Understanding Ratings, Direct Deposit Programs and Bond Insurance
UNDERSTANDING RATINGS, DIRECT DEPOSIT PROGRAMS & BOND INSURANCE
With the ever-changing markets and legislation updates, an inside perspective by experienced public finance bankers can better educate school district clients on the ins and outs of financing a bond issue. Bringing unique school district experience, this article highlights questions Missouri school district business officials face on a daily basis regarding finance processes:
What determines a district’s rating?
There are several factors that go into a district’s rating, most of which are out of the district’s control. The local economy in terms of both tax base and income levels of the District’s patrons is the biggest driver of a District’s rating. The District’s ability to raise operating revenue is also a key factor. For example, if a District has reached its “maximum voter authorized levy,” their inability to increase the tax rate if assessed values decline will be a negative factor. Another big factor is the state economy if a district is heavily reliant on state aid payments for their operating budget. Standard and Poor's (“S&P”), the rating agency that rates the Direct Deposit Program, does most of the ratings across the state of Missouri. Beyond the economic factors that drive a majority of the rating, S&P will do an examination of the district's finances focusing on budgets in the current year, prior years and future projections. Having stable future projections is a key to maximizing the District’s rating.
Finally, S&P will take a qualitative look at management practices—an overall examination of District policies, practices and procedures— that enhance financial functionality within the district. Much of these factors revolve around board policies that have been implemented regarding budgeting, board reporting and other policies. Since this portion of the rating is less than a third of the overall rating score; however, if a district is close to getting an upgrade or downgrade, enhancing or supplementing those policies, practices and procedures can be a crucial move.
What can superintendents or districts do to enhance their rating?
The biggest factor that Standard & Poor’s focuses on right now, and where we see a difference among our clients, is the actual amount of reserves in a districts’ operating budget. If a district allocates 25-30% of reserves, as a percentage of their annual expenditures, oftentimes a small rating bump will occur. Luckily, if a district is in an area where there's positive upswing in the economy, those forecasts can sometimes add to enhancement. In the end, the biggest opportunity for a district to enhance ratings is to be comfortable with raising reserves.
What is the Missouri Direct Deposit Program?
The Missouri Direct Deposit Program is a pooled program that enhances the credit rating of a district by providing extra security to investors that payments will be made. Because of the added security, the program gives a district access to lower interest rates on bonds. The program carries an “AA+” rating and allows a wider array of investors to purchase the District’s bonds. The District’s state aid is “intercepted” from the District on a monthly basis (via federal wire) for 10 months out of the year. A district has a tenth of the bond payment for the following year intercepted from state aid so the district is getting a lower transmittal rate. The District then uses funds available in Fund 3 to reimburse their Fund 1 for the state aid that is intercepted. This is a great program option for districts that don't have credit ratings similar to the AA+.
What is bond insurance and when does a district utilize it?
Bond Insurance is another option for credit enhancement. In many circumstances, this can help lower a district rating much like the Direct Deposit Program. Like a home insurance policy, bond insurance protects the bond insurers and bond holders should the district not make payments. Bond insurance is very expensive and a thorough review of the deal prior to purchasing is critical to assure it’s a worthwhile investment.
By: Joe Kinder & Brent Blevins, George K. Baum & Company