Financing the new police station: GO bonds or a parcel tax?
by Matt Magilke
In 2016, the police station ad hoc committee made a recommendation to the city council to build a new $25-million police station. The committee, however, has yet to make a recommendation on how to finance the cost.
In January, the city presented two options to the committee. The first was a general obligation (GO) bond. Just like the school bond that was passed in November, GO bonds would be serviced with taxes collected based on a property’s assessed value. Under this plan, about 85 percent of the total cost would fall on residential property owners, while nonprofits and commercial properties would pick up about 15 percent of the cost.
The second was a parcel tax (COP bond) based on the square footage of improvements. Under this plan, residential property owners would pay about 68 percent of the total cost, with nonprofits and commercial property paying about 32 percent of the total cost.
At first glance, COP bonds would be the preferred option from a resident’s point of view. However, from a total-cost-of-financing perspective, COP bonds are more expensive to issue than GO bonds for two reasons.
First, COP bonds are rated AA, while GO bonds are rated AAA. This means the interest rate the city would pay on COP bonds is about 0.30 percent higher than on equivalent 20-year GO bonds. Second, the city would be required to borrow an additional $1.4 million under a COP bond. The $1.4 million is deposited with a trustee and is supposed to be used to pay bond interest during construction.
Based on what the city presented to the ad hoc committee in January, the total taxes levied under a 20-year COP bond would be about $39.5 million, while the total taxes levied under a 20-year GO bond would be about $34.8 million. Clearly, it wouldn’t make much financial sense for the city to pay an additional $4.7 million in finance charges for COP bonds just to save residents about $3.1 million, as commercial property and the nonprofits (mostly, the Colleges) would be on the hook for the difference.
A closer look at the city’s numbers is warranted, however, as a $4.7 million difference is so large, that anyone with any financial knowledge should be asking questions about the details. There is simply no way that borrowing an additional $1.4 million, coupled with a 0.30 percent higher interest rate can result in a 48 percent increase in total finance charges over 20 years.
After several requests from both the city and the city’s underwriter, I have reconciled the huge difference in financing costs between the two options.
It turns out that many of the decisions being made (either by the underwriter or the city) with respect to the COP bonds increased the total cost to the tune of approximately $3.2 million. That’s right! If the COP bonds are structured similarly to GO bonds, the COP bonds would, in fact, cost the city about $36.3 million, rather than the $39.5 million cost presented to the committee.
So what is creating the difference? First, the COP bonds recommended by the underwriter are actually 22-year bonds, not 20-year like the GO bonds. This results in an extra two years of interest because, unlike the GO bonds, no principal payments are being made during the first two years.
Second, the city did not apply the $1.4 million sitting with the trustee to the total debt service cost of $39.5 million. Remember, the city was supposed to use the extra $1.4 million to pay interest during the first two years. Perhaps the city had other plans for that money.
If the ad hoc committee is to make an informed recommendation about how the police station should be financed, it should be presented with an apples-to-apples comparison between GO bonds and COP bonds.
My calculations—presented to the city before submitting this letter—show that a similarly structured COP bond would cost the city, over 20 years, about $1.5 million more than equivalent GO bonds. And based on this number, a COP bond would reduce taxes on residential property owners by approximately $265,000 a year for 20 years. The annual cost to commercial property would increase by about $120,000. The cost to nonprofits, including churches, would increase by about $29,000 per year. And the cost to the Colleges would increase by about $192,000 per year.
To put this in perspective, for a 2,000 square foot home assessed at $500,000, the tax on a GO bond would cost about $185 a year. That same homeowner would pay about $120 a year under a COP bond.
I urge all Claremont residents to get informed about this issue and voice their opinions at the next ad hoc committee meeting (a whopping two residents showed up at the last meeting).
It would also be helpful to know if anyone has asked the candidates for city council what their thoughts are about these two options, as they will ultimately play an important role in making the final decision.