Warning Signs

Property taxes aren't just a bill for you, they're the brick work of our nation

By: Paul Lambert

This piece was originally published on Paul’s long-running Educate Hilliard meta blog.

Before reading Thomas Suddes’ column in the Columbus Dispatch today, I had not given any thought to what happens, should property taxes be abolished in Ohio, in regard to the many millions of dollars of bonds that have been sold by the Hilliard City School District over the years. Turns out the bond counsel for the district has.

Here’s what’s in the prospectus of one of the recent bond issues:

“From time to time, (i) legislative proposals may be introduced in the General Assembly, (ii) ballot initiatives may be proposed by electors and (iii) court proceedings may be filed, which, in each case, if to become law, could alter or amend one or more of the ad valorem property tax matters referred to herein, which may serve as the source of debt service payments by the School District and which may have a materially adverse effect on the market value of the Series 2025 Bonds. There can be no assurance that legislation enacted, ballot initiatives approved, or actions by a court, after the date of issuance of the Series 2025 Bonds, will not have a materially adverse effect on the market value or marketability of the Series 2025 Bonds or financial condition of the School District. Prospective purchasers of the Series 2025 Bonds should consult their own counsel regarding pending or proposed State property tax legislation, related ballot initiatives and court proceedings, as to all of which the School District, Bond Counsel and the Underwriters express no opinion.”

That’s a lot of legalese to say: look there’s a possibility that changes to the property tax system could occur which affect the ability to redeem these bonds, or even make interest payments, and if that happens, the market value of these bonds might suffer.

In other words: we’ve warned you. You can’t sue any of us if you lose money on these bonds just because voters blow up the funding for the school district and the district defaults on the bond debt. Invest at your own risk.

Hilliard City School bonds have been rated AA1/AA+ for a long time. These are the second highest rating given by Moody’s and S&P, the major bond rating agencies. Bond ratings are like credit scores, and this is like having a credit score of around 800. Just as credit scores affect what interest rate we have to pay on mortgages and car loans, the S&P/Moody’s rating affects the interest rate bond issuers have to pay. The higher the rating, the lower the interest rate.

The dollar amount of interest the District will have to pay on these bonds doesn’t change during their life, nor does the amount they’ll have to redeem, but in the secondary bond market, the price of these bonds is affected by how much risk the prospective buyers perceive they’ll be taking. As would be expected, the more risk the buyer perceives, the less they’ll be willing to pay for the bond. When a highly rated bond is bought on the secondary market, the buyer will pay somewhere around the face value of the bond, usually $1,000 - as long as interest rates in general are steady.

But if the next buyer perceives that there’s a chance the issuer might miss some interest payments, or might default on the bond altogether, they’ll be willing to pay much less. Maybe $500, maybe less if they perceive the risk is great. This is when the bond traders start calling it a “junk bond” and it becomes the kind of bond that ends up in “High Yield Bond” mutual funds and money market accounts.

If this referendum to abolish property taxes makes it to the November ballot, I would expect the bond market to rerate every municipal bond issued by an Ohio government that gets a substantial fraction of its funding from property taxes. It wouldn’t be pretty.

Not that the rerating means the school districts etc aren’t still obligated to pay. The first paragraph of the offering document (”Prospectus”) says:

“The School Facilities Bonds, Series 2025B (the “Bonds”) are voted general obligation debt of the Hilliard City School District, Franklin and Union Counties, Ohio (the “School District”), and the full faith, credit and revenue of the School District are irrevocably pledged for the prompt payment of the principal of and interest on the Bonds.”

In other words, the interest and principle on these bonds have to be paid first, before anything else. I’m assuming that means before salaries and benefits, building operating costs, utilities - everything. I’m not a lawyer, and certainly not a bond counsel, but that’s what the language seems to say.

Wall Street and bond traders don’t wait around until something actually happens to price the potential of a thing happening into the assets they buy and sell. They try to anticipate where things are going, because what they like to do most is to buy low and sell high (Warren Buffett famously said that most amateur investors get this exactly backwards).

I don’t track bond prices over time, so don’t know the history of the Hilliard Schools bonds currently active. But I think it’s pretty likely that if the abolish property taxes referendum makes it to the ballot - the price of HCSD bonds will fall precipitously. And it will dang near impossible for any Ohio local government to issue new bonds until the General Assembly decides what’s going to replace property taxes in the local government funding mix.

That’s another reason to not favor this referendum: it creates chaos, and the financial markets hate chaos.

By all means, get rid of property taxes and find another way to fund our local governments. Sadly, the referendum’s proponents have done only half the job.

EducateHilliard is written by Paul Lambert, a past member of the Hilliard Board of Education and former Fiscal Officer for Norwich Township