School Finance: Long-Term Debt Planning for School Districts

For many New Jersey school districts, facilities and capital budget needs are cyclical. Between 1997 and 2006, a record number of New Jersey school districts issued bonds to pay for various building projects.

Many of those same school districts will be debt-free within the next five years, and they will have the opportunity to implement facility improvement projects without any additional impact to the taxpayers. This article will discuss the options that are available to New Jersey school districts for financing projects with little or no tax impact.

In the early 2000s, many New Jersey school districts had their first opportunity to take advantage of school building aid. The Educational Facilities Construction and Financing Act (EFCFA), which became law on July 19, 2000, provided certain levels of funding for facilities’ improvements for both special needs and non-special needs districts.

Under EFCFA, special needs districts received state funding of 100 percent of the eligible costs of a school facilities project, and non-special needs districts generally received 40 percent of the eligible costs of a school facilities project. The state controlled the construction of facilities in the special needs districts. In the non-special needs districts, which were mostly suburban districts, taking advantage of the debt service aid required the passage of a school bond referendum. Many districts took advantage of this opportunity.

For New Jersey districts the timing could not have been better. Some of these districts were lagging in updating their buildings while others were experiencing increased enrollment and needed new buildings. The opportunity to take advantage of 40 percent funding was too good to resist. Some districts built new schools every few years. The total amount of bonds issued was unprecedented.

Starting in the mid 1990’s and continuing through this “boom” period of school building projects, school district budgets reflected this increased debt service (and resulting tax increases).

Fast forward to 2018. The school districts that issued bonds during the frenzy of the early 2000s are coming to the end of the term of these bonds and could be debt-free within the next five to ten years.

Above are 3 sample examples of debt service budgets for the next 5 years.

School district #1 can request approval of a bond referendum in their budget year 2018-2019, and then begin the phase-in of debt service in the next budget year. By incrementally increasing the debt service between 2020 and 2023, they can finance their capital projects without any new tax impact. District #1 can accomplish this because they have a gradual decrease in debt service.

The chart shows that District #2 and District #3 have more drastic decreases in their debt service. These districts would plan for a bond referendum and bond issuance in the year before their debt service “drop-off.” They would then have a smooth transition to the new debt service. All three school districts can achieve the financing of new projects without additional impact to the taxpayers as long as they plan the referendum size so that it does not exceed the existing debt service.

If a school district issues bonds and plans the new debt service to coincide with the completion of existing debt service, the tax impact can be minimized or eliminated. Whether a district has $500,000 or $5,000,000 of annual debt service coming off the books within the next five years, school districts which have facility improvement needs might want to consider long-term debt planning to minimize the effect of any new debt on the taxpayers.

Issuing Bonds is Not the Only Option The first thought that comes to mind for financing facility improvements is to issue bonds. Other options are available and should be researched.

Understand the Current Debt Position of Your District It is easy to overlook the debt service portion of school district’s budget.

Debt service is fixed when bonds are sold, and it is a separate part of the school tax rate. It is not an optional budget allocation.

When annual budgets were subject to voter approval, the debt service portion of the budget was not presented to the voters for that same reason; the voters approved the referendum, so there was no requirement that the annual debt service go back to the voters for approval.

It is therefore important for each board member to understand the current debt position of the district and when each series of bonds will be paid off. Once a thorough review of the current debt service budget is accomplished, district officials can see the potential for financing a capital plan with no impact to the taxpayers.

Planning for a Bond Referendum Can Take a Year or Longer The first step it to complete a needs assessment. Once the debt position of the district is understood, long-term debt planning can begin. A needs assessment should be the first step. Capital projects usually consist of one or more of the following: maintenance repairs, updating of facilities, and facility expansion. Many districts with older buildings do not get significant state aid for operations and therefore rely on property taxes for operations and maintenance.

Too often, these districts have not kept up with projects that can be considered maintenance. Roof repair and replacement, rooftop unit replacements, unit ventilator replacements and building envelope projects are just a few of the items that are often deferred.

These types of projects are likely to be included in a long-term capital needs assessment. Additionally, facility updates like lavatory and locker room renovations, auditorium repairs and the installation of safety and security equipment would be included in a plan for a district that has not has any major capital funding for many years. Finally, if the district’s enrollment is expanding, or if programs require additional classrooms, expenditures for these projects would be included in a needs assessment.

Assigning a Value to the Need Each of the projects under consideration would then be assigned a value. It is important to note that the project costs do not only include construction, planning and design. If a district is considering a project that includes a classroom addition for example, there will be associated costs like additional staffing and operational costs that should be considered. Although staffing and operational costs cannot be included in a bond referendum, once the projects are constructed and operational, these costs become part of the operating budget of the district and could increase taxes.

How to Pay for the Projects After the district officials prioritize the project list and assign a cost to each project, financial planning can begin. Districts can pay for capital projects in one of four ways; however, the source of funds differ, so it is important to understand each option. Projects can be funded through the operating budget, from capital reserve, through a successful bond referendum and through an Energy Savings Improvement Program (ESIP).

First, projects can be funded through a district’s operating budget on an annual basis. The downside to this option is that this funding method is limited because operating budgets are subject to a spending cap, and, unless capital budgets are routinely included in the operating budget, it will cause stress on the budget. On the positive side, if a district can afford this option, no long-term debt is accrued.

The second option is funding though the capital reserve. This reserve is funded by annual (optional) deposits directed through a resolution of the board of education. Using a disciplined approach, a school district can amass a significant allocation in this reserve over a number of years.

A third option is accomplished through a successful bond referendum approved by the voters. The biggest benefit of this option is that certain projects can receive 40 percent debt service aid. (Eligible projects are entitled to 40 percent aid. However, the state has decreased the aid by 15 percent, and therefore the aid should be anticipated to be 34 percent. This is 85 percent of the 40 percent rate.)

Essentially then, the state of New Jersey is paying up to 60 percent of the project. This requires debt service to be budgeted throughout the term of the bonds. If a district has debt coming off the books as was discussed earlier, this option could be used with no additional impact to the taxpayer.

The final option is funding certain energy conservation measures through an Energy Savings Improvement Program (ESIP). This financing tool was authorized in 2009, and since then, many school districts have taken advantage of this option. By using an ESIP, a district can finance the construction and implementation of energy conservation measures without any budget impact. The law allows school districts to finance these projects through a lease purchase or by issuing refunding bonds. Voter approval is not required for this financing option because it is budget-neutral. The lease or refunding bonds are repaid through a combination of energy savings, operational cost savings and grants or rebates from the New Jersey Clean Energy Program (CEP).

Projects that are financed with ESIP include lighting replacement, boiler replacement, control systems, unit ventilators, rooftop units and building envelope repairs. In the last few years, some school districts have also included the installation of solar panels as a revenue source to offset the costs of an ESIP project.

It is important to understand that debt service aid is not available to ESIP projects. The revenue-neutral aspect of these projects is the source of funds that are described above. However, using an ESIP along with a bond referendum can allow a district to fund more projects without an impact to the taxpayer. This strategy is discussed below.

Timing of Financing and Source of Funds for Construction Projects Once a decision is made regarding the funding source for the capital plan, a timeline can be developed. Any combination of the financing options described here can be used to minimize the impact to the taxpayers. Using the operating budget and capital reserve will eliminate the need for additional funding. Using the ESIP option to fund certain projects will not affect the budget and can reduce the amount required for a bond referendum.

If the decision is made to finance the projects through a bond referendum, the coordination of the referendum vote and the issuance of bonds is critical. The school district fiscal year is July 1 to June 30. If bonds are issued, a payment is normally due six months after the bonds are sold.

Another option after a successful referendum is the issuance of bond anticipation notes (BANs). This financing option is referred to as temporary financing because it is a short-term loan. It is sometimes attractive because only interest is required to be paid, and the interest payment is due at the end of the loan term; six months, nine months or 12 months following the BAN issuance. The BAN can be re-issued every 12 months, but after three years from the initial issuance date, principal (partial payments) is required to be paid. Depending on the amount of funding needed and the plan for budgeting the debt service following a referendum, the incremental costs of a BAN can be part of a successful financial plan. For example, some districts limit the total amount of BANs issued to just the cost of design and land acquisition. If the building design will take six to nine months, issuing only the partial amount needed for design will minimize the tax impact and budget requirements. The down side of using BANs as a temporary financing method is that the district is not locking into long-term interest rates and in an increasing rate environment, this can be risky. At some point, either early in the process or following the issuance of BANs, if a bond referendum is used, long-term bonds are sold, and the debt service is added to the district’s budget.

Making the best use of the source of funds for capital projects will minimize the impact to the taxpayers. As was discussed earlier, many districts have debt service coming “off the books” in the next few years and using that allocation can allow new projects to be financed with little or no tax impact. Additionally, the combination of financing some projects with capital reserve, through the ESIP option, and or through the issuance of bonds after a successful referendum could enable a district to achieve the implementation of a comprehensive capital plan with minimal (or no) cost to the taxpayer.