It might feel as if getting a bond rating for your district is a sign about how good or bad your teachers and schools are, but at the heart of it, those letters are just a measure to investors of how risky it is to lend a district money. Get beyond the voodoo of it all, and with some hard work, you can have a great impact on how bond-rating firms see your financial health.
"The bottom line for your rating is: What is your ability to repay?" says Don Smith, the building fund director for Academy School District 20 in Colorado Springs, Colo., with 30 years of experience in the field. "Every bond issue is a unique experience, but any time you can make a small step in your rating, you can save a considerable amount of money."
Anyone willing to lend your district millions of dollars over 15, 20, 30 years (typically banks, insurance firms, pension funds-any institution looking for a steady, secure return on it's investment) wants to ensure the district won't default on the loan. To provide independent confirmation of how much risk is involved, school districts turn to one or more of three big firms-Moody's Investors Service, Standard & Poor's, and Fitch Ratings-to provide a rating.
Each firm has its own rating methodology. Standard & Poor's best rating, for example, held by just a handful of districts nationwide, is AAA. Then comes AA, A, BBB, BB, and so on, with each possibly amended with a plus or minus. Moody's highest rank is Aaa, then Aa, A, Baa, Ba, B, and so on, with its letters possibly amended with a 1, 2 or 3. Regardless of the type of letters, the idea is the same underneath: Each firm does research on the economic strength of the district, including a review by a rating committee, and provides its best guess as to how creditworthy the district is.
When it comes time to sell a bond, lenders are willing to get a lower rate of return for a more desirable loan. The rate your district gets for its bonds is connected not only to your rating but how much you want to borrow, for how long, the interest rate environment and other factors.
Whether your school district has just passed a new bond referendum or is considering refinancing a current bond, there is no hard-and-fast rule about how much you can save by improving your bond rating. But a quick hypothetical example helps show why the rating matters. Let's say your district wants to sell $50 million worth of bonds amortized over 20 years. If the district has an A rating-a solid investment grade-perhaps you can borrow at 5 percent, and the debt service would be $4 million a year. If you can get your rating up to AA, you probably would be able to save at least 15 basis points (100 basis points equal one percentage point), making the rate 4.85 percent. It would save roughly $900,000 over the life of the bond.
Many factors that bond rating firms use to rate a district are essentially outside an administrator's control: the diversity of the local tax base, the employment rate, median household income, enrollment patterns. However, district officials do have power over other parts of the ratings formula and can even mitigate the impact of the demographic and economic factors.
Get Fiscally Healthy
Personal credit ratings are based on how much a person owes, how much that person earns and how he or she has treated creditors in the past. To a large degree, your district's bond rating is no different. "You have to have sound financials," Smith maintains.
Pay down existing debt, he adds, such as any debt to vendors or if there is a gap between how much was brought in last year versus how much was spent. "Make sure there are no surprises-no unfunded liabilities like pension obligations that will come due during the life of the bond."
The School District of Hillsborough in South Florida recently raised its bond rating one level to Aa2, making it one of only two districts in the state to have Moody's highest rating. Gretchen Saunders, the district's chief business officer, gives most of the credit to the district's ten-year campaign to build an embargoed contingency fund balance of $79 million. By saving a little each year, including large one-time payments such as from Pepsi for the right to sell soda at the schools, the district has created a rainy-day fund that can only be touched during an emergency or for unforeseen circumstances. There is no law preventing districts from using contingency funds for anything it wants, but that's not financially sound. Not only did the financial stability impress Moody's, but it also is comforting for a district to have a reserve. "We're the largest employer in the county; a lot of people rely on us to be able to make payroll every month," Saunders says.
Even if you can't imagine having the resources to put millions away, your district can have a big impact on its bond rating through the budgeting and planning processes. Your team's foresight, organization and level of responsibility are being judged, and policies that help reduce the likelihood of credit deterioration get high marks.
"If you can make movement to deal with a problem like a high debt load, that's so important," says John Musso, the executive director of Association of School Business Officials International and a veteran of managing two dozen bond issues at the district level over the years. To lower its debt, a district can raise taxes, outsource work, fire teachers, cut administration costs-anything that pares away at how much it owes.
"Sometimes it's as simple as having a board policy to do things right, or showing that you reacted in a timely manner to a budget issue," Musso says. "Use multiyear financial forecasting to show that you're thinking clearly about the future."
The benefits of something like multiyear financials-which project the income and expenses of a district for several years to come-go beyond just getting a better bond rating. They can be a valuable tool to ensure the district is financially sound.
Put Your Problems in Context
If your district is facing declining enrollment, if local residents generally don't make much money or if voters have been unwilling to pay for schools, the rating agencies know it. Don't try to hide your district's weak points; get in front of them instead. "There are a lot of outside factors that are difficult for us to control, but if we're knowledgeable about it and show that we understand the total community, that matters," Musso says. "If you identify that, yes, there's a problem, but we have strategic steps to overcome it-that can be the difference between a full rating or a plus or a minus."
Be prepared to show the town's economic development plan, for example, or describe in detail how a new housing development is going to impact enrollment.
And no detail is too small, even for a district where things are going well or that is among the larger districts nationwide. Saunders says that her district, the nation's eighth largest, had an explanation for why one school had three classes that didn't meet minimum standards for class size. It's the level of detail that will make a difference. "If there's an issue," she says, "have a solution."
Make a Good Impression
Once the paperwork is in order, district officials present their case to the bond-rating agency, typically in New York. Don't assume that the paperwork you've compiled will speak for itself-the presentation matters.
You don't need a dog-and-pony show, but be sure to point out clearly the factors that you think are relevant but might be missed. And be ready to answer the hard questions. "If there's an issue, it looks better when we don't have to ask about it, and [it looks better for the district] when there's a detailed plan," says John Kenward, a credit analyst with Standard & Poor's.
One option is to ask the ratings team to come to your town for the presentation. "The local economy is very important from our point of view. So actually seeing the situation on the ground, if it's in flux but elements are growing or recovering, that can be helpful," Kenward says.
Another option: Widen your presentation team to include local chamber of commerce members, staff from the mayor's office, school board members-anyone who can speak authoritatively about the community's status. Doing this brings more depth of knowledge to the table and also shows that the district has support and is working hand-in-hand with many local decision makers.
Once the presentation is over, you'll receive a call with the contingent rating. If it's less than what you had expected, the game is not over. "That's when you can negotiate," Musso says. "You absolutely can say, 'We were hoping for an AA rating. What were our deficiencies?' Once you hear what they focused on, be willing to say, 'I must not have been clear enough about those issues,' and reiterate whatever you can to make your case."
There is a good chance that several team members assigned to rate your district were not present at the presentation, so it's reasonable and expected that you provide a polite and comprehensive explanation of how you're handling the problems they identify.
Rating insurance is another area of possible savings. Several firms specialize in providing the policies, which will provide the lender full compensation if the district can't make the bond payments. By shifting the risk of default to the insurer, the district essentially is guaranteed an AAA rating, but the policy cost may not be worth it.
"It all comes down to a cost-benefit analysis. What matters to the district is the difference between how many basis points will the interest rate drop and the cost of the insurance," says Mary Harris, an assistant professor at Cabrini College in Radnor, Pa. who coauthored a study of the bond rating process of nearly 150 school districts.
The insurance market fluctuates, just like the interest rate environment does, so don't assume you will or won't get insurance until you've run all the numbers. "If I can move up one rating, what does that do to my cost?" Smith says. "I've seen periods where it was foolish not to buy insurance, because it was so cheap."
In the end, such pragmatism is your greatest ally when entering the bond market. Balance the costs and benefits; even paring down your district's debt can be a misstep if that debt is necessary now. If you can make the bond rating process work for you, instead of you working for it, you'll be in great shape.
Carl Vogel is a freelance writer based in Chicago.