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Last Updated: 2/28/2014
Budget Issue: Recommend new interest calculation for future special fund loans
Program: State Borrowing Costs
Finding or Recommendation: Recommend using blended interest rate on future special fund loans to more appropriately compensate special funds for their reduced balances.
Further Detail

$4.5 Billion in Special Fund Loans Outstanding. Beginning in 2002-03, the state used loans from special funds to help close General Fund budget shortfalls. The amount of special fund loans outstanding reached $2.4 billion in 2004-05, but fell to roughly $750 million in 2007-08. Borrowing from special funds increased sharply as the state struggled with huge budget shortfalls during the most recent economic downturn. As of December 2013, $4.5 billion in special fund loans were outstanding.

Interest Calculated Based on Date On Which Loan Was Made. The annual budget act requires the Director of Finance to notify the Joint Legislative Budget Committee within 30 days of ordering the repayment of a special fund loan. When these loans are repaid, the General Fund incurs interest on the loan, which is charged to Item 9620 of the annual state budget plan (as described here). That interest is calculated based on the earnings rate of the state’s Pooled Money Investment Account (PMIA) on the day that the loan was made (even if that day was years ago).

Current Interest Calculation Method Seems Unreasonable. Because the interest rate on a given loan does not change over time, some loans have far higher interest rates than others. For example, the average PMIA rate during 2008-09 was 2.2 percent, while the average rate in 2011-12 was 0.4 percent. On average, a loan issued in 2008-09 would therefore earn nearly six times as much interest each year as if that loan were issued in 2011-12. Considering that the average PMIA rate in December 2013 was 0.3 percent, loans issued in years in which PMIA rates were much higher, in our view, result in requirements for the General Fund to pay unreasonably high levels of interest. Furthermore, if interest rates return to normal historical levels in the coming years—perhaps between 4 percent and 6 percent—none of the special fund loans currently outstanding will earn levels of interest comparable to what could have been earned if their balances remained invested in the PMIA.

Recommend Using Blended Rate on Future Loans. Currently, the state is repaying its past special fund loans, and it is unlikely that there will be substantial new special fund budgetary loans (loans from special funds to the General Fund to help balance the annual budget) in the near future.

We recommend a change to the manner in which interest is calculated for any future special fund budgetary loans. Specifically, for any special fund budgetary loans approved beginning in 2014-15, a blended interest rate that accounts for changes in PMIA rates over time would more appropriately compensate special funds for their reduced balances. This could be done using average monthly or yearly rates to reduce administrative workload. Should the Legislature adopt our recommendation, the Department of Finance could be directed to work with the State Controller’s Office to suggest appropriate statutory language to implement this change.

LAO analysis prepared by: Ryan Miller. Reviewed by: Jason Sisney.