The Financial Flimflam of Lease Revenue Bonds
Several of us have been researching the Lease Revenue Bonds that the city of Encinitas used to finance the purchase the Robert Hall property. We knew at the very beginning that this borrowing method was used to get around the requirements of Proposition 13 that necessitate a vote for any tax increase. What about the other details of this financing technique? No one seemed to know anything, and the city was extremely unhelpful in supplying any insight.
In 2001 the city of Encinitas and the San Dieguito Water District (SDWD) drafted a “Joint Exercise of Power Agreement” and created the Encinitas Public Financing Authority (EPFA) for the sole purpose of issuing Lease Revenue Bonds for financing the purchase of the Hall property. The Chief Executive Officer who runs this Authority is City Manager Kerry Miller. This authority is supposed to be an independent agency operating apart from the city. The city of Encinitas through its Public Works Department owns, controls, and administers the “Operating Facilities” of the SDWD. The city then transferred the operating facilities of the SDWD to the EPFA and declared the EPFA the sole owner of these operating facilities. It is very important to note here that no money, not a penny, changed hands. This was purely paper shuffling.
It gets more complicated. The EPFA then leased the operating facilities of the SDWD back to the City, and through the City back to the SDWD. Thus the City became both the “lessor” and the “lessee” of its own water district. An Operating Lease Agreement between the EPFA and SDWD/CITY formalizes this relationship. This explains the name Lease Revenue Bonds. The SDWD Financial Statements, June 30, 2001 and subsequent statements from the district explain it this way under Note 8b, Operating Lease Commitment:
“The District is a participating member of the Encinitas Public Financing Authority (the Authority), which owns the operating facilities occupied by the district and other agencies. Those agencies are committed to the Authority under operating leases at rates and terms sufficient to cover the debt service requirements of the related Certificates of Participation.”
And now comes the zinger from the 2001 Lease Revenue Bond Prospectus:
“The bonds are not a debt, obligation or liability of the City, the State of California or any of its subdivisions (other than the Authority) nor do they constitute a pledge of the faith and credit or the taxing power of any of the foregoing (including the Authority) and the City.” At this point you are probably thinking that this is the kind of creative accounting done at ENRON.
It is clear the City is not responsible for repaying the money it is borrowing. Then, who is? Well, the Authority. And who is the Authority? Well, the City and the water district. Thus it is the water district that has repayment responsibility. The repayment money through lease payments normally comes from the general fund. What happens when there isn’t enough money in the general fund to cover the repayments? The water district is responsible and must come up with the money. This ultimately has to come from the water users in the district through the rates and fees they pay if the City is not to default on the bonds. If money is needed, rates and fees are simply raised. No vote of water users is required to do this.
If you live in the San Dieguito Water District you should be getting very nervous at this point. Water rates and fees can be increased to make bond repayment on borrowings that have no relationship to the normal activities of a water district. The SDWD bond obligation for its share of the Badger Filtration Plant is a legitimate debt repayment. Other bond obligations are very questionable, even if disguised as lease payments. Lease Revenue Bonds are issued to construct “facilities “ that are then used to produce a revenue stream to make the lease payments. The purchase of the Hall property has generated no income. Therefore the money to make the lease payments can only come from water users. If you live in the Olivenhain Water District (OWD), you are in fat city. You have no repayment responsibility. But the City has two water districts within its boundaries and does not control the OWD. This fact opens the possibility that water users in the SDWD will pay more for citywide obligations than water users in the OWD. When the City took over the SDWD it agreed not to mix monies. Can we be sure this is being respected?
All of this would be a waste of time researching and worrying about, if the City were not considering more borrowing in the same manner. The purchase of the Hall property with Lease Revenue Bonds is a done deal. The new borrowing is not. It was very significant that the budget workshop on Wednesday, May 10 was a joint meeting of the City and the SDWD. This makes it perfectly clear what the City is contemplating—more Lease Revenue Bonds. At the workshop Jay Lembach of the Finance Department fumbled and evaded an answer when asked by Mayor Guerin about ultimate repayment responsibility. He didn’t want to say water users in the SDWD, if money were unavailable elsewhere. But money seems unavailable elsewhere. Otherwise why is a huge bond issue being considered?
The State of California through its Department of General Services has the State Administrative Manual on line at http:/sam.dgs.ca.gov/TOC/6000/6872.htm.
I will close with the first line from this page on Lease Revenue Bonds: “Definition: Revenue bonds (or enterprise revenue bonds) are a form of long-term borrowing in which the debt obligation is secured by a revenue stream produced by the project.” I think we have the right to ask the city about the whereabouts of the revenue stream that will secure the debt obligation of any new borrowing.
*bloggers note--Is "flim flam" one word or two?