Borrowing Alternatives For Arizona Community College Districts
The purpose of this Memorandum is to summarize the borrowing alternatives available to Arizona community college districts. Under current law, such borrowings are governed by the provisions of the following laws:
- Title 15, Chapter 12 of the Arizona Revised Statutes (the “Community College Law”);
- Title 35 of the Arizona Revised Statutes (the “Public Finances Law”); and
- The Internal Revenue Code of 1986, as amended (the “Tax Code”), and the arbitrage and rebate regulations promulgated thereunder (the “Federal Regulations”).
Compliance with the Community College Law and the Public Finances Law is necessary for the borrowing to be valid and legally binding, and compliance with the Tax Code and the Federal Regulations is necessary for the interest on the borrowing to be exempt from federal income taxation.
The constitutional debt limit for Arizona community college districts is 15% of the net secondary assessed valuation and applies to general obligation bonds, leases and lease-purchase agreements issued, or entered into by the district. In order to determine whether a district has available constitutional debt limit capacity, all outstanding principal due on the district’s general obligation bonds, leases and lease-purchase agreements is measured against the current net secondary assessed valuation. This constitutional debt limit does not apply to revenue bonds or pledged revenue obligations issued by the district. Additionally, in order to issue general obligation bonds, an Arizona community college must have voter authorization. Currently, Arizona law requires Arizona community colleges to hold its bond elections on the first Tuesday following the first Monday in November.
Applicable law allows a community college district to use bond proceeds for capitalized interest on its bonds for a period not to exceed the greater of two years or a period ending six months after the estimated date of completion of the project or accomplishment of the purpose for which the bonds are issued. The district may provide for such capitalized interest without a prior appropriation.
Applicable law also permits community college districts to sell bonds at a discount or premium. Whenever bonds are sold at a discount, the bonds must be sold at a price and bear interest at such rate or rates so that either the true interest cost (yield) or the net interest rate received upon the sale of the bonds does not exceed the maximum rate otherwise authorized by applicable law. The district may sell its bonds and obligations at either a competitive (public sale or online bidding process) or negotiated sale.
A credit rating of community college district debt by the New York rating agencies, Fitch, Inc., Moody’s Investor’s Service or Standard & Poor’s, is not legally required, but a favorable rating may reduce the interest rate paid by a district. The rating agencies review the overall management, debt and financial picture of the district, including recent audits and fund balances. Bond insurance may also reduce the interest rate paid by a district on its debt.
In connection with the issuance of its bonds, a community college district may enter into agreements (credit agreements) to provide additional security or liquidity, or both, for the bonds, including municipal bond insurance, letters of credit, lines of credit, standby bond purchase agreements and surety bonds (remarketing agreements) providing a mechanism for remarketing bonds tendered for purchase. The term of the credit agreements or remarketing agreements may not exceed the term of the bonds, plus any time period necessary to cure any defaults under the agreements.
Under Section 265(b)(3) of the Tax Code, banks and certain other financial institutions are not allowed any deduction for interest expense attributable to tax-exempt debt acquired after August 7, 1986, unless the “small issuer exception” applies. If a community college district reasonably expects that it will not issue more than $10 million of tax-exempt debt during the calendar year and it designates the debt as a “qualified tax-exempt obligation” pursuant to Section 265(b)(3), the restriction on the deduction for interest expense does not apply.
Voted General Obligation Bonds. Arizona community college districts are authorized to issue general obligation bonds for capital outlay purposes to purchase land, purchase, erect, remodel or complete buildings, purchase equipment and facilities for educational or auxiliary purposes of the district. The general obligation bonds are secured by ad valorem taxes on the secondary assessed valuation of the taxable property in the district. The community college district levies a secondary property tax in an amount sufficient to repay the debt. In order to issue general obligation bonds, a community college district must have 1) constitutional debt limit capacity and 2) voter authorization. Additionally, before issuing any general obligation bonds, the district must submit information regarding the planned project to the joint committee on capital review for review.
Revenue Bonds. Arizona community college districts are authorized to issue revenue bonds to finance revenue producing buildings such as classrooms, housing, dining halls, student union buildings, field houses, stadiums, and bookstores that are secured by the district’s tuition, fees, rental and other charges from students, faculty members and others (the “Revenue”). The bonds are payable from Revenue of the district. There is no limit as to the amount of revenue bonds a district can issue, but the new revenue bonds must meet any parity bond tests for any outstanding revenue bonds and pledged revenue obligations (see below). Additionally, before issuing any revenue bonds, the district must submit information regarding the planned project to the joint committee on capital review for review.
Additionally, a community college district cannot issue any revenue bonds which cause the total amount of all of the community college district’s bonds issued for classrooms to exceed the greater of 25% of all bonds then issued for the community college district or $1,000,000.
Pledged Revenue Obligations. Arizona community college districts are authorized to issue pledged revenue obligations in order to enter into lease or lease-purchase agreements for real property, including buildings and improvements to the property. The district cannot use pledged revenue obligations to finance personal property such as furniture or other property that is not attached or bolted to one of the district’s buildings. These pledged revenue obligations are secured by the district’s tuition, fees, rentals and other charges (the “Revenue”). The district would use the Revenue to repay the pledged revenue obligations. The term of any lease or lease-purchase agreement entered into for real property, including buildings and improvements to the property cannot exceed 15 years. The principal amount outstanding under any leases or lease-purchase agreements for the acquisition of real property cannot exceed $2,500,000 in each year and $15,000,000 in the aggregate. Additionally, the new pledged revenue obligations must meet any parity bond tests for the district’s outstanding revenue bonds and pledged revenue obligations.
Certificates of Participation. Arizona community college districts are authorized to enter into lease agreements to issue certificates of participation secured by the district’s lease payments. These types of leases are “walk-away” leases, which mean that the lease’s term is subject to annual renewal and budgeting. In the event the district fails to budget or pay its lease payments, the certificate holders repossess the project that it financed i.e. the certificate holders could literally remove the property from the building. The district can utilize these types of leases for any type of project that finances property capable of being repossessed, but they are more expensive because they are considered to be a lower quality credit because of the annual “walk-away” option.
Refunding Bonds. Applicable law permits Arizona community college districts to issue refunding bonds or obligations to pay the outstanding bonds or obligations of a district in order to (i) restructure the debt burden of the district, (ii) reduce the interest costs of the district or (iii) avoid a default. The district is not required to hold an election prior to issuing refunding bonds or obligations. The issuance of refunding bonds or obligations requires compliance with complex Federal Regulations. At the commencement of any refunding, a community college district should consult bond counsel regarding the federal tax implications involved.
For More Information
If you have questions about these or any other public finance issues, please contact one of the public finance attorneys below: