District Continues Practice of Making Interest-Free Loans from Building Fund

By David M. Greenwald

Davis, CA – Last December, the Measure M Citizen’s Oversight Committee unanimously backed a recommendation conveyed in a letter from Chair Donna Neville, alleging that the school district is in violation of the law for failing to repay loans made from the Measure M fund to the district General Fund without paying interest on those loans as required by state law.

“The law here is clear. In attempting to address this issue with the district, I consulted with more than a half dozen legal colleagues who work in public finance and bond compliance, and they all confirmed that interest must be paid on these loans,” Neville said in the letter that was sent to the district.

“Over the life of the Measure M program this failure to repay the loans with interest could amount to as much a half a million dollars in lost interest [for the Building Fund], depending on the amounts borrowed, interest rates, and the length of the loans,” she continued. “This is not only illegal; it is a betrayal of the voters’ trust.”

In its second annual report delivered to the District in May, the Measure M Citizens’ Bond Oversight Committee included a statement that the practice has continued.

The committee, whose membership has changed since the Neville letter, states, “We recognize that these loans are permitted by the Education Code, but we believe that the District must repay these loans with interest.”

They continue, saying that “case law dictates that the District must make the Building Fund whole upon repayment of these loans by paying the amount of interest that money would have earned if it had remained in the Building Fund.”

Last December, then-District Public Information Officer Maria Clayton told the Vanguard, “After careful consideration and discussion, including the engagement and consultation of legal counsel, the District’s position is described in this memo, which is titled Board Policy on Interfund Borrowing.”

According to the referenced memo dated September 30 from Superintendent John Bowes, the Citizens’ Oversight Committee “requested that the Board of Education consider whether it should amend Board Policy No. 3110 (Transfer of Funds) to prohibit temporary borrowing of Measure M bond proceeds, and if not, whether it should amend the Policy to require the transfer of an amount equal to interest when the borrowing is repaid.”

Bowes said, after conferring with bond counsel and municipal advisor, “we determined not to recommend any changes to BP 3110 at this time.”

In their view, “The advice we received is that our temporary borrowing practices are not prohibited by law and are consistent with Generally Accepted Accounting Principles (‘GAAP’), rules of the Governmental Accounting Standards Board (‘GASB’), and the aforementioned CSAM and SACS.”

Instead, they argue, “Education Code section 42603 gives broad latitude to a school district governing board to temporarily transfer funds from one fund or account to another under specified conditions.”

They note, “Interfund borrowing is distinguished in school district accounting from an interfund transfer, which describes a flow of assets from one fund to another without equivalent flow of assets in return and without a requirement for repayment.”

The Oversight Committee, made up of members of the public, disagrees.

They have repeatedly requested that the DJUSD governing board “modify current board policy to require the payment of interest” but the board has thus far “failed to do so.”

According to the report: “The board’s legal counsel has advised the board that she is unaware of any interest requirement related to the Building Fund and that she is unaware of any judicial decisions that require the payment of interest. We respectfully disagree.”

The Oversight Board believes, “This legal advice is contrary to the view of other legal experts, and is contrary to the advice provided to school districts throughout California by the Fiscal Crisis Management Assistance Team, which advises school districts on various fiscal matters.

“The Official Statement for the Measure M bonds plainly indicates that all of the principal as well as interest earned on that principal must be used for Measure M purposes,” they write.  Thus they believe, “When the District makes interest free loans from the fund it fails to honor this commitment and it diminishes the amount of interest earned on the principal. Further, numerous California cases stand for the general legal principle that where a fund is entitled to retain interest, it follows that a loan made from that fund must be repaid with interest.”

Furthermore they write, “The District’s refusal to modify its current policy has, so far, deprived the Measure M Building Fund of as much as $200,000 in interest that it would have otherwise earned.”

While the Oversight Committee membership has changed since last December, they have recently stated that they continue to “stand by our original recommendation that the board should modify current board policy to require the payment of interest. This would bring the District into line with the guidance provided by the Fiscal Crisis Management Assistance Team to all school districts throughout California and with the practices of other public agencies.”

They conclude: “By not paying interest, the District not only reduces the amount of funding available for Measure M projects, but it also exposes the District to legal liability.”

—David M. Greenwald reporting


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About The Author

David Greenwald is the founder, editor, and executive director of the Davis Vanguard. He founded the Vanguard in 2006. David Greenwald moved to Davis in 1996 to attend Graduate School at UC Davis in Political Science. He lives in South Davis with his wife Cecilia Escamilla Greenwald and three children.

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22 Comments

  1. Matt Williams

    I strongly support the Bond Oversight Committee’s position on this issue.

    For the life of me I can’t understand why the Board and the Supervisor are taking the position they are.  My question to the Board and the Supervisor is, “Why is it so important to you to add one more community fight/controversy to our already contentious community?”

    That question is especially resonant when one looks at the fact that regardless of whether the interfund interest is paid or not, DJUSD overall does not lose a penny of interest expense. Any interest paid by the General Fund will be recognized as interest income in the Building Fund.  Financially, it is a zero-sum game. My second question to the Board and the Supervisor is, “Why is it so important to fight over a net zero dollars issue?”

     

     

    1. Keith Y Echols

      . Any interest paid by the General Fund will be recognized as interest income in the Building Fund.  Financially, it is a zero-sum game. My second question to the Board and the Supervisor is, “Why is it so important to fight over a net zero dollars issue?”

      I think the reason is because the District is hard up for cash right now.  Particularly because of the loss of revenue due to lack of student enrollment.  Yes the Building Fund and the General Fund are all the District’s money when it comes to the bottom line on the Balance Sheet.  But on the Cash Flows Sheet, I’m guessing it’s a different story.  Or to put it another way; it’s kind of like raiding your retirement account to buy a new car because if you can’t you get to work without it.

      1. Matt Williams

        I think Keith is correct when he says, “I think the reason is because the District is hard up for cash right now.” 

        I also think he is correct when he says, “it’s kind of like raiding your retirement account to buy a new car because if you can’t you get to work without it.”

        I am also inclined to say, “it’s essentially the same as the City of Davis deciding to deal with its cash flow problems by deferring necessary maintenance of its roads, bike paths, and buildings in order to free up cash to cover General Fund expenditures”

        Paraphrasing the words of astronaut Jack Sweigert, “Okay, Davis, we have had a problem here.”   That would be the appropriately transparent and moral thing for both the School Board and the City Council to do when these cash flow issues come up.   The expression “It’s not the crime, it’s the cover-up” also comes to mind.

        1. David Greenwald

          Matt – the biggest problem which Bruce Colby used to explain well is how taxes are collected and the cashflow problem for school districts. It’s not quite raiding retirement to buy a new car, it’s more like getting a payroll advance each month to pay last month’s bills.

        2. Keith Y Echols

          My poorly worded (and constructed…I often times write these comments too quickly) analogy was meant to demonstrate raiding something that’s yours but is has a specific use (retirement/building school stuff) to pay for your current needs (a car to drive to work/money to pay for on going school district expenses).

          As I said in another post; in the end I don’t think this is that big a deal (yes, the district should keep it’s books and financial obligations to their funding sources straight).  I think the bigger issue is the districts financial situation; getting it’s revenue and costs straightened out.

      2. Matt Williams

        That is a good analogy David, and in real life, if you raid your retirement, the retirement administrator assesses a fee for processing the transaction that extracts the cash that you need for the car.  When you pay the retirement fund back, you don’t get the dollars expended to cover the cost of the transaction processing back.

        I have absolutely no problem with the interfund borrowing.  It is almost always financially advantageous to the jurisdiction (whether School District, City, or County) because the interest rate being paid by an investment institution to the jurisdiction is almost always less than the interest rate that a lending institution will charge.  In this particular case, the interest rate is a matter of public record and administered/calculated by the County where the School District resides … in this case I believe it is Chief Financial Officer, Chad Rinde.

        The problem I have … and the City of Davis does the exact opposite of what DJUSD is arguing for, is the payment of interest at an established rate by the borrowing Fund (recently Stormwater and Solid Waste) to the lending Fund (recently Wastewater).  That same arrangement was followed when interfund borrowing provided the cash needed to complete the assessment of the possibilities for what would become Valley Clean Energy.  DJUSD should follow the excellent example of the City of Davis on this issue … and pay the interest amount calculated by Chad Rinde.

  2. Bill Marshall

    Sure sounds like, that unless the current DJUSD Board remedies this (with interest, and policy changes to prevent it from recurring), they should be recalled, and a new Board seated.   The New Board’s first action should be to dismiss the equivalent of the CFO… second should be the dismissal of the Superintendent… third should be replacement of legal counsel…

    Old adage… “Fool me once, shame on you… fool me twice, shame on me”…

    1. David Greenwald

      Or they could take the advice of their own oversight board – a body that they advertise during the campaign as being the fail-safe for public accountability.

  3. Ron Glick

    “The District’s refusal to modify its current policy has, so far, deprived the Measure M Building Fund of as much as $200,000 in interest that it would have otherwise earned.”

    How did they come up with this amount? I think to understand what is going on you need to understand what how the amounts are determined. Then you can do a cost benefit analysis with the cost of private bridge funding.

    1. Matt Williams

      There is no need to go to the extra expense of private bridge funding.  The interfund borrowing makes lots of sense, just not interfund borrowing with no interest.

    2. Keith Y Echols

      “The District’s refusal to modify its current policy has, so far, deprived the Measure M Building Fund of as much as $200,000 in interest that it would have otherwise earned.” 

      How did they come up with this amount? 

      The article says:

      They continue, saying that “case law dictates that the District must make the Building Fund whole upon repayment of these loans by paying the amount of interest that money would have earned if it had remained in the Building Fund.”

      I dunno…rough math (going by simple flat interest and not compounded)…says that the principle might be around $10M at 2% interest.  If it was over only one year.  I guess this has been going on for a few years?  So the principle is less….the variable of course is what the building funds interest rate is.

      The amount doesn’t matter.  Borrowing from yourself is always better than borrowing from some one else.  (that is of course if the amount transfered/borrowed doesn’t interfere with the projects the building fund has scheduled….that is the real issue/concern).

      1. Matt Williams

        From the Oversight Committee report on the DJUSD website

        We do, however, have a concern regarding the fact that the Districttemporarily borrowed $8 million in cash from the Measure M building fund to address general fund cash flow needs. We have not concluded that this was a misuse of funds and we recognize that this loan will be repaid prior to the end of the fiscal year.

        .
        … and later in the report said:

        Although we found that the District expended Measure M funds for allowable purposes, we do have one issue that we believe needs to be brought to the public’s attention. During fiscal year 2019-20,the District temporarily borrowed $8 million in cash from the Measure M building fund to cover district operating costs.It also intends to do short-term borrowing from the Building Fund in future years. As of April 22, 2020, the District had repaid $4 million of this loanand will repay the remainder when it receives its May 2020 property tax allocation. We emphasize that the District did not misuse Measure M funds. Nonetheless, because the District intends to make such loans in the future without paying interest,and because these loans come with recognized risks, we believe it important to highlight this practice in our report.

        To provide context as to why a district might temporarily borrow from its building fund, the Committee recognizes that many school districts in California have cash flow management issues. This happens because there is a disconnect between when districts incur certain expenditures and when they receive revenue. Districts have regular, ongoing monthly expenditures for many activities, including payroll. However, Districts receive their property tax allocations, which typically comprise twenty percent of total school district funding, twice a year−in January and May. Consequently, the District, like many other school districts in California, often has a cash shortfall prior to the receipt of that tax revenue. Districts have various options to address this cashflow issue. One common method is the use of a Tax Revenue Anticipation Note (“TRAN”), a short-term note issued by the district and secured by the anticipated tax revenues to be collected in the same fiscal year. There are also other, alternative methods of borrowing. Because it is generally less expensive and more expedient, many districts prefer to temporarily borrow internally from other available district funds. According to the District, it saved approximately $400,000 by borrowing internally and not using a TRAN.

        While it may be legal to temporarily borrow from the building fund, the California State Treasurer warns that there are risks associated with this practice.The California Debt Issuance Advisory Committee (CDIAC), within the State Treasurer’s Office advises that temporary borrowing from bond funds may pose risks to issuers, bondholders, and creditors of the borrower. These risks include the potential loss of tax-exempt status for district-issued bonds.

         

         

  4. Don Shor

    When legal counsel assert directly contradictory claims, it’s usually resolved by a judge. If anyone truly cares about this issue, they can find someone with standing to sue and let a court resolve it.

    1. Keith Y Echols

      That’s the thing….I wonder if anyone really cares other than the technicality of adherence to the strict definition of the voter’s wishes.  I’m guessing the money borrowed from the building fund is being used to prop up the school district because the district is short on cash and would be in worse shape if it didn’t “temporarily transfer funds” (no interest borrowing) from the building fund.   So the alternative of cutting school services or raising taxes again is greater evil compared to the district possibly (likely) violating some laws/rules and giving itself interest free loans.  

      1. Matt Williams

        One answer to the questions that Don and Keith have asked is contained in the following quote from one Committee member.

        Committee member Bret Hewitt explained, “It is a fundamental proposition that a dollar a week from now is not worth the same amount as a dollar today without an interest component.  It’s called time-valued money.”

        “If the school district is paying back $15 million and $12 million before that without interest, we are by definition diminishing the purchasing power of the bond funds,” he said.  “There is no other way to look at that.”

        He said, “It is clear to me that it is our duty, as champions of the bond fund, we need to push this matter.”

        1. Ron Oertel

          Reason # (fill-in-the-blank) that I don’t like school districts.  Perhaps even more so, regarding Davis’ school district.

          Too much autonomy in the first place.

        2. Don Shor

          So the oversight committee wants DJUSD to incur costs amounting to $400K in order to avoid possibly losing the tax-exempt status for the bonds?

          Because it is generally less expensive and more expedient, many districts prefer to temporarily borrow internally from other available district funds.

          Are there examples of any of these many districts that do this losing the tax-exempt status for their bonds?

        3. Keith Y Echols

          hmm….While borrowing from yourself seems harmless….I suppose Hewitt is right.  The lack of interest is essentially like taking money away from the fund.

          How quickly is the district repaying the fund?  I mean it’s one thing if it’s a quick loan that is less than a month or a quarter.  Kind of like paying off your credit card bill before interest accumulates.  But if the $200K amount is correct…then yeah…the district owes some serious $$ to the fund.

          What happens to money in the building fund if certain projects happen and others don’t?  Where does the money go?  Or does it just sit around until another school district building project gets approved?

          All this financial shenanigans just further illustrates the school districts limited financial situation.  Something has to be fixed on the revenue or cost side of things.   I’m still in favor of affordable teacher housing.  Turn some of the district land into affordable teacher housing.  Heck you could probably use some of the building fund money to construct the homes.  Then you have homes that you could rent out to teachers at an affordable rate and get a long term source of income for the district.

  5. Ron Oertel

    Perhaps they can use the building fund to “debuild” an unneeded building/facility at some point.

    Presumably, sometime after they stop poaching kids from other districts, rather than face that decision.

    Perhaps as the entire school system is increasingly filled with those who don’t pay the parcel taxes (or are no longer “poachable” at some point), the answer will become more obvious.

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