Kansas transportation bonds economics worse than told

The economic details of a semi-secret sale of bonds by the State of Kansas are worse than what’s been reported. From February 2016.

The late realization last year that the Kansas Department of Transportation had issued $400 million in long-term bonds — largely under the radar — has been met with appropriate levels of indignation by some editorial writers. An example is Dr. Edward Flentje who wrote:

Right-wing Republican lawmakers have operated under the radar to suspend all statutory limits on highway debt, and that unprecedented authority was recently used to issue record-breaking levels of long-term debt to pay for their reckless income tax cuts this year and next.

Six lines buried deep in a 700-page appropriation bill last spring gave the Kansas Department of Transportation unlimited authority to issue debt, and in early December, without public disclosure, the agency used that authority to issue $400 million in highway bonds. (H. Edward Flentje: Debt limits suspended to pay for tax cuts, Wichita Eagle, December 18, 2015)

A few notes: The Secretary of Transportation has, in the past, been given broad — but maybe not “unlimited” — authority to issue bonds and borrow money. The series 2012C bonds were issued with this statement: “The 2010 Act Amendments authorized the Secretary to issue highway revenue bonds so long as the Secretary certifies that, as of the date of issuance of any such bonds, the maximum annual debt service on all Outstanding Bonds and on such bonds proposed to be issued will not exceed 18% of Revenues projected for the then-current or any future Fiscal Year.”

In 2010 Kansas had a Democrat for a governor, which should caution us to not make this issue too political. As far as borrowing from the “Bank of KDOT,” it’s been done before, as explained in 2015 by KDOT. 1 And, payments on these loans have been deferred or not made.

Instead of politicizing the issue, let’s concentrate on the facts and merits. And when looking at the Series 2015B bonds, there is plenty to criticize.

KDOT outstanding bonds, showing interest-only issues. Click for larger version. Does not include Series 2015B bonds.
KDOT outstanding bonds, showing interest-only issues. Click for larger version. Does not include Series 2015B bonds.
First, the state will not pay any principal on these bonds until 2026. Until then the state will pay only the interest on the $400 million, which is $20 million per year. Then, starting in 2026, the state will make 11 annual payments of various amounts towards the principal. In all, KDOT’s schedule shows the state will pay $282,494,750 in interest on a loan of $400 million.

I don’t think that most Kansans would appreciate the state borrowing so much money for such a long time without making any effort at retiring the principal. But before we politicize: The KDOT Series 2010A bonds ($325 million, dated September 1, 2010) don’t require principal payments until 2032. (These bonds are “Buy America Bonds,” a program of the 2009 American Recovery and Reinvestment Act, and the federal government will pay 35 percent of the interest.) The plan, as outlined in KDOT’s official statement, is that starting in 2032 the state will make five annual payments of between $61 million and $69 million, totaling $325 million, and then the bonds will be retired. 2

There’s even more to criticize about the 2015B bonds. The actual proceeds the state will receive from the bonds (after costs of issuance and the underwriters’ discount) is $488,242,912. How, you may be asking, can the state issue $400 million in bonds but receive $488 million when it sells them? The answer is an “original issue premium” of about $89 million.

To explain: Bonds similar to these ought to yield in the range of 2.00 percent to maybe 2.75 percent. But, KDOT is paying 5.00 percent interest. Therefore, bond buyers are willing to pay more than the face value (the $400 million) for these bonds, because they will be earning higher-than-market interest. 3 In fact, these bonds were sold at premiums ranging from 119 percent to 126 percent. Meaning that for every $1.00 worth of bonds bought (representing money the state must repay), the state actually received from $1.19 to $1.26. 4

That sounds like a good deal for the state, but in exchange for the premiums, the state pays much higher interest. There are several different ways of looking at this, but the upshot is that the state is receiving additional money now in exchange for paying a higher interest rate for many years. About $89 million in extra interest, which increases the actual cost of these bonds beyond what we thought.

(Again, before we politicize, the state under a Democratic governor has done the same.)

The allure of borrowing large sums and spending now is not limited to transportation bonds. The state is currently using the recent $1 billion in proceeds from KPERS bonds as a rationale to skip KPERS contributions this year, and also suspend a rule that most proceeds from the same of surplus property goes to KPERS. See This is why we must eliminate defined-benefit public pensions.


Notes:

  1. FY 2002 Loan to State General Fund. The 2002 Legislature borrowed $94.6 million from the State Highway Fund for the State General Fund and directed that the funds were to be repaid to the State Highway Fund by June 30, 2003. The 2003 Legislature deferred the repayment of the $94.6 million loan into four equal annual installments beginning prior to June 30, 2007. In addition, the 2003 Legislature directed that the State Highway Fund transfer to the State General Fund $30.6 million for activities of the State Highway Patrol and the 2003 Legislature directed that this transfer also be repaid in four equal annual installments beginning prior to June 30, 2007. The first repayment installment was made in June 2007 and the second in June 2008. The 2009 Legislature delayed the June 2009 repayment to June 2011 and the 2010 Legislature eliminated the language authorizing the June 2011 repayment. At this time, there is no authorization for the final two repayments. The Department’s projections included in this Official Statement do not include receiving the final two repayments.
  2. EMMA (Electronic Municipal Market Access), $325,000,000 State of Kansas Department of Transportation Taxable Highway Revenue Bonds, Series 2010A at emma.msrb.org/EA407275-EA318568-EA714328.pdf.
  3. A bond will trade at a premium when it offers a coupon rate that is higher than prevailing interest rates. Investopedia at www.investopedia.com/terms/p/premiumbond.asp.
  4. EMMA (Electronic Municipal Market Access), $400,000,000 State of Kansas Department of Transportation Highway Revenue Bonds Series 2015B at emma.msrb.org/IssueView/IssueDetails.aspx?id=EP369775.