Fox C-6 school officials say they will consult with attorneys to see if they can recoup some of the millions of dollars they believe the district lost as a result of bad advice from George K. Baum & Co., a nationwide financial services firm, in connection with the $18.5 million bond issue voters approved in August 2012.
As part of its recent audit report, the Missouri State Auditor’s Office claims the way those bonds were sold to finance district improvements will cost the district an additional $5.6 million in interest.
Representatives from George K. Baum did not return repeated calls for comment.
When a school district or other public entity gets voter approval for a bond issue to finance a project, the bonds are sold to investors and that money is used to pay for the improvements. Then, property tax revenue the entity collects is used to pay off the bond debt, including the principal and interest.
“While investors hold the bonds, they will receive interest payments, typically every six months, and once a bond matures, they get the principal back,” said Fox chief financial officer John Brazeal, who was hired after the bond debt was incurred.
Jim Berblinger was the CFO for several years until his retirement late in 2012, and then Mark McCutchen took over the position until 2014, when Brazeal was hired.
Neither Berblinger nor McCutchen could be reached for comment.
After voters approved the Fox district’s $18.5 million bond issue, the bonds were sold in two parts – $9.75 million of it in 2012 at 5 percent interest and $8.75 million in 2013. Of the $8.75 million sold, $3.875 million of it was at 4 percent interest and the rest was at 5 percent.
At that time, the market interest rate was 3 percent, so the district is paying too much, the Auditor’s Office said in its report.
As a result of selling the bonds “at a premium” – at a higher interest rate to make them more attractive to investors – the district actually borrowed more than $4 million above the $18.5 million voters approved, the Auditor’s Office said.
“The district received an additional $4.2 million above the par value, or approximately $22.7 million, for use on school projects. By structuring the sales in this manner, the district will possibly incur approximately $5.6 million in additional interest costs,” according to the audit report.
Brazeal said that the district would have been better off asking voters to approve a $22.7 million bond issue and then borrowing that at the going 2.75 percent or 3 percent interest rate.
“It’s foolish for us to have $18.5 million on the books at 5 percent interest; it’s better to have $22 or $23 million at 3 percent,” Brazeal said. “It looks like we didn’t know how to manage our resources.
“When you’re looking at whether the deal cost $5.6 million more, it depends on what a person’s opinion is about (selling bonds at a) premium. Some think it’s additional bond proceeds, but what it really is, is increased interest costs. In my view of things, when you have premium dollars, it should go into the bank and be used to defray excess interest rates. But, the district spent the money, which effectively disguised the fact that it was running significant deficits in that ’12-’13 year.”
Brazeal said he can’t be sure why George K. Baum & Co. representative Dick Bartow and district officials structured the bond debt the way they did, but he speculated that someone originally “misread or miscalculated” the amount of debt the district’s tax rate would support and later when the bonds went to market, figured it out and decided to sell them in two parts and at a premium to get the extra money.
“That begs the question of whether the voters’ authorization (for an $18.5 million bond issue) was respected or not,” Brazeal said.
‘A disaster’
In January 2013, after the last of the bonds were sold, former Fox Superintendent Dianne Critchlow reportedly explained to other school officials that “the district had ‘earned’ extra money when the bonds were issued, stating in a letter: ‘You may ask yourself how can this occur?’ and then gave an explanation that ‘all the stars aligned for the school district,’” according to the audit report.
“This explanation was wrong because extra money is not ‘earned’ in a borrowing transaction; and likewise, money does not fall from outer space,” the board replied in its comments that were included in the audit report. “Ultimately, the bond financing represented by Series 2012A and Series 2013B should be viewed as a disaster,” the board said.
To make matters worse, the district not only is paying too high an interest rate on the bond debt, but also it’s stretched over too long a period, the Auditor’s Office said,
“Neither bond issuance is callable until about 10 years after issuance, and repayment of the bond principal for both issuances does not begin until March 1, 2026.”
Brazeal said there are a lot of problems with the way the bond debt was structured. “It was sold above market rates and with no call provisions, which means I can’t refinance into a lower cost structure,” he said. “I’ve processed a lot of borrowings and seen a lot of others, and I’ve never seen one so disadvantageous to the issuer of the bonds. It’s very poorly strategized.”
And how was it spent?
Brazeal said the bond issue money largely was spent on items the district asked for when it went to voters for approval, like improving athletic facilities and fixing roofs and pavement.
However, the Auditor’s Office said that about $1.8 million was spent “for projects not on the original bond project list and that would have normally been funded with property tax revenues. These decisions may have resulted in the need for more funding and thus the sale of bonds at a premium.”
Brazeal said some of the money was spent on school buses and technology and items that have a shorter lifespan than the bond debt, which he thinks is a bad idea.
“Typically, when you borrow money and buy assets, it is prudent to buy assets that outlive the debt,” he said. “So, one of the things that’s squirrelly about this deal is, in typical bond deals, you have maturities starting in years two and on, but the first one here is in 2026, which is 14 years after the 2012 bonds were issued and 13 years after the 2013 ones, meaning that before we pay $1 of principal, a lot of assets have reached the end of their lifespan. Since there are not principal payments (until 2026), we’re paying interest only on bonds for a very long time.”
Another big problem, Brazeal said, is that the district didn’t keep good records to show how the bond issue money was spent.
“Typically it’s critical to be able to identify how bond proceeds are spent,” he said.
He said that can be done in three different ways: placing the money with a third-party trustee and having that party pay the bills; opening a separate bank account for the funds and paying bills from that; or setting the money aside in a separate account on your own books and tracking expenses there.
Fox followed none of those strategies, he said. “The (bond issue) monies were comingled with the district’s funds and there was no indicator specifically identifying when (bond issue money) was spent. So, I can’t say specifically how it all was spent. We have since examined records and created a list of potential projects that were funded with (bond issue) money where it was intended.”
Baum on both sides
The Auditor’s Office criticized the district’s use of George K. Baum & Co. as both its financial adviser and underwriter on the bond issue, reporting that the Municipal Securities Rulemaking Board, an agency that oversees financial advice and underwriting firms, says that “the financial adviser has a fiduciary responsibility to the governmental entity (issuer) and cannot act as both financial adviser and underwriter on the same bond issue.”
Since the district used George K. Baum & Co. for both jobs, the only financial advice it got was provided by the bond underwriter, which the Auditor’s Office says “could result in inadequate financial advice.”
In addition, the Auditor’s Office said the district did not request bids from financial advisers and underwriters but just chose George K. Baum & Co. because the company had done work for the district for many years.
As part of its report, the Auditor’s Office recommended that in the future, the district solicit bids for financial advisers and underwriters, a recommendation the office has made to school districts statewide, rather than have a negotiated sale with one vendor.
In its comments to the report, the board agreed with most of the Auditor’s Office’s recommendations.
Reimbursement possible?
At the June 14 Fox Board of Education meeting, John Laughlin, the board president, said school officials are exploring whether George K. Baum & Co. can be held responsible for mismanagement of the bond issue and, thus, be required to reimburse the district for some of the money it lost.
In addition, district officials said they are considering reporting George K. Baum & Co. to the Securities and Exchange Commission for allegedly mismanaging the bond sales and serving as both the district’s financial adviser and underwriter.
In the meantime, Laughlin, Brazeal and Superintendent Jim Wipke said they need to continue focusing on the most important task they have, which is educating children.
Brazeal said the district already has taken steps to get its finances back on track, with balanced budgets for the last two years. In addition, he’s currently working on a budget for the fiscal year that begins July 1 and hopes to present a balanced one for board approval.
“From a financial perspective, we’re making the adjustments necessary to live within the resources provided by state and local taxpayers,” he said.