Some of these same things come into play when you want to refinance your home to lower the monthly payment because of lower interest rates. The first question that has to be answered is how long will it take for the amount of the monthly reduction to equal all the additional costs incurred to refinance the loan. It typically takes two to five years before you start saving money from the lowered interest rate because you have to recover the refinancing costs first.
Now all this sounds obvious and it is, but the principles apply across the board. They apply to refinancing any kind of debt whether it is your debt or government debt and in our case, city government debt. Whether it is general fund debt or Redevelopment Agency debt. Terminology changes and the debt is called bonds instead of a mortgage. It is easy to see that it will be some time before the lower interest rate of the new bonds will make up for what it cost to refinance them and money can start being saved.
The bond houses can only make money when they sell bonds. Bonds typically run 20-25 years, so there is a big incentive for the bond salesmen to encourage cities to refinance debt. It is also usual to suggest that the refinancing costs be added to the principle, of course, all at the lower rate. This sort of shell game goes on all the time and this is where the the profit comes from. This is also where campaign contributions can come into play. The bond houses are major lobbyists for Redevelopment and California redevelopment agencies activities. Bond sales are where the money is to lubricate the wheels of legislation and the taxpayer pays the bill.
All this relevant because our Civic Center bonds are being looked at for potential refinancing. They were already refinanced once in 1986 and they contain an option to reissue them in 10 years, which is in August. The current bonds are at 6.65 percent and the outstanding balance is $13,085,000 due in 2009.
Bonds are different from mortgages in that bonds have a single balloon payment at maturity, the amount of which is called “face value,” whereas mortgages have a declining principal balance that is paid off along with interest until the due date.
In the Downey bond refinancing discussions, no mention has been made of a reserve fund to pay off the bonds in 2009, only 13 years away. If there is a reserve fund growing, why not pay off all that there is money for and only refinance the balance? Since they have been in place for ten years there should be a much smaller balance—like half. Or are the bonds just going to be refinanced at maturity to run on forever as an interest-only debt?
It must be remembered that it costs money to finance debt. In a mortgage, it is called points. In the bond market there are two main expenses. One is the fee ($40,000 in this case) for the bond counsel for evaluation and acting as intermediary. Secondly, there is the underwriters’ fees, the big money charge. In municipal financing 5 percent for underwriting is common, which would mean $600,000 in Downey’s case.
I encourage full disclosure of all numbers when this comes up for council vote, and a statement about what plan, if any, is in place for the payoff in 2009. Supposedly, we have to accumulate $13 million in 13 years. It is my understanding that the current General Fund reserve is less than $2 million. Has any money been saved to pay off these bonds over the past 10 years? Is any money going to be put aside for the next 13 years?
Why don’t we pay these things off and have a debt free city?