Recent Developments in Administration of School District Debt

By Mary Lyons, Capital Financial Advisors

The economic crisis of 2008-2009 changed many aspects of our equity and bond markets, beyond the problems of governmental deficits and declining tax revenues. For municipal bond issuers like New Jersey Boards of Education (NJBOE), the crisis has produced greater investor scrutiny and caution, tightened regulatory enforcement, and constricted credit. Three changes will impact both current and future NJBOE bond issues:

·  Changes at the Depository Trust Company (DTC) for making debt service payments;

·  An update on secondary market disclosure requirements;

·  A new criteria system for credit ratings.

Making Debt Service Payments – Changes at The DTC

For most New Jersey Boards of Education, payment of principal and interest to investors of outstanding bonds are made (although not always smoothly) through the DTC, a national clearinghouse for municipal and corporate securities that allocates payments to entitled investors on more than 3.5 million securities. In 2009, this amounted to almost five million payments totaling close to $3 trillion.

Currently, the DTC makes debt service payments to the registered holders of municipal bonds, regardless of whether it has received the funds from the paying agent or municipal bond issuer. However, beginning on February 7, 2011, the DTC will only pay investors those payments that it believes it has received on time from the paying agent or issuer and which have been identified properly at the CUSIP level. (A CUSIP is a unique alphanumeric identifier which is specific to a bond issuer and to the maturity for which a payment is being made.) If the DTC has not received the funds from the issuer or paying agent by 3 PM of the day on which the debt service is due or the funds have not been properly identified, the DTC will not pay the entitled investor, technically putting the bond issuer in default. This will reflect poorly on the issuer and may impact its credit rating as well as market reception for any future bond sales.

Dealing with the DTC under current circumstances can be arduous; when these new changes go into effect, paying your debt service in a timely manner may become even more demanding unless as a Business Administrator you are prepared.

Know what your debt service payments are, when they are due, and what CUSIP the payments should refer to. That is, the interest that you pay on a given date is the total interest due on the outstanding maturities from a given bond issue. Each one of those maturities has a separate CUSIP number and a portion of the total interest payment is due for each CUSIP. Typically, you will know the total interest or principal due, but not necessarily the amounts due per CUSIP. Knowing the latter is not necessary if your totals match those of the DTC. If not, you may need to have detailed back up. If you are uncertain as to your CUSIP numbers or require CUSIP level detail for debt service payments, your financial advisor or bond counsel should be able to assist you. The DTC sends out several types of notices prior to debt service due dates; however, they are sometimes sent to the wrong entity, or are not correct. DTC notices include Letters of Transmittal, or Redemption Payment Summaries for principal payments; and auto faxes for interest payments. Note that the notices are sent to the registered paying agent, which may not be the BOE.

Review any notices that you get before the debt service is due. Make sure they match what you believe you owe. Note that for a maturing or called bond, the DTC may include in its Letter of Transmittal or Redemption Payment Summary the interest due on that bond, rather than in the auto fax sent out for interest payments. If that is the case, be careful not to pay that interest amount twice.

Know who is responsible for paying your debt service. Usually a Board of Education acts as its own paying agent. In some instances, such as in the case of refunding bonds, an escrow agent is responsible for paying the interest and refunded principal portions of the debt service, and pays those amounts directly to the DTC. Sometimes, Escrow Agreements are written such that the escrowed funds are sent instead to the NJBOE. In other instances, the NJBOE has retained a separate paying agent (a bank) for a particular bond issue.

If the Board of Education is the paying agent, make sure the transmittal of funds is properly documented and is sent in a timely manner. If you act as your own paying agent, be sure your bank, which will be wiring the funds to the DTC, is up to speed on what information must be included on the wire detail. (The DTC has information on its website which details this process.) Make sure your funds are wired to the DTC on time and that your bank receives a wire confirmation.

Secondary Market Disclosure Requirements Update

Secondary market disclosure is a continuing requirement for all municipal bond issuers with outstanding long-term bonds that require disclosure. For most NJBOES, this means annually uploading your CAFR to a website maintained by the Municipal Securities Rulemaking Board, entitled EMMA.The uploaded files must be word searchable pdf files. The disclosure documents are hyperlinked to the bonds that the issuer has outstanding so that investors can look up information when they are making decisions on investments in the issuer’s debt. Underwriters have become increasingly diligent about requiring disclosure compliance in bonds for which they purchase through negotiated sale or on which they competitively make bids and concerned about issuers, which have not made their disclosures in a timely manner.

This concern stems from a May 2010 Interpretative Release from the SEC regarding amendments to rules within the Securities and Exchange Act, which govern secondary market disclosure requirements. According to the SEC, underwriters - which purchase municipal bonds in the primary bond market and re-offer them to investors in the secondary bond market – must reasonably believe that disclosure to secondary market investors is accurate and comprehensive. A history of material and persistent breaches in its secondary market disclosure obligations on the bond issuer’s part, the SEC warns, may undermine the underwriter’s ability to form such reasonable belief. By extension, this may suggest that underwriting firms will become reluctant to purchase the procrastinating issuer’s bonds.

Meeting secondary market disclosure requirements is a fairly simple process. If you are unfamiliar with EMMA, speak to your financial advisor, auditor or bond counsel who can help you fulfill your obligations, which must be met on an annual basis. Additional disclosure rulings may be forthcoming with regard to the prospectus issued when bonds are sold. The Wall Street Reform and Consumer Protection Act passed this summer and the recent SEC action against the State of NJ for pension program disclosure in one of the State’s recent bond offering documents would suggest that additional disclosure rulings might be forthcoming with regard to the prospectus issued when bonds are sold. Stay tuned.

New Criteria Systems for Credit Ratings

All three major credit rating firms - Fitch Ratings, Moody’s Investors Services and Standard and Poor’s - now use a global rating system for municipal bonds. This system attempts to assign criteria for municipal ratings that are similar to those for corporate ratings, theoretically boosting most municipal ratings due to lower default rates. The wide publicity that preceded the criteria revamping, combined with investor jitters, has created an environment in which investors scrutinize ratings more closely and strongly prefer highly rated municipal debt. For NJBOES, this may mean obtaining an underlying rating, based solely on the credit of the school district rather than depending strictly on the “AA” programmatic rating of the New Jersey School Bond Reserve Act. (For NJBOES whose underlying credit is less than “AA,” it may not make sense to pursue an underlying rating, depending on other variables.)

Additionally, a number of NJBOES have been contacted by their rating agency, independent of any new debt issue, and have had their ratings reviewed based on the new criteria. In many instances, their rating has been improved. Complicating the rating picture, the rating agencies have also raised a red flag over concerns about reduced state aid and the imposition of the new 2.0% CAP law ((P.L. 2010, c. 44)). For those NJBOES less dependent on state aid, this has been less of an issue than for those more dependent.

It is expected that credit concerns will continue for investors, spreads between highly rated issuers and poorly rated issuers will stay wide, and issuers without underlying ratings may not attract as many investors as those with such ratings. Be sure to consider these factors when developing strategies for bond sales.

Mary Lyons is vice president, Capital Financial Advisors. She can be reached at or 856-533-2314.