CFDs, Plain and Simple...I Hope

The purpose of this post is to provide a basic understanding of what CFDs are, why they exist, and how the management (or mismanagement) of these financial instruments affect our quality of life and our families' future. Once the majority of our fellow citizens have a basic understanding, the detailed facts and figures will be more effective in getting them to act for change.

I believe there needs to be a change in our city’s financial strategy. This can only happen if we are able to convince city council members to change their financing strategy or we replace the current council members. Either option will require a voting majority that fully understands what the current strategy is and how it is affecting them. It is clear from past elections that a majority of Beaumont voters don’t see problems with the current strategy. We need more informed voters.

What are CFDs?

 

Following is an excerpt from an article entitled What is a Mello-Roos fee?

Background

The passage of Proposition 13 in 1978 limited the ability of public entities to increase property taxes based on a property’s assessed value. To raise additional funds for improvements and services, the Mello-Roos Community Facilities Act was passed in 1982. This Act allows for a special annual tax to be imposed on property owners in certain communities.

The Mello-Roos Community Facilities Act of 1982

The Mello-Roos act allows any public entity (e.g. city, county, special district, school district, or joint powers authority) to establish a Community Facilities District (CFD) to finance public improvements and services. These improvements can include: sewers, streets, police, ambulance, fire prevention services, schools, parks, libraries, museums, cultural facilities, and other basic infrastructure.

Is Mello-Roos Needed?

The Mello-Roos Act establishes a source of funds needed for the development of required infrastructure when no other funding sources are available. Typically, Capital Facilities Districts (CFDs) are formed in undeveloped areas or to build roads, and water and sewer infrastructure for new homes and commercial space. In some cases, CFDs are used in older communities to fund new schools or additional community improvements. The tax stays in effect as long as it is needed to pay for the bonds, interest and administration costs, not to exceed 40 years.

What’s happening in Beaumont?

 

When new housing developments are built, new infrastructure (roads, sewer, lighting, parks, schools, etc.) is needed to accommodate the increased population. The preceding paragraph indicates Mello-Roos were established for funding infrastructure “when no other funding sources are available.” This is where the City of Beaumont first went wrong.  There are two ways infrastructure can be funded. The developers can be required to pay for the infrastructure up front and then pass along the cost to home buyers through higher home prices. Or cities can provide the infrastructure and finance it with CFDs. Either way the homeowners assume the costs; I’ve heard estimates in Beaumont of $30,000 per new home.  The City of Beaumont had another funding source, the developers, Beaumont didn’t need Mello-Roos.

20 years ago, our City Council was advised to attract developers with lower up-front costs by funding the needed infrastructure with Mello-Roos. Most homeowners have 30 year mortgages. In theory, financing the infrastructure costs through a 30 year mortgage or with 30 year bond payments should make little difference to homeowners. This is assuming the bonds are left alone to mature. The Mello-Roos fees reduce new home prices but increase annual tax payments; tax payments inherited by future buyers suppress future home values.  

The City of Beaumont established the Beaumont Financing Authority to manage Mello-Roos financing. The BFA is managed by the city council but technically is a separate entity from the city. This is why the City Manager claims the City has no bond debt; the debt is held by the BFA and managed by the city. The BFA established a Community Facility District (CFD 93-1) encompassing the undeveloped areas of the city the council planned for housing developments.

The district was then divided into smaller areas. The law requires property owners to vote to approve the CFD financing and to give the BFA the authority to manage the debt for each area. The BFA is supposed to restrict the spending of the funds exclusively for services to the homeowners in the areas paying off the debt. The BFA is required to prove the funds are not being used for services outside the CFD areas. Very few cities, including Beaumont, have accounting in place to provide the proof and it doesn’t appear there is any oversight agency enforcing these restrictions.

When the areas were established, the BFA drew the boundary lines so there was one property owner, a home developer, for each area. Of course the developer votes to approve the plan and the city sells the bonds and manages the funds for infrastructure projects. The developer has much lower up-front out of pocket expenses. The law doesn’t require any bond payments until the homes are built and occupied. This makes it harder to believe the claim the City Manager makes when he says the developers in the undeveloped areas (for example Lehman Brothers’ Heartland Warehouse project) are making their annual CFD payments.

Once the original Bonds are issued, the maturity term is usually between 20 and 30 years. My home is in area 18 and we have a 20 year term. When we bought our home in 2006, we were told we would have to pay the CFD payments for 20 years which worked well for our college and retirement plans. What we weren’t told was that our developer had given the BFA the authority to refinance the bonds and any additional debt to pay for “administrative” costs.

The state law places limitations on the refunding of the original CFD bonds. The financing authorities are not allowed to issue new bonds that either extend the term or increases the remaining debt (principle and interest) to replace the original bond series. Financing Authorities are required to prove in the documentation submitted to the city council for approval that new bonds won’t add additional costs to homeowners and the new maturity date isn’t later than the original date. This is why many homeowners believe their CFD obligation has a fixed end date.

So how does the City of Beaumont get around these rules? How are they able to extend our payments and additional 10 years, obviously increasing our costs? All you have to do is take a look at the documentation provided in the City Council’s agenda package.

First, the City Manager tells the City Council they are able to refinance the bonds at a lower interest rate, reducing the BTA’s operating expenses. The interest rate for what the BFA pays on the debt will be lowered but homeowners will continue to pay the original higher rate.

Next, the city council approves a financing schedule that issues three separate bonds. The first is a series bond that has the same maturity date as the bonds being refinanced (the original series). The cost to the homeowner for these bonds will meet the legal requirements of not increasing the costs to the homeowner of the bonds being refinanced. The other two bonds have terms that run consecutively beginning at the original bond’s maturity date and ending 20 years from the new issuance date.

I know this maybe a little confusing. Here is a link to the first page of Exhibit A in the staff report presented to the council that outlines the schedule for the most recent bond refinance, Area 17A in Tournament Hills. Click Here.

If you want to see the complete staff report, click here.

The City can claim they are following the legal requirements that limit the refinancing of the original bonds. They will point to the authorization granted to the Beaumont Financial Authority by the original property owner ( the developer not the homeowners) to justify the additional debt to pay for administrative costs.

Commissions, or fees, will be paid to Mr. Kapanicas’ firm, General Government Management Services; Rod Gunn Associates Inc (Financial Advisor); Oconnor & Company Securities Inc (Underwriter); McFarlin & Anderson (Bond Counsel); and Union Back (Trustee). The City Council will claim they are doing the right thing because they lowered the Beaumont Financial Authority’s administrative costs. Homeowners are on the hook for an additional ten years of payments. In my case, an additional 10 years would put my total CFD payments at $84,000 instead of the original $56,000 I signed up for.

In the long term, it is obvious, I would have been better off paying $30,000 more for my home. When I eventually sell my home, the buyer will be required to  continue the CFD payments. Since a buyer would have to assume the Mello-Roos fees on my home, I would have to discount the price of my home compared to homes without Mello-Roos. If Beaumont continues to develop new homes with Mello-Roos financing, our home values will be suppressed by neighboring communities who develop homes without Mello-Roos.