LOS ANGELES — S&P Global Ratings will stick with its established methodology for rating general obligation school bonds in California.
Other rating agencies have moved to rating school GOs using factors other than general fund and operations, but for S&P the focus remains on fundamentals.
S&P issued a report Wednesday.
“We have received a lot of questions from investors asking if all California school districts are the same and should they just look at revenues,” said Jenny Poree, an S&P Global analyst.
And to that, S&P says, “no.”
“While certain features of the California school district sector – such as the statutory lien; the role played by the county; the ‘lockbox of funds’ — can lend some protection to bonds in the sector, S&P Global Ratings continues to believe that credit fundamentals are the primary determinant of ratings,” S&P analysts wrote.
None of the rating agencies are providing blanket ratings on all school districts based on assessed valued versus operations, but some rating agencies give more weight to a school district’s assessed value and the property tax base that supports taxes levied to repay GO debt.
Fitch Ratings began evaluating districts in a bifurcated manner after Orrick, Herrington & Sutcliffe, San Diego Unified School District’s bond counsel, provided rating agencies with legal opinions about bankruptcy risks ahead of a November 2015 bond sale.
California has three unique characteristics that bond attorneys have said provide reassurance in bankruptcy. The first is there are limitations through Assembly Bill 1200 to prevent a school district from entering bankruptcy. The next is that Senate Bill 222, adopted in 2015, says that local GOs would be treated as a statutory lien in bankruptcy, which makes the bondholders a secured creditor. And, third is that the bonds would be treated as special revenues in bankruptcy, which means the bondholders could continue to receive payments during the pendency of the bankruptcy.
Fitch told the Bond Buyer in March 2015, however, that it would need a special legal opinion in order to issue a general obligation bond rating on a California school district based on its assessed property values, as opposed to its general fund and operations.
Such opinions led to Fitch assigning AAA or AA-plus underlying general obligation ratings to bonds issued by several California school districts that have lower issuer default ratings.
Fitch still rates each school district on an individual basis.
Moody’s Investors Service, Kroll Bond Rating Agency and S&P all took the legal opinions into account, but Fitch gave the opinions the most weight.
S&P’s report seeks to clarify its view on the issue.
“We have continued to receive a lot of questions from issuers on the statutory lien and special revenue designation,” Poree said. “We wanted to put out something to the market that would make our views more transparent.”
While California school districts have extra protections through AB1200 and a lock-box mechanism where counties can pay bondholders directly, there are no guarantees, S&P analysts said.
S&P acknowledges that Assembly Bill 1200 makes it unlikely any school districts will file bankruptcy, but a distressed situation could still result in some kind of debt restructuring.
If a California school district were permitted to file for bankruptcy protection, the court could permit bond terms to be altered as it has in other proceedings, said Jane Ridley, an S&P analyst.
“We have seen in Detroit and Puerto Rico, in bankruptcy, or a distressed debt situation, you can’t be confident about what will happen,” Ridley said. “That is why we focus on the credit fundamentals and what the likelihood is that they will be able to repay the debt.”
California counties can provide a lockbox to school districts wherein bond payments are collected from taxpayers and go directly to bondholders, but they are not required to
S&P pointed to El Dorado County, in the Sierra Nevada mountains east of Sacramento, which no longer handles the payment of principal and interest for its school districts. El Dorado Union High School has had two instances of delayed debt payments, S&P analysts wrote.
“There is uncertainty,” Ridley said. “That is the issue. You can do the lockbox, and all of the other things, but it comes down to financial operations and the ability of school districts to operate and repay the bondholders.”
Even so, the S&P analysts acknowledged that AB1200 has been “battle-tested” and shown to work to protect school finances. In addition to preventing school districts from entering bankruptcy, it also gives the state Department of Education the ability to take over school districts that are struggling financially.
The analysts partly credit the law for why a large majority of the state’s school districts endured California’s fiscal crisis with their credit quality intact.
“In short, while we give little weight to the structural or security features of a transaction, we believe that AB 1200 has had the effect of improving the management and supervision of districts across California,” S&P analysts wrote in the report.
As a result, they expect upgrades to exceed downgrades over the next one to two years.