ABCS OF CROSS YEAR TRANS FOR SCHOOL
DISTRICTS

There are very few options available to school districts to assist with the mismatch of revenues and expenditures. A few counties allow temporary loans from the County Treasurer’s Investment Pool but that action requires approvals by both the County Board of Supervisors and the County Treasurer. Traditionally, many school districts have issued Tax and Revenue Anticipation Notes (“TRANs”) to help with that mismatch of revenues and expenditures. In the “XYZs of California School Debt Financing, Third Edition,” Orrick, Herrington & Sutcliffe defines TRANs as “short term debt instruments used to finance cash flow deficits in anticipation of receiving taxes and other revenues.” If structured correctly, TRANs are particularly useful to school districts because they are one of the few financing instruments that can be used to pay operating expenses of school districts.

Typically, TRANs are issued at the beginning of the Fiscal Year for a 12 or 13-month term and repaid from revenues from the same fiscal year. However, given the decrease of revenues to school districts, many need more time to repay their TRAN. While some school districts may be able to wait until November (historically a month in which school expenditures exceed revenues) to issue their TRANs, others who need TRANs earlier may need to issue two TRANs in one fiscal. Many school districts have avoided the issuance of TRANs that cross fiscal years (“Cross Year TRANs”) over the last few years by being very disciplined with their cash management and using non general fund cash balances to bridge the mismatches in revenues and expenditures. However, several years of prudently maintaining this balance has weakened school districts’ cash balance position and many will not be able to continue paying their obligations without a significant improvement in the economy or Cross Year TRANs.

While the California economy appears to be slowly improving, school districts are not likely to have their finances improve for some time due to large State budget cuts and the lag time local government budgets encounter. More school districts are turning to Cross Year TRANs in order to meet their cash flow needs. With the lack of bond insurance providers and the limited amount of investor interest in purchasing Cross Year TRANs, school districts need to pay special attention to the structure of their TRANs. Detailed below are the common indices used to benchmark short term financings as well as a summary of the school district TRANs sold since September 2009. As you can see in the graph below there are significant differences in how school district TRANs have priced recently. Some of the key factors that affect the pricing of a TRANs are timing, structure, term, type of sale, and rating.

To achieve the lowest interest rate possible, school districts need to structure their TRANs to be viewed favorably by both rating agencies and investors. Most TRANs are structured such that when the pledged revenues are received, a portion is set aside in a trust account to repay the TRANs. This gives investors some certainty that when received, pledged revenues will be used to repay the TRAN. While this protects investors once the pledged revenues are received, it does not address the possibility that a school district may not receive the pledged revenues. In Moody’s Investor Services recent publication, “Application of Moody’s Short-Term Note Methodology to California TRAN Issues,” Moody’s states that “the primary risk associated with a TRANs is the predictability and sufficiency of the deferred revenues as a source of repayment is weak at best.”

In order to help mitigate the concern of a school district not receiving the pledged revenues on time or as projected, cash balances outside the general fund are often identified as possible repayment sources. Often times these funds include non debt capital funds, internal services funds, workers compensation and self insurance funds, and deferred maintenance funds. These sources of funds are often referred to as “alternative liquidity.” Identifying a school district’s alternative liquidity is a difficult balance because it is necessary to show that liquidity as available as a repayment source; however, if it is viewed as too easily available, Tax Counsel may require a reduction in the size of the TRAN. Working with a reputable and experienced Tax Counsel early in the process should help avoid later complications.

While alternative liquidity is essential to creating a solid credit, investors also expect that it will not actually be needed. A school district also needs to demonstrate its ability to budget and prepare for midyear budget adjustments. This is especially important for school districts because their ability to increase revenues or reduce expenditures midyear is very limited and their fund balances are considered low when compared to other local government agencies. Preparing detailed actual cash flows from the immediate year prior, estimated current year cash flows and projections of future cash flows for the upcoming fiscal year are critical for rating agency review and for building investor confidence.

After determining the primary credit features, it is time to make additional adjustments in order to make either a cross year TRAN or a traditional TRAN a more attractive credit while also meeting the cash flow needs of a school district. A school district needs to also consider the best approach for entering the market. Some alternatives may be to review the local pooled TRAN programs, if available, along with standalone options. If you would like additional information concerning school district TRANs or any school finance matter, please contact Adam Bauer at 949-660-7303.