CHICAGO — The credit profile of some Illinois school districts that rely heavily on premium bond structures — where debt repayment is delayed or additional proceeds are raised upfront — may suffer, but Moody’s Investors Service said in a report yesterday that it doesn’t automatically view the use of such structures as a negative.
In a special commentary, the rating agency found that the state’s school district sector does not face immediate credit pressure from the use of premium bond structures — with a focus being on capital appreciation bond structures — with the type of bonds being just one of many factors analysts consider in their reviews. Those other factors include the strength of the pledged security, rate of principal amortization, total debt outstanding, debt structure, debt service as a percentage of a district’s expenses, tax growth rates, and financial flexibility.
Questions from issuers over how the agency views CAB structures and the impact on credit ratings prompted the special commentary from the rating agency. It also follows a series of published reports in a local newspaper that covers many of the rapidly growing suburban school districts on the outskirts of Chicago and Cook County. Many are turning to capital appreciation bonds to accommodate the construction of new schools with limited ability to raise taxes due to state tax caps.
“Districts that use capital appreciation bonds are usually experiencing high growth,” said Shawn O’Leary, a Moody’s analyst and one of the authors of the report. “There’s been a lot of questions over whether we view these as a credit negative. We don’t view their use by itself as a negative. You have to see what it does to their overall debt structure. It’s just one component of a district’s debt picture.”
The negative public attention stems, in part, from the overall increased costs in repaying a premium bond structure, which Moody’s cautioned in its report is fodder for public policy debate over issue of cost and transparency, but not necessarily the primary factor in a credit review.
“Moody’s primary focus is bondholder security — that is, the ability and willingness of a particular issuer to repay debt on time and in full,” O’Leary and his co-authors wrote. “It is only when matters of public policy and transparency either endanger or augment bondholder security that these issues become a larger component of our rating analysis.
Capital appreciation bonds do not pay interest on an annual or semiannual basis. In most cases, the bonds provide a premium because they offer no call feature, which prevents districts from refunding the bonds for a lower interest rate or from restructuring should tax growth accelerate. Some districts have also come under public fire for offering higher coupons to generate more proceeds upfront or driving up borrowing costs by issuing CABs with balloon or bullet maturities.
Moody’s said for some districts’ CABs offer a solution to their financing needs. Often, its districts that are at or near their statutory debt limit and face immediate needs for additional facilities to accommodate rapid enrollment growth. Furthermore, these districts are often asked by voters to build new schools and maintain low student-to-teacher ratios while having little to no impact on tax rates. Additional funds generated at sale when bidders offer more funds than the face value of the bonds. For example, a bond with a $1 million par value that creates $1.1 million of proceeds has generated $100,000 in premium.
