BRADENTON, Fla. - A Kentucky school district wants bondholders to focus on its fiscal strengths amid a pension crisis that spurred the downgrade of an important state credit enhancement program.
As the Scott County School District prepared to finance a much-needed high school, it obtained its own underlying rating rather than relying solely on the state’s enhancement program.
“We’re certainly hoping this latest rating helps in the first week of September when we sell these bonds,” said Superintendent Kevin F. Hub.
The district obtained an underlying rating last year, amid persistent attention on Kentucky and its low pension funding levels.
Moody’s assigned its Aa3 rating to the bonds the district will issue through the Scott County School District Finance Corp. It assigns the school district its Aa2 underlying rating.
The district's decision to obtain its own rating foreshadowed Moody's Investors Service’s July 20 downgrade of the Kentucky School District Enhancement Program to A1 from Aa3, at the same time the state’s issuer credit rating was lowered to Aa3 from Aa2.
The downgrade reflected Kentucky’s revenue underperformance and the state’s “very low pension funding levels,” Moody’s said.
On Sept. 7, the Scott County School District Finance Corp. will price $58.4 million of lease revenue bonds competitively to finance a 1,500-student high school to supplement over-capacity facilities in the fast-growing county north of Lexington.
The underlying rating offers prospective bidders more information about the district’s finances that will help them conduct their own analysis, according to financial advisor Chip Sutherland, a managing director in public finance with Hilliard Lyons.
Even if an enhancement program is unrated, it still offers value for investors, Wells Fargo Securities Senior Analyst Roy Eappen said in a June 23 commentary.
“Bondholders benefit from the layer of protection such enhancement programs provide in the event of default or potential default,” he wrote.
In Kentucky, many of the state’s 173 school districts have relied on the ratings of the state’s pre-default, state-aid intercept enhancement program to make their case when accessing the bond market.
Hub said he believes fewer than 10% of the state’s public school districts have underlying ratings. But a move is afoot to advise districts on the benefits of getting their own credit ratings as they prepare for issues that could arise while the state’s pension problem persists, Sutherland said.
One such issue, he said, arose after Moody's downgraded most of the state’s credits July 20, including the Kentucky Public University Intercept Program rating, which was lowered to A1 from Aa3.
The next day, Moody’s placed eight Kentucky public universities and colleges, one foundation, and their $1.9 billion of rated debt under review for downgrade to evaluate “the financial and governmental linkages” between the state and the relative positioning of its public universities, lead analyst Mary Cooney said.
The affected entities are the University of Kentucky, the Kentucky Community and Technical College System, Eastern Kentucky University, Murray State University, Northern Kentucky University, the University of Louisville and its foundation, Morehead State University and Western Kentucky University.
Moody’s said it is evaluating the relationship between the state and those entities, assessing state appropriations for their operations, cost of post-retiree benefits funding, and capital as well as state-appointed boards. The review also includes expected fiscal 2017 operating results, the 2018 budget, and projected fall enrollment. Key rating drivers will be liquidity, cash flow, reserve levels, expenditure flexibility, leverage and plans for additional debt, Cooney said.
The ratings of many enhancement programs tend to move in line with state government ratings, according to Eappen, whose Wells Fargo’s report was released before Kentucky was downgraded.
“To the extent that state credit quality continues to be challenged, there is a greater likelihood for downward rating actions attached to such enhancements,” Eappen said. “There are more instances of bonds with an underlying rating that is either equal or greater to the credit enhancement it may carry.”
Eappen cited the University of Kentucky, which is currently rated Aa1 by Moody’s and under review.
At the time of his report, the Kentucky Public University Intercept program was rated Aa3.
Sutherland said his firm began advising public school districts to seek their own ratings partly because of how investors have conducted their own credit analysis of underlying creditworthiness since the recession. Their analysis also focused on bonds wrapped with credit enhancement such as insurance or dependency on a state enhancement program.
“With increasing regularity, investors began to dig deeper to analyze an issuer’s credit absent any enhancement,” he said.
On top of that, he added, Kentucky’s public pension problems unfolded.
“In fact, investors were starting to shy away from Kentucky’s public school issuers altogether whose bond ratings solely depended on the credit enhancement provided by the Commonwealth,” Sutherland said. “We wanted to get those investors back because we know there are lots of pockets of credit strength in Kentucky.”
Obtaining underlying ratings, he said, is a step towards helping investors take a deeper look into those credits.
The Scott County School District will be one of the largest Kentucky public school financings in the market since Moody’s downgrade of the state enhancement program.
The superintendent said he hopes the strategy of obtaining an underlying rating last year will interest more competitive bidders in the school’s transaction.
“It was great that our partner at Hilliard Lyons suggested last year that we embark on this process,” Hub said. “Last year, it enabled us to get better financing on our current bonds, and that helped our debt ratios.”
Since the district has spent this year creating a financing plan to relieve overcrowding, Hub said he also hopes the district’s story will interest potential bondholders.
“It’s a story of a community that’s been trying for 20 years to get a second high school,” Hub said, adding that prior superintendents and school boards were unsuccessful in raising the taxes to finance new construction.
With the need for a new high school and other schools growing more urgent, Hub said he and the current board showed the community enrollment trends to enlist support for raising taxes by 5.7 cents per $100 of assessable tax value. The increase, unanimously passed by the school board, goes on tax bills this fall. It will back the new bonds pricing Sept. 7.
“Because of our heavy and consistent growth, we just need to keep building schools,” Hub said.
The district’s enrollment is steadily increasing by more than 100 students per year, according to Moody’s. It currently has 9,100 students enrolled in elementary, middle and high school.
Scott County had 4.5% unemployment in June, compared to 5.7% for Kentucky and 4.5% for the nation. The region is poised to continue growing.
Toyota Motor Corp.'s largest vehicle manufacturing plant in North America is in Georgetown, the county seat. Toyota currently employs more than 8,000 people, and announced a $1.3 billion expansion this year that will increase the number of employees.
“This helps to showcase what we have here, and helps illustrate what a strong community this is for business and economic support,” Hub said, adding that the Toyota facility has spurred satellite industries offering new jobs.
The Scott school district will issue fixed-rate, 20-year bonds with serial and term maturities. Steptoe & Johnson PLLC is bond counsel.
Proceeds will be used to construct the 240,000-square-foot Great Crossing High School.
Moody’s said the district’s Aa2 long-term issuer rating reflects its above-average income profile and stable reserves as well as its sizable and growing $4.7 billion tax base, which benefits from its proximity to Lexington and the University of Kentucky.
“Budgetary pressure due to the district's participation in the Kentucky Teachers' Retirement System and the Kentucky County Employees' Retirement System pension plans will remain manageable,” Moody’s said.
Moody’s said its adjusted net pension liability for the district is $38.9 million as of 2016 or a modest 0.5 times operating revenues.
With Kentucky’s pension plans among the worst-funded in the nation, Gov. Matt Bevin has said he plans to call a special session soon to deal with pension reform at the state level.
Hub said the district is pricing next week in order to start construction this year and complete the new high school by August 2019.
“We’ve committed funds annually in our budget to cover retirees,” Hub said. “We do that every year without exception. The Kentucky General Assembly hasn’t continued to fund that obligation every year.”