CHICAGO — Moody’s Investors Service late last week downgraded two of five Wisconsin school districts, citing fiscal pressures posed by risky investments in collateralized debt obligations with a credit default swap to fund their other post-employment benefit liabilities.
Moody’s affirmed the ratings of three of the districts, but all five remain on the agency’s watch list for a possible downgrade as analysts await action by the schools to make good on their moral obligation to repay notes issued to fund the failed investment.
The agency downgraded West Allis-West Milwaukee School District’s general obligation rating two notches to A3 from A1 on $19.5 million of debt and downgraded Whitefish Bay School District’s rating one notch to Aa3 from Aa2 on $710,000 of debt.
Moody’s affirmed Waukesha School District’s A2 GO rating on its $12.3 million of outstanding debt; Kimberly School District’s A1 rating on $55.2 million of debt; and Kenosha School District’s A1 rating on $145.7 million of debt.
Depfa Bank PLC last month formally demanded repayment of its $165 million loan to the districts, calling on them to make good on their moral obligation pledge to repay the notes used to establish trusts to help pay their OPEBs. The bank also seized the meager $5.3 million that remained in the trusts. Depfa’s request for repayment is pending before the board of each district, leaving members to decide whether to include repayment in each district’s fiscal 2011 budget.
After the Depfa action, Moody’s put the credits on negative watch due to “uncertainty about the districts’ willingness and ability to meet the obligations” of their trusts. Analysts took their latest action after a review of each district’s ability to meet the obligation.
West Allis issued $72.4 million of notes with $60 million still due, amounting to 70% of its operating budget. “Given revenue-raising limits on Wisconsin school districts and insufficient liquidity in available reserves, the district is unlikely to be able to meet its obligation in the upcoming fiscal year, even if it is included in the budget,” analysts wrote.
The district could turn to long-term bonds to meet the obligation, but that could pose a challenge to its operating expenditures.
Whitefish Bay’s trust issued $9.7 million of notes. While the district has the funds available to repay the debt, Moody’s chided the district for taking such risky action.
“The rating action is due to the district’s failure to adequately assess the risks associated with tying its moral obligation pledge to the performance of a high-risk investment, an action uncharacteristic of the district’s previous high Aa2 rating,” analysts wrote.
The district could tap $6.7 million that has been allocated for future post-employment benefits and it has sufficient liquidity in its general fund balance of more than $6 million to close the gap. The district could also issue long-term bonds without the principal and interest payments significantly pressuring its general operations.
The three districts whose ratings were affirmed are also in a better position to repay the notes.
Waukesha’s trust issued $50 million of notes with $47.5 million still outstanding, which represents 35% of its operating budget.
“Given improvements in the district’s basic credit characteristics, we believe the A2 rating incorporates the district compromising its operating budget by tying its moral obligation pledge to the performance of high risk investments,” Moody’s wrote.
The district, however, would be hard-pressed to meet the liability through debt issuance without comprising other operating expenditures.
Kimberly issued $4.3 million of notes, or 11% of its operating budget. The district has over $2 million allocated for future post-employment benefits that can be used to meet the district’s obligations and has sufficient liquidity in its general fund balance of almost $7 million. The district could also issue long-term bonds to meet the obligation without significantly pressuring its general operations.
Kenosha issued $28.4 million of notes, which amounts to 12 % of its operating budget.
“Favorably, the district expects to have $5.5 million at the close of fiscal 2010 allocated for future post employment benefits that can be used to meet the district’s obligations,” Moody’s wrote.
The district could issue long-term bonds to meet its obligations without significantly pressuring its general operations.
The schools thought the investments were safe in 2006 when they entered into the transactions and claim they did not know they were exposed to subprime or other market risks. When the subprime real estate market collapsed and the value of other structured securities fell, the value of the trusts dwindled. The trusts went into default in December 2007 and the districts were required to cure the defaults, but did not take any action.
The districts have sued the firms that proposed and structured the trusts — Stifel, Nicolaus & Co., James Zemlyak, an executive vice president at the firm, and the Royal Bank of Canada Europe Ltd. — alleging they fraudulently misrepresented the safety of the investments. The firms counter that the districts were aware of the risks.