease certificate is financially prudent,” he said. “And it’s a way to maintain a level tax base without having to ask the taxpayer to pay more. What we’re saying is we’re going to look for savings in transportation, and repurpose that to fund the lease certificates for the next 20 years.”
Read the full article on: Evanston Round Table