Bonds and Sinking Funds: Public School Districts Need Both

This article is intended to explain briefly the difference between Public School District Bonds and Sinking Funds, as well as illustrate why a Public School District needs BOTH in order to operate in the most fiscally responsible manner.

What is a Public School Bond?

“Local school boards are legally authorized to take out debt through resolution bonds. The way it works is that districts sell bonds and then levy a tax on local property to pay off the principal and interest owed on the bonds over time…. In order to raise taxes to pay for…[bond] debt, a school district must receive majority approval from local voters. State law mandates the information and type of language that school districts must use when asking voters to approve of their borrowing and taxing.” https://www.mackinac.org/23791 Because of the interest that is required to be paid on the Bond debt, a District’s taxpayers generally end up paying a vastly greater amount than the actual value of the Bond dollars that were received, especially for long-term repayments of 10, 20, or 30 years.

What is a Public School Sinking Fund?

Local school boards are legally authorized to levy a millage to support facility infrastructure. “Under current law, schools can maintain permanent sinking funds for future capital projects, like buying real estate,…construction or repair of school buildings, [school safety modifications, and technology purchases]. [Sinking Funds] also let schools have money on hand for emergency repairs, like [repairing or] replacing a leaky roof.” https://www.mackinac.org/4421 There is a limit of 3 mils and a 10 year term for Sinking Funds, however as you will read below, there are distinct advantages realized by Districts that maintain Sinking Funds, whether or not they have bond debt.

Why are Bond initiatives so expensive?

In general, Bond dollars are utilized for renovations, remodeling, replacing of aged infrastructure, building new facilities, facility/site additions, and the like. These are typically large-dollar initiatives that are financed over several years (e.g. 10 or 20 years) and that would completely drain any General Fund if Bond funds were not available. Anecdotally, Bonds are not for maintaining a facility; they are rather intended to build the facility. Maintaining the facility—which is a comparatively smaller annual amount—can come from the District’s General Fund or more appropriately from a District’s Sinking Fund. That said, another reason that Bond issuances are such large amounts is because, legally, Districts are not allowed to perform facility “repairs” using Bond funds, so facility maintenance with Bond funds often becomes full replacement instead of precise and calculated repair.

Michigan School Law, confirms the items for which Bond funds can be utilized. However, take special note that “repairs” are NOT on the list of allowances. Even the Michigan Department of Treasury lists “Repairs” in “Unallowable uses of bond proceeds.” https://www.michigan.gov/documents/3160_2815_7.pdf

MCL 380.1351a(1) gives the following allowances for Bond use: “…purchasing, erecting, completing, remodeling, or equipping or reequipping, except for equipping or reequipping for technology, school buildings, including library buildings, structures, athletic fields, playgrounds, or other facilities, or parts of or additions to those facilities; furnishing or refurnishing new or remodeled school buildings; acquiring, preparing, developing, or improving sites, or parts of or additions to sites, for school buildings, including library buildings, structures, athletic fields, playgrounds, or other facilities; purchasing school buses; acquiring, installing, or equipping or reequipping school buildings for technology; or accomplishing a combination of the purposes set forth in this subsection.”

What about the General Fund As Compared To A Sinking Fund?

In comparison to Bonds, both General Fund dollars and Sinking Fund dollars CAN be used for facility repairs. However, it is to the District’s advantage to keep as many dollars in the General Fund as possible for academic and related concerns, utilizing other income sources, such as Sinking Funds, for non-academic concerns such as facility repairs.

Again, in contrast to Bond dollars, Sinking Fund dollars are for land, technology, construction AND repairs to facilities. According to MCL 380.1212 (1), Sinking Funds can be used for “the purchase of real estate for sites for, and the construction or repair of, school buildings, for school security improvements, or for the acquisition or upgrading of technology.”

Why not just use General Fund dollars for repairs?

When a Sinking Fund is not established, potentially large dollar amounts are funneled away from a District’s General Fund for facility repairs. This is exactly what we want to avoid, and why it is so vital to have a Sinking Fund, even if it is a comparatively small percentage of the total millage at any given time. When the General Fund is tapped, this takes vital academic, salary, and normal operations funds away from the District.

Why not just use Bonds for all facility issues?

If the District only has Bond dollars with which to implement facilities changes, then the District is locked into paying for the highest cost solutions for facilities problems—namely, full replacement of decaying infrastructure—because “repairs” are not an allowable use for Bond funds. However, the presence of a Sinking Fund--even a comparatively small one that may or may not accompany a Bond issuance—allows for facilities and general infrastructure repairs to be completed through Sinking Fund dollars, and hence, at a much lower cost than full replacement through Bond dollars. It could easily be argued that it is fiscally irresponsible to pay a premium for new infrastructure (because the District is locked into only Bond dollars), when a repair (utilizing Sinking Fund dollars) would suffice indefinitely and for a considerably lower cost.

Aren’t Bonds “better” than a Sinking Fund?

People who think that Bond dollars are “better” than Sinking Fund dollars do not understand the purposes, advantages, and disadvantages of the two options. A public school District needs BOTH Bond dollars and Sinking Fund dollars to operate in the most fiscally responsible manner. One is not better than the other. They work in tandem with each other. In a nutshell, Bond dollars are used for high-value infrastructure purchases, and Sinking Fund dollars are used for repairs to infrastructure.

Again, since Sinking Funds ballot initiatives are limited to 3 mils and 10 years, they typically are not suitable for large scale new construction that might need to be financed over perhaps 20 or 30 years--this is what Bonds are for. However, Sinking Funds are perfect for the on-going facility repairs for which Bond dollars are not allowed to be used. Hence, it is clear that both funding sources are necessary for a District to operate in the most fiscally responsible manner possible and to protect General Fund operational dollars from being used for CAPEX items.

Is there any rush to get a Sinking Fund?

For those who think it is OK to keep putting off getting a Sinking Fund established, it should be realized that even a $200M bond issuance would NOT be able to purchase enough facilities updates to alleviate entirely the need for infrastructure repairs across more than a dozen and a half District buildings of various ages over course of 6 years. No bond issuance in the past ever has been able to accomplish this, and no bond issuance in the future will either. As a result, operational dollars from the General Fund necessarily will be funneled away from academic and related issues to pay for facilities issues that otherwise should be paid for through an established Sinking Fund.

Someone told me that Sinking Funds are too restrictive. Is this true?

Sinking Fund dollars are audited every year for appropriate use, and this fact makes Sinking Funds more appealing to voters than open-ended Bond dollars that often fall short of their campaigned intent. Voters are leery of open-ended Bonds for good reason. This is not a restriction as much as it is a value-added safeguard for constituents.

There are significant financial advantages with the use of Sinking Funds.

1. Sinking Funds do not have to be repaid like Bonds do.

2. Sinking Funds do not incur finance fees like Bonds do.

3. Sinking Funds do not incur interest charges like Bonds do.

4. Sinking Funds operate on a “pay as you go” cadence; no money is borrowed.

5. Sinking Funds are paid to the District annually, so there is no wait time for the realization of those funds.

6. Sinking Funds allow Districts to pay for on-going repairs at a lower cost than high-cost replacement projects that utilize Bond dollars. Those savings are then investable by the District to generate revenue.

7. There are no limitations on the length of time that Sinking Fund dollars can be accumulated.

All of this makes Sinking Funds prudent an attractive to both a District’s Finance Office as well as the District’s constituents, whose taxes go directly to District needs instead of paying interest on Bond debt. This also means that constituents’ taxes go farther when they are linked to Sinking Funds, rather than only Bonds.

References:

· Michigan School Business Officials (MSBO) website https://www.msbo.org/sinking-fund

· Michigan Association of School Boards (MASB) website https://www.masb.org/vf_sinking-funds-versus-bonds-kingscott.aspx

· Michigan Compiled Law 380.1212 http://www.legislature.mi.gov/(S(m2ccpzsqp1lebbascvpxeqsy))/mileg.aspx?page=getObject&objectName=mcl-380-1212

· Michigan Compiled Law 380.1351a http://www.legislature.mi.gov/(S(q3ybcbhl4vge24cq0bnesiti))/mileg.aspx?page=GetObject&objectname=mcl-380-1351a

· Michigan Department of Treasury https://www.michigan.gov/documents/3160_2815_7.pdf