Pennsylvania's intercept program to enforce the payment of school district bonds is a positive for investors, Janney Capital Markets said in a report.

According to Janney director Tom Kozlik, new treatment by Moody's Investors Service of the program's post-default enhanced ratings prompted the review.

"This is an important development," Kozlik wrote in the report.

Under the program, to which all school districts in the commonwealth are subject, the state's education secretary can withhold basic funding or state-aid payments from a school district that misses a debt-service payment and redirects the funds to the paying agent bank to the benefit of bondholders.

The program consists of two pre-default mechanisms and one post-default.

Moody's in September changed how it assigns enhanced ratings for the post-default program, known as Act 150 and the most commonly used intercept mechanism. "Post-default" refers to the intercept mechanism and does not mean a participant has defaulted.

Previously, all Act 150 issues received a rating two notches below the state rating and the rating moved in tandem with the state rating. Moody's now uses a "bottom-up" approach where the enhanced rating also reflects the underlying credit characteristics of the school district itself.

Moody's withdrew enhanced ratings on 38 issuers without an underlying rating and updated enhanced ratings for 160 others. It also withdrew its programmatic A1 rating of the intercept program itself.

"The post-default enhanced rating now reflects the underlying credit characteristics of the school district itself. The fact is the enhancement is not the underlying rating," Kozlik said in an interview Thursday.

Pennsylvania school districts typically receive between 10% to 78% of their overall budget from the state through monthly aid payments.

Moody's rates Pennsylvania's general obligation bonds Aa2. Fitch Ratings and Standard & Poor's rate them AA. The intercept program is not a general obligation of the commonwealth.

S&P still treats pre- and post-default mechanisms the same, two and three notches, respectively, below the state rating. S&P said in a report last April that it would not necessarily move in conjunction with state rating shifts.

Fitch last July lowered Pennsylvania from AA-plus, citing pension underfunding.

Kozlik recommends that school systems in pre-default intercepts use a fiscal agent, one of two system options. "Use of it has increased slightly but I don't know why more districts below the Moody's enhanced rating are not using this," said Kozlik.

"Underwriters and financial advisors do it and know the necessary constructs," he said. "In every environment you want to keep the cost of funding as low as you can, and especially in this one."

Kozlik also recommends that school districts strongly consider applying for an underlying rating, even if they expect to rely on the intercept.

"We advise investors to buy and hold school district bonds they believe offer a strong level of credit based on the underlying credit fundamentals, with the state enhancement providing an extra layer of credit protection," the report said.

David Fiorenza, a Villanova School of Business professor, said the program "should be viewed as an additional positive check for school districts and their bondholders and not overregulating."

Fiorenza, a former chief financial officer of Radnor Township, Pa., said an expansion of the program could help smaller districts statewide.

"Many smaller municipalities, under 10,000 population, would benefit from such a program as their finance and management staff may not have the volume of debt issues seen in the cities and authorities in the state," he said.

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