Report 97127 Summary - September 1998

Marks-Roos Bond Act Borrowings: Several Cities Misused the Program and Some Financed Risky Projects Which May Result in Investor Losses

The Legislature created the Marks-Roos Local Bond Pooling Act (act) in 1985 as a flexible tool for local agencies to finance needed capital improvements or other projects benefiting the public. However, many cities have used their authority under the act inappropriately. Waterford (see footnote 1) and San Joaquin established public financing authorities (PFAs) and issued bonds to finance highly speculative projects throughout the State that do not directly benefit their cities. In exchange for financing the projects, the cities received a portion of the bond proceeds for costs unrelated to administering the bonds or to the financed projects. Together, these cities received $1.3 million in fees for issuing $148.9 million in Marks-Roos bonds.

In addition, the two cities did not adequately control the projects. As a result, both financed projects that do not have proper permits or approvals, and one paid too much to acquire some assets. For example, we estimate that, because it relied on a deficient appraisal report commissioned by the seller, one of San Joaquin's PFAs may have paid up to $9.2 million too much for land it purchased. Furthermore, because this property's use is currently limited under the California Land Conservation Act, the PFA may not be able to fully develop it until January 1, 2008. The delay or potential failure to fully develop this land is likely to cause the PFA to default on $23 million of its debt.

Further, the cities, or other members of the PFAs, did not adequately perform administrative duties, such as monitoring project progress, reviewing project costs, maintaining accounting records, and obtaining financial audits. This lack of control resulted in one PFA reimbursing a developer for a $100,000 loan to a political organization and paying twice for services costing $27,000.

More alarmingly, many projects have not generated revenues sufficient to pay the principal and interest due to investors, nor are they likely to do so in the near future. If PFAs are unable to raise the money to make required bond payments, they will default on the bonds. Despite the risk of default, the cities' PFAs continue to finance highly speculative projects.

We also noted less severe yet still questionable uses of the act in the cities of Lake Elsinore, Coalinga, and Oroville. The Lake Elsinore PFA paid up to $1 million in duplicate bond issuance costs. The Coalinga PFA financed a golf course over 100 miles away in Merced in return for a fee of $345,000. Oroville transferred over $200,000 of interest earned on Marks-Roos bond proceeds to its general fund. Additionally, although the cities of Avenal, Dos Palos, Selma, and Wasco did not appear to abuse their Marks-Roos authority, they exposed investors to increased risks by financing projects outside of their jurisdictions. Finally, based on their responses to our survey of the 12 cities we reviewed, the cities of Atwater, Ione, and Placerville do not appear to have misused their authority under the act. In fact, Ione has never issued Marks-Roos bonds.

Whether the actions of Waterford and San Joaquin are legal is not clear--this question is best left to the legal system. However, these actions appear inconsistent with the intent of the act. Not only have some of these actions put individual investors at risk, but according to the California Debt and Investment Advisory Commission (CDIAC), defaulting on bonds could affect the ability of governmental agencies throughout the State to raise funds for needed capital projects.

To be effective, the flexibility that the act offers local agencies must be accompanied by responsibility and accountability. The local agencies and government officials who approve misuses of the program should be held responsible and accountable for their actions. Immediate steps are warranted to ensure this flexibility is exercised appropriately by local agencies.