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New Jersey School District Credit Ratings – You’re On Your Own Now!

Like everything else related to the economy today, New Jersey School Districts’ Credit Ratings have entered a new era. Gone are the days when school districts could comfortably sell their bonds using the State’s credit enhancement program. The program rating is still there, it just isn’t worth what it used to be…like so many stocks in the Dow Jones Industrial Average! Consequently, it is important that Business Administrators do everything they can to secure the ratings and credit enhancement deemed necessary and structure the bonds appropriately to attract investors. This article, although meant to advise generally on rating presentations, will specifically refer to the parameters used by Standard and Poor’s rating agency.

Pre Economic Crisis…

Since 1972, all New Jersey School Districts were guaranteed an “enhanced” bond rating that was commensurate with the State’s bond rating, most recently AA and Aa2 respectively from Standard and Poor’s and Moody’s rating agencies. At that time, a trust fund was established entitled  the “New Jersey Fund for the Support of Free Public Schools”. This fund guarantees the repayment of school bonds. It maintains a balance equal to a set percentage of outstanding school bonds, and if a district were to default on a payment (which has never been done in New Jersey) the fund would be available to pay the bondholders. The resulting credit rating allowed New Jersey school districts to secure favorable interest rates in the bond market. So, whether the district had an operating deficit or a fund balance surplus, the district was guaranteed at least a AA rating based on this School Bond Reserve Act, or Chapter 72 as it is also known. 

Post Economic Crisis…

The recent economic crisis has changed the way the market perceives enhanced bond ratings.  Although New Jersey school districts are still entitled to the same enhanced rating, investors are now “looking through” enhanced credit ratings to the issuer’s underlying rating and basing their interest rate bids on the financial merits of the issuer. The result is that New Jersey school districts, in addition to the enhanced rating, are now advised to obtain an underlying credit rating based on the results of an evaluation of the district’s financial operations. And at least one of the agencies, Standard and Poor’s, also completes a Financial Management Assessment (“FMA”) as part of the rating evaluation.

Rating Agency Presentation, Part I - Financial Assessment

It is important to understand that the rating analyst will have reviewed the district’s audited financials for the past three years prior to the rating discussion. The analyst also will be familiar with any major events concerning the municipality (ies) covered by the district and/or school district itself hat might have generated headlines in the past. You can expect to hear questions as simple as “I see that your fund balance has been decreasing in the past three years” to something specific like ”we understand that the teachers have not had a contract for eleven months and the sticking point is contributions to medical benefits.” However, the primary topics included in the financial assessment discussion are budget results, enrollment projections, economic changes and capital planning. The business administrator should be prepared to discuss historical trends as well as future projections for each of these areas.

The rating analyst will question any variances in budget versus actual for revenue and expenses. There will also be inquiries concerning year-to-date spending and projections for year end results and reserve levels. Any extraordinary budget items that are anticipated in the near future, i.e. a settlement of litigation, a higher number of anticipated retirements or increased expenses from a new school opening would be included in the discussion.

Also included in the list of items to be discussed is an evaluation of economic growth, residential housing, largest taxpayers and enrollment projections in the district. The business administrator should be familiar with any recent or proposed changes in the list of the largest taxpayers. Although this item is more relevant to a municipal government than a school district, the loss of an assessment resulting from the closing of a large taxpayer’s operations will ultimately have an impact on a district’s tax rate. If, for example, many of the employees of a particular business live in the town in which the business is located, there could be an effect on student enrollment if the business ceases to operate or relocates a significant number of employees. A drastic change in the housing stock of a town that previously experienced a housing boom will affect a school district with enrollment changes as well as ratable base changes, and this should also be disclosed to the rating analyst.  Evidence of foreclosure activity may also be addressed.

Any State or local policy changes that affect enrollment should be disclosed. A change in policy for pre-school programs or the implementation of full day kindergarten and its affect on the budget and enrollment would also be included in the financial assessment of a district.         

Rating Agency Presentation, Part II - Financial Management Assessment (FMA)

Standard and Poor’s rating agency includes an evaluation of the district’s financial management as part of their rating process. This portion of the review allows a business administrator to demonstrate management strengths which can ultimately result in more cost-efficient operations. 

Even though many constraints are placed on districts through the State budget guidelines, the results of financial operations will generate questions that the rating analyst will want answered. For example, the fact that the State limits the amount of surplus a district can carry does not prohibit the analyst from asking whether the district has a policy on surplus. The correct answer should be something like the following:  “The State only allows us to carry a 2% surplus, but I would like to have 3% of operations as my surplus. Additionally, since the State has allowed us to establish an emergency fund as well as a capital reserve fund, I try to budget as much as I can in each of those funds.” 

Some other management questions focus on budget monitoring and year end budget projections. The analyst will be interested to know if the business administrator completes a multi-year revenue and expense forecast. You will be asked about any reports that are used for budget monitoring and whether they are submitted to the board on a monthly basis, for example. The analyst will also be interested in reports for cash flow and capital planning. Even though the State only requires a 5 year capital plan, any internal capital planning, even one done on an informal basis, should be disclosed to the analyst. Although New Jersey school business administrators are hamstrung in many ways regarding the structure of their budget as well as spending constraints, making the most of your sometimes limited options will exemplify your management ability and will increase your chances to procure a high rating for your school bonds.       

By providing this information to the credit rating agency, the district’s bond rating can be affected positively by the diligence of the business administrator in showing that he or she is a good manager who monitors the budget, keeps the board members informed on a regular basis and is prepared to deal with unexpected problems that could be uncovered by these practices.  Taking a more proactive approach in obtaining a credit rating will allow the district to obtain the best underlying rating for the district and in turn save on interest expenses when bonds are offered for sale.