Advance Refunding of Park District Bonds

By Daniel L. Johnson

Although the statute authorizing the issuance of general obligation park district refunding bonds (Ill. Rev. Stat. ch. 105, pars. 255.19 et seq.) was passed over 40 years ago, it is only recently that a great deal of interest in this subject has developed. This article will attempt to briefly explain the manner in which these financings work and the ways park districts can benefit from this kind of bond issue.

Two sources of law govern the issuance of park district refunding bonds. First, the Illinois statutes provide the legal authority for issuing the bonds. The statute cited above and Section 6-1 of The Park District Code authorize the issuance of general obligation bonds for the purpose of refunding other general obligation bonds without a referendum. Pursuant to Sections 6-2 and 6-4 of The Park District Code, a referendum is, however, required to issue general obligation bonds for the purpose of refunding revenue bonds. On the other hand, a recent amendment to Section 8-15 of The Park District Code provides that no referendum is required to refund an outstanding installment purchase contract with a refunding installment purchase contract.

The second source of law affecting park district refundings is the federal arbitrage regulations. These regulations govern whether the interest earned on the refunding bonds will be exempt from federal income taxes. Districts want to be certain that they comply with these arbitrage regulations because investors will not purchase such bonds unless they are certain that the interest thereon will be tax-exempt. These arbitrage regulations relating to advance refunding are extremely complicated; therefore, districts will normally want to begin working with experienced professionals who specialize in these kinds of bond issues at the very beginning of any refunding bond transaction.

There are two basic types of refundings. In the first type of refunding, the new refunding bonds are exchanged for the outstanding bonds being refunded, or the outstanding bonds are redeemed using the money derived from the sale of the new refunding bonds. It is rarely possible to do this type of general obligation refunding today because the holders of the outstanding bonds are usually not known, and most park district general obligation bonds are not callable prior to their maturity. Furthermore, if the outstanding bonds carry a lower interest rate than the new refunding bonds, retiring the outstanding bonds prior to their maturity would be financially disadvantageous. Therefore, the second type of refunding called advance refunding is almost always used by a park district refunding its bonds today.

In an advance refunding, the money derived from the sale of the new refunding bonds is used to either pay the expenses of issuing the refunding bonds or are deposited in an escrow account established at a bank having trust powers. The money in this escrow account is invested in United States Treasury obligations scheduled to mature at such times and bearing interest at such rates that the cash flow produced in the escrow account will be sufficient to pay the debt service on the outstanding bonds.

The arbitrage regulations contain two very important rules related to this escrow account. First, the maximum yield that the district is permitted to earn on its investments in this account is limited to the yield the district is paying on the new refunding bonds (not the yield on the outstanding issues being refunded). This means that when a district refunds low interest rate bonds with higher interest rate bonds, the principal amount of bonds necessary to fund the escrow account will be less than the principal amount of bonds being refunded. Therefore, the refunding can be structured so as to not increase the total principal and interest payments to be made by the district even though the interest rate on the new bonds is higher than the interest rate on the old bonds. Furthermore, when computing the allowable yield on the investments in the escrow account, the district is permitted to adjust such yield upward to take into account the expenses of issuing the refunding bonds. The second important rule contained in the arbitrage regulations relating to the escrow account concerns the securities to be purchased. Generally the district must purchase special State and Local Government U.S. Treasury Securities directly from the Bureau of Public Debt. Additional regulations have been issued by this Bureau relating to these purchases, but a discussion of those regulations is beyond the scope of this article.

As one can readily see, the structuring of the refunding bond issue and the necessary escrow to comply with the various regulations and legal requirements are quite complicated. Nevertheless, more and more districts are finding that such refunding bond issues merit study. There are four basic reasons that a district might refund its bonds. First, the original reason for issuing refunding bonds was to avoid defaulting on outstanding bonds. Fortunately there are few refundings for this reason today.

Second, districts might refund to reduce interest costs. If outstanding

Illinois Parks and Recreation 40 May/June 1984

In an advance refunding, the money derived from the sale of the new refunding bonds is used to either pay the expenses of issuing the refunding bonds or are deposited in an escrow account established at a bank having trust powers "

bonds are callable and they are refunded with lower rate bonds, the district's interest costs will be lowered. In addition, some districts decide to reduce their gross interest costs by refunding their long term bonds with shorter term refunding bonds. Such districts will, however, likely increase their bond and interest tax rate as a result of such restructuring.

A third reason to refund is to provide park districts with an opportunity to restructure their indebtedness. Park boards can determine to retire their district's debt over a shorter or longer period of time, to reduce or increase the district's bond and interest tax rate, to consolidate the district's indebtedness, to change the maturity date of the district's indebtedness, to level out the district's debt service payments, to reduce or increase the principal of the district's bonded indebtedness or to otherwise adjust the indebtedness and debt service requirements of the district. Illinois law provides that refunded general obligation bonds for which a sufficient escrow account has been established do not count against the district's overall debt limit or non-referendum bonding limit (.575% of the equalized assessed valuation of the district). Therefore, some districts find it advantageous to refund their outstanding bonds in order to reduce the principal amount of bonds outstanding or to retire their outstanding bonds more quickly as the district can issue more non-referendum bonds or can reach the point at which they can issue such non-referendum bonds more quickly. Fourth, refundings provide an opportunity to eliminate restrictive covenants made by a district in connection with the issuance of outstanding bonds. Such covenants would have been made in connection with the issuance of park facilities revenue bonds and generally relate to matters such as the issuance of additional revenue bonds and the application of the revenues of the district's facilities.

Notwithstanding that refunding bond issues are quite complicated, one can see that there are many ways in which park districts can benefit from such issues. Therefore, interest in these kinds of financings can be expected to increase as park districts learn more about these benefits.

ABOUT THE AUTHOR: Daniel L. Johnson is a partner with the Chicago law firm of Chapman and Cutler. He has a B.A. from Cornell College and a J.D. from the University of Illinois College of Law. He specializes in public finance and municipal bond law in Illinois, including general obligation and revenue financings by Illinois cities, villages and park and school districts.

Illinois Parks and Recreation 41 May/June 1984