Now may be a good time to invest in actual school buildings

By Rob Gilligan,

In March of 2016, the Center for Green Schools at the U.S. Green Building Council released its report “State of Our Schools: America’s K-12 Facilities” in collaboration with the 21st Century School Fund and the National Council on School Facilities. In its analysis, the Center indicated that at that time, Kansas was underspending on facilities and there was a projected gap of about $356 million annually or approximately $731 per student.

Coming out of the 2008 recession, and mired in a legal battle over state school finance that saw a decrease in the equalization aid the State of Kansas provides for school bond projects. Kansas schools haven’t made up much ground in the three years since the report was released. But there is hope that some positive market opportunities and a new long-term funding plan with the state means we can now focus on reinvesting in school infrastructure.

The first opportunity to highlight is in the area of finance, and the current low bond rates available. Greg Vahrenberg, managing director at Raymond James and Associates, offered this insight to the current bond market situation:

To the surprise of many, interest rates have declined during 2019 and during recent weeks the pace of the decline in rates has accelerated.

Coming into 2019 many economists were predicting interest rates would remain stable and gradually increase throughout the year. The Federal Reserve (FOMC) had been raising short-term interest rates with the last increase occurring in December 2018. The prediction for further rate increases was that the FOMC would likely discontinue raising the Fed Funds rate or may have one or two more increases in 2019.

Few predicted a cut in rates by the FOMC during 2019. However, the opposite has occurred and interest rates declined steadily since the beginning of the year.

Furthermore, at its meeting in July 2019, the FOMC cut short-term interest rates by 25 basis points
(0.25 percent). The bond market had widely expected the interest rate cut by the FOMC and there was little market reaction after this move. However, shortly after the FOMC interest rate cut, there were concerns about a trade war between the U.S. and China that exposed a fragile world economy and resulted in a rapid decline in rates during August.

To put the interest rate decline into perspective, the 10-Year U.S. Treasury Note was at 3.30 percent during November 2018 and now the yield stands at 1.51 percent as of August 30, 2019. While, it was difficult for many to predict declining interest rates for 2019, it’s fair to speculate that very few, if anyone, would have predicted the yield on the 10-Year U.S. Treasury Note would fall by more than half during the first eight months of 2019.

With rates at new historic lows, now is a great opportunity to save on long term investment and also stay ahead of the inflationary curve in construction. According to Ed Zarenski, a construction economics analyst and retired construction professional, we can “anticipate 2019 construction inflation for nonresidential buildings, excluding any new tariff impact, at 5 percent, rather than the long-term growth average of 3.5 to 4 percent. Adjust for new tariffs impact.”

In effect, this means that schools would be at a possible 2-3 percent advantage to borrow money at current low rates and lock in lower construction costs now rather than save in capital outlay over a few years and pay for the project with cash.

Of course, new construction projects and the process of developing and approving a bond plan aren’t something that can be done in a short period of time; but that doesn’t mean the low bond rates don’t offer other opportunities for schools. In fact, some Kansas schools are already taking advantage of one of the best opportunities for savings by looking to refinance current bonds issued at a higher rate, with many different ways to save.

Dustin Avey, managing director at Piper Jaffray & Co. Public Finance, offered these thoughts on the current market and the opportunities presented.
The bond market is once again experiencing interest rates at all-time record lows. As a result, it provides an opportunity to evaluate outstanding bonds for potential savings opportunities. More importantly, however, it also is a good reminder to review long term financial strategies and objectives for the bond and interest fund. These strategies may include options for mill levy management, accelerating repayment of bonds and/or evaluating bond capacity for future projects. There are several factors to consider when evaluating a refinancing and it is important to understand how any potential refinancing may impact long term strategies and objectives.

Two Kansas examples

Vahrenberg echoed Avey’s observations and highlighted two Kansas districts that have recently taken advantage of the market opportunity.
This decline in interest rates has created an opportunity for Kansas school districts. Although one of the bond refinancing techniques, the tax-exempt advance refunding approach, was eliminated with the Tax Cut and Jobs Act in 2017, school districts can still refinance bonds with tax-exempt refunding bonds, provided the bonds being refinanced can be redeemed within 90 days. If the bonds being refinanced have a call feature, or optional redemption provision, more than 90 days from now, then school districts can issue taxable general obligation refunding bonds to capture a savings for taxpayers as a result of the low interest rates.

The following two school districts in Kansas were among the first to move quickly to issue taxable advance refunding bonds and capture a significant savings for their districts given the recent accelerated interest rate decline in August. Their savings are shown as follows:

Lansing USD 469
Final Principal Amount = $75,280,000
Rating:  Moody’s “A1” / BAM Insured S&P: “AA”
Final Maturity: 2038
Final Savings = $4,850,740
Average Interest Rate of Bonds being Refunded:
3.70 percent
Average Interest Rate (TIC) on Series 2019 Refunding Bonds: 2.68 percent
Present Value Savings Percentage: 5.11

Salina USD 305
Final Principal Amount = $65,055,000
Rating: Moody’s “Aa2”
Final Maturity: 2034
Final Savings = $5,086,727
Average Interest Rate of Bonds being Refunded: 4.28 percent
Average Interest Rate (TIC) on Series 2019 Refunding Bonds: 2.45 percent
Present Value Savings Percentage: 6.62

It’s important to remember that the market is constantly changing and between the time this information was gathered and when your districts may look at the opportunities the rates will most likely be different. The important thing to remember is that maintaining open communication with your finance professionals can help your district plan for future investment needs and find opportunities for savings when they are available.

To learn more about the current market situation and what that might mean for your district, reach out to Avey or Vahrenberg for assistance.

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