Fitch Ratings plans to weigh several factors unique to qualified school construction bonds, but will still approach the securities in basically the same way it handles traditional tax-exempt offerings, the agency said in a report to be issued today.
“It’s fair to say that by virtue of an issuer using this structure, it wouldn’t really have a significant or any rating impact unless one of the things happened that we point out in report,” said Eric Friedland, a managing director and group credit officer for U.S. public finance who co-authored the report.
Amy Doppelt, a managing director and another co-author, said the report is particularly relevant because the bonds have taken off recently and market participants are curious as to how they will be rated.
“It took a while for states to figure out how they were going to allocate their shares, and suddenly it’s just out there in full force,” she said.
In February, $22 billion of QSCBs were authorized as part of the American Recovery and Reinvestment Act. And in April, the Treasury Department allocated the first $11 billion tranche to the states and the 100 largest school districts in the country, with the second tranche to be allocated in the future by the Internal Revenue Service. The bonds provide investors with tax credits in lieu of exempt interest payments.
Fitch said it plans to consider these issues the same as other bonds with similar repayment pledges. Most QSCBs thus far have been sold as general obligation bonds, even though any security type is allowed, according to the report.
However, Fitch said it also will consider several key differences when rating the bonds.
For example, QSCBs are required by the Treasury Department to have a maximum of 15-year final maturity, and given that the securities are being marketed to taxable investors, most carry a bullet maturity with no amortization.
With traditional school tax-exempt debt, the principal is typically amortized annually over 25 or 30 years.
As a result, Fitch will be examining whether QSCB issuers are setting aside funds annually to pay off the principal of the bullet maturity when a it comes due. The most creditworthy bonds would establish savings that are held by the trustee exclusively for bondholders or similarly separated from general operating funds, according to the report.
Issuers who do not set aside money for such payments will be viewed negatively by Fitch and should not count on refinancing to be able to provide funds for payments, the agency noted.
Fitch also is concerned that, with the $22 billion limit on the amount of QSCBs that can be issued nationwide, some school districts will speed up their capital plans and issue debt sooner than appropriate to take advantage of the financing tool.
If that occurs, Fitch will consider whether the new debt alters or overloads the issuer’s current debt burden.
Another issue of concern for Fitch is how QSCB issuers position themselves in case their bonds lose their qualified tax status.
Some QSCB deals have been structured with mandatory extraordinary make-whole call provisions that would take effect if violations — such as not spending the bond proceeds within three years or earning impermissible arbitrage — result in the loss of the bonds’ tax status.
Such large, unplanned expenditures could put stress on issuers’ credit ratings, according to the report.
However, Fitch said that it will view positively a structure that has been adopted in several recent QSCB offerings.
Under this structure, the tax-credit bonds would be converted to interest-bearing bonds if they lose the tax credit, and instead of making one large payment, the issuer would provide quarterly taxable interest payments at the tax-credit rate.