Credit Assessment for Special District Financing.

• Author: Hitchcock, David
• Position: Statistical Data Included

As communities grow, governments look for new ways to finance growth without increasing taxes. Special district financing allows local governments to target taxes at newcomers, lessening the burden on current taxpayers. This article examines the structure and credit quality of special districts, including special assessment, tax increment, and community facilities districts.

Population growth brings with it an increased need for schools, roads, utility lines, emergency services, and other service and infrastructure needs. As America's urban cores grow out, taxpayers in some areas are becoming reluctant to finance the growth necessary for new development. Increasingly, voters want newcomers to pay for the additional infrastructure needs that new growth creates.

This desire to have newcomers pay their own way has led to a proliferation of different infrastructure financing methodologies. Special districts have become, in many parts of the country, one of the favorite ways to accomplish this, particularly in jurisdictions subject to stringent debt or tax limitations. Special districts can be structured in such a way that existing residents do not pay new taxes, and the districts can be set up in currently unpopulated zones where approval is certain.

This article will describe the main types of special districts, their advantages and disadvantages to a city or county, and the risks from a bondholder's perspective. While some special districts carry high credit risk, others may be very creditworthy and carry strong bond ratings.

Special districts come in many shapes and flavors. They can encompass just one parking structure or cover a whole school district. The type of taxes they impose vary widely, but may be grouped into four main categories: special assessment districts, tax increment financing districts, community facilities districts, and special purpose general obligation districts. Each category carries separate risks and will be discussed below.

Special Assessment Districts

The first category consists of special assessment districts. Special assessments impose an additional tax, based not on the value of property, but on a perceived benefit to the property. Special assessment taxes may be calculated based on road-front footage, acreage, or another formula. Tax and debt burdens can fluctuate wildly from parcel to parcel, since some properties may be built upon while others consist of raw land. Generally, every parcel has to pay its taxes to meet bond debt service (cash flow coverage on debt service is just one times), and no taxpayer can cover the delinquent tax payments of another. Thus, a debt service reserve is very important from a bondholder's perspective to cover potential tax delinquencies; otherwise, the bonds are only as strong as the weakest taxpayer.

Taxpayers like special assessments because they do not need to fear that their taxes will rise if a weak taxpayer defaults, since the tax payment for each taxpayer is fixed. The main risk to bondholders (and taxpayers) lies in the possibility of high tax burdens on selected parcels, particularly on undeveloped land. Average district debt burdens do not truly indicate credit risk, since the risk resides in the fewer parcels with high debt. As districts develop, they carry less bondholder risk to the extent most parcels are developed. Tax revenues will not rise as a special assessment district develops, but the debt burden will improve.

Tax Increment Financing

Tax increment financing (TIF) does not represent a new tax (as is the case with special assessment debt), but a reallocation of existing taxes. As a result, TIF bonds are sometimes referred to as Tax Allocation Bonds. Overlapping taxing entities get the same tax revenues as they did at the time of TIF creation from what is called the 'base' assessed valuation. New incremental assessed valuation above the base is taxed at the same overlapping tax rate as the 'base assessed value,' but taxes on the new property are sent to a city's redevelopment agency.

Residents like TIF districts to the extent that tax rates do not go up. However, creation of a TIF district may pit overlapping taxing jurisdictions against a redevelopment agency. Extensive litigation often develops from the overlapping jurisdictions' desire to avoid losing future tax revenue, although such litigation can often be settled amicably with an agreement to 'pass-through' a portion of excess tax increment revenues.

From a bondholder's perspective, assuming sufficient...