1. finance
2. personal finance
3. debt management

6/9/2013
How to Maintain and Improve Your Bond Ratings
10 Keys to Establishing and D
Documenting Effective Management ti Eff ti M
t
Practices
Presenter
• David Webb is the Chief Financial Officer for D
Deer Park ISD…until June 30, 2013
P k ISD
til J
30 2013
• On July 1, he will retire from school business after 26 years and go to work for George K. Baum and Company, a municipal bond underwriting and financial advisory firm.
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Introduction
• A district’s bond ratings are important for many reasons. First and foremost, the ratings communicate to potential bond holders what a district’ss creditworthiness is. Second, ratings are integral in a district
creditworthiness is Second ratings are integral in
determining the ultimate cost of the bonds due to their impact on the net interest cost of the bonds. Finally, the bond ratings are a direct reflection of a district’s overall financial management practices and outlook for the future. • For many years, the bond rating process was a mystery. Recently, the rating agencies have been more forthcoming about their focus and the components of their rating process In an April 2009
and the components of their rating process. In an April 2009 discussion with representatives from all three ratings services, I
gleaned some specific information from them. Texas Bond Ratings
• The ratings firms have a unique system for rating municipal bonds. Most Texas school ti
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districts have an investment grade rating, meaning the rating agencies believe their bonds to be of high quality and worthy of bondholder investment. The following is a description of their rating systems and tables displaying the ratings given to Texas districts.
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Investment Grade
Ratings
# of Districts
Aaa / AAA
1
Description
Highest Rating,
Very Secure
Aa1 / AA+
Aa2 / AA
Aa3 / AA‐
High Quality, very
little difference from
Aaa / AAA
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55
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Investment Grade, con’t
Ratings
A1 / A+
A2 / A
A3 / A‐
# of Districts
109
140
150
Description
Good ability to pay
P&I, but may be
susceptible to adverse economic
conditions.
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Investment Grade, con’t
Ratings
# of Districts
B 1/BBB
Baa1/BBB+
122
Baa2/BBB
103
Baa3/BBB‐
61
Description
Ad
Adequate ability to
t bilit t
make P&I payments
at this time.
Non‐Investment 2
Grade Bonds
Ongoing issues or
Ongoing
issues or
uncertainties, vulnerable to default
Rating Agency Focus
• Rating Agencies focus on four primary areas in f
formulating their ratings…
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• Current Debt / Plans for Debt
• Financial Performance
• Current Economic Conditions
• Financial Management
Let’s discuss these four areas briefly…
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Current Debt / Plans
• Rating agencies will review a district’s capital plans for the bonds to be sold.
the bonds to be sold. • They want to know what projects the bonds will be used for and how much funding is apportioned for each project. • They will review the proposed repayment schedule and how it fits into the districts existing debt structure.
• They always want to know about future debt plans.
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• They also consider the overlapping debt from other taxing entities. The total debt burden on the taxpayers is a factor in rating a district’s bonds. Financial Performance
Rating agencies will review a district’s past financial performance, but they also want to know what the
performance, but they also want to know what the future holds and how prepared the district is for it. They look to see if a district’s financial performance has improved in recent years, and if it is likely that the district will maintain or improve its financial position over the next few years. The rating agencies do not perceive Texas school districts
The rating agencies do not perceive Texas school districts to have much financial flexibility, despite the fact that Texas districts have more reserves in fund balance than districts in other states.
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Current Economic Conditions
• The economy has an impact on a district’s financial outlook and ability to make bond payments.
outlook and ability to make bond payments. • Economic trends may alter taxable values, which impact both M&O and I&S tax revenues and tax rates. • Rating agencies review demographic data such as median wealth, unemployment rates and socio‐
economic makeup. • Important also are growth trends and projections in I
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enrollment and the diversity of the local tax base.
Financial Management
• An important aspect of a district’s bond rating is the overall financial management practices implemented
overall financial management practices implemented by Trustees and district management and stability in the district’s financial management. • The flexibility to make budgetary course corrections in mid‐year is also important. How a district deals with financial constraints – traditionally or creatively – is a key to the rating agencies’ evaluation. key to the rating agencies
evaluation.
• Investment practices are also important in the evaluation process. 6
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10 Keys to Sound Financial Management
There are a number of areas that the ratings companies review when evaluating the i
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financial management of a district. Building and maintaining sound financial practices worthy of a high bond rating, and documenting your district’s procedures and practices, can be accomplished by addressing ten key areas. Let’s discuss briefly…
1. Adequate Reserves
• Maintaining adequate cash reserves may be the most effective practice a district can implement to enhance its credit rating. Adequate cash reserves can protect against unexpected expenses or revenue shortfalls, and provide additional investment income if not needed during the year. • Cash reserves also protect districts from borrowing needs when revenues and expenditures fluctuate, sometimes significantly. • A written plan for achieving and maintaining these reserves is A itt
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necessary. Make sure your district has a plan for how much cash is needed to start each year, and document the plan as part of your budget document and in your District Improvement Plan. 7
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2. Multi‐Year Forecasting
• Developing a 5‐year forecast of state and local revenues and projected expenditures may be tedious and time‐
consuming, but it does paint a fairly clear picture of where your district may be in a few years, based on known or easily estimated assumptions. • Sharing these forecasts with rating agencies, during the bond review process or more frequently, and using this forecast as a starting point in the budget development process demonstrate that you have a long‐range outlook for your district finances and that you update it periodically. • It is a proactive financial strategy and a best practice to follow. 3. Financial Reporting
• Interim financial reporting during the year is important also. Many districts make financial reports to their
also. Many districts make financial reports to their board on a periodic basis. • Ideally, financial statements will look very much like the statements in the annual financial report. • Notes to the financial statements or other explanations are strongly suggested, even if they are not as extensive as the notes in the annual report
extensive as the notes in the annual report. • Districts that provide comprehensive financial disclosure on a routine basis are viewed more favorably by the rating agencies. 8
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4. Contingency Plans
• Districts adopt their budgets, hoping for the best and often expecting the worst. But few districts actually formulate contingency plans in case things go wrong
case things go wrong. • Taxable values can suddenly decrease, major taxpayers can file for bankruptcy unexpectedly, and interest rates can rise and fall sharply. Major equipment can fail, and we are all subject to weather‐related phenomenon like flooding, hailstorms, tornadoes and hurricanes. • Every district needs a written contingency plan. • Funds can be designated or reserved out of fund balance for such contingencies as well. Having these plans in place and documenting them concisely is important to the rating agencies. It is indicative of
them concisely is important to the rating agencies. It is indicative of pro‐active planning to mitigate the financial impact of a variety of potential disasters, and it provides stakeholders with assurance that a major portion of their local infrastructure will be restored quickly if such a disaster occurs.
5. Non‐Recurring
Revenues
• Certain revenues are clearly non‐recurring in nature. Auctions, a lawsuit settlement, the sale of land or a b ildi
building, or other non‐recurring sources of cash are h
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unpredictable. • Rating agencies review how much a district receives in non‐
recurring revenues, and also at the extent to which the district relies on these unpredictable sources of funds. • Reliance of more than 15% is NOT a favorable sign. However, when non‐recurring amounts of revenue are received, a specific plan for how the funds will be spent i d
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should be developed and communicated to all stakeholders. 9
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6. Debt Management
• Overall debt management encompasses 3 key i
issues. They are…
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a. Debt Affordability
b. Debt Disclosure Practices
c. Debt Avoidance
Let’s look at each one separately…
6a. Debt Affordability
• Rating agencies consider the development of a policy document or management statement that
policy document or management statement that documents the types of debt a district is willing to consider as a strong management practice. • Aside from voter‐authorized bonds, other debt instruments such as TAN’s or TRANS’s, QZAB’s, QSCB’s and Certificates of Obligation (CO’s) are debt alternatives.
debt alternatives. • Additionally, a comprehensive debt policy will discuss variable rate bonds and when or if they will be considered. 10
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6b. Debt Disclosure
• There are a number of debt disclosures that are required prior to issuing debt, and others that are required subsequent to the debt issuance. b
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• Our financial advisors do a great job of making sure that we comply with the minimal requirements for these continuing disclosures. The minimal disclosures required by GASB 34 and the SEC Rule 15c‐12, however, are minimal, and there is no reason why school districts cannot provide additional information. • Examples of additional disclosures include monthly cash E
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flow projections, a multi‐year history of tax levies and collections and sources and uses of short‐term borrowing. 6c. Debt Avoidance!
• Rating agencies view a “pay‐as‐you‐go” practice of capital acquisition favorably.
capital acquisition favorably. • Realistically, under the severe constraints of Texas public school finance, there are very few districts that can afford to pay for any significant capital improvements with current reserves. • However a “pay‐as‐you‐go” practice for smaller capital improvement items is a sound alternative to voter
improvement items is a sound alternative to voter‐
authorized bonds. Again, this is a practice that is indicative of pro‐active management and consensus between administration and elected trustees.
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7. Rapid Debt Retirement
• Rating agencies place a high degree of importance on the rapid repayment of debt. p y
• Matching the useful life of an asset to the accompanying debt is important, but a more rapid retirement plan is a definite plus in the ratings process. • The rule of thumb is to have 60% of total principal retired within the first ten years. Obviously, if a district is used to issuing debt and amortizing the payback over 20 years or more via a straight line method, this criteria will be impossible to meet. • Bonds used to purchase busses and other vehicles should be paid off within 10 years since busses have little more than minimal salvage value after that time. All technology expenditures should be amortized over 5 to 7 years. 7. Rapid Debt
Retirement, con’t
• . This “front‐loading” of debt repayments may cause upwards pressure on the tax rate, especially if the
upwards pressure on the tax rate, especially if the district’s values are not increasing at a significant rate. • However, rating agencies are wary of “back‐loaded” debt that needs to be repaid with revenues generated by future growth, which may or may not occur. • Having a written debt retirement policy that caps the final maturities of bonds to 20 years or less debt that
final maturities of bonds to 20 years or less, debt that matches the useful life of the assets purchased and a shift to 60% debt retirement in the first 10 years will enhance the district’s underlying bond rating.
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8. Capital Improvement
Plans / Cost Forecasting
• Every district has plans for capital improvements. • Facility directors know what buildings need new roofs, y
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plumbing, electrical wiring and HVAC equipment. • Superintendents and Trustees know which school are aging and in need of major renovation or replacement. • Business officials know what their limited options are for financing these projects. • However, few districts actually convert their capital plans into a written document complete with timelines and costs
into a written document, complete with timelines and costs and financing options. • Rating agencies look to see if there is a written, 5‐year plan and how often the plan is updated. This document will assist districts in enhancing their creditworthiness.
9. Awards / Recognitions
• Every district has their preferences for presenting annual budgetary information to the Board of Trustees. Conversely, the annual financial report to TEA is very standardized in its format
financial report to TEA is very standardized in its format. • Neither the budget documents we prepare for our Trustees or the annual financial report provide all of the data elements in one document that the rating agencies want. • ASBO and GFOA both have award programs for budget documents and annual financial reports that require an extraordinary level of detail, accuracy and consistency, both of which typically contain more information than otherwise would be presented in a typical budget document or financial report
budget document or financial report. • Rating agencies appreciate the valuable information in these reports, and receiving the awards from GFOA or ASBO gives them a strong degree of assurance as to the high quality of the data.
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10. GASB Compliance
• The rating agencies consider compliance with GASB pronouncements as imperative. • Fortunately in Texas, our auditors and TEA incorporate GASB F
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GASB
compliance into our annual audit. • At the top of the rating agency list of GASB compliance is GASB 45 –
accounting for other post employment benefits (OPEB). The first implementation date for this GASB pronouncement was in 2007, and it is being phased in over three years. OPEB disclosures may include post‐retirement benefits such as medical, dental, vision, life, long‐term disability, and will possibly impact debt ratios, liability disclosures and budget practices
disclosures and budget practices. • Rating agencies will want to review actuarial reports that estimate this liability, assumptions used to arrive at the actuarial estimates and the district plans for managing or reducing the liability over time. Summary
• Addressing these 10 factors and documenting your district’s plan for each will greatly enhance your chances to maintain or improve your bond rating
your bond rating. • Good financial management practices are critical to a district’s financial success. • Documenting the many practices, policies and procedures that are in place is critical to improving your bond ratings. • Communicating these practices during the ratings meetings and periodically during the year between bond sales is an effective way to keep the rating agencies apprised of your progress. Adopt these best practices, document them fully and communicate them to the ratings agencies, and you will make progress towards improving your bond ratings and saving your district money in the future. 14
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Q&A
• Questions and Answers
• Concerns and Discussions
• Sources of Information – Moody’s, Standard & Poor’s, Fitch, Municipal Advisory Council of Texas
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