Credit crisis impairs school funding streams. Bailout proposal could improve ability of schools to finance construction, bonds

October 3, 2008
By Frank Wolfe

As the nation’s credit and financial markets navigate turgid waters, the success or failure of a proposed $700 billion bailout of financial institutions could also have an effect on school districts nationwide.

In addition, the huge bailout likely will mean that Congress and a new administration will be under pressure to rein in domestic spending, including education.The Senate approved the bailout package by a 74-25 margin Wednesday, and the House is expected to consider the legislation today.

Already cash-strapped by the inflationary pressures of rising gas and food prices, schools in the last several weeks have been faced with inaccessibility of cheap credit for capital improvements to schools — bonds typically viewed as secure.

As a result of the credit crunch, institutional investors have been demanding higher interest rates on long-term 20-year tax-exempt municipal bonds used to finance school construction, and municipal bond issuances across the country have been delayed or eliminated. In the last several weeks, the rates on the issuance of such bonds have jumped from 4.5 percent to 5.3 percent.

In Maine, School Administrative District No. 51 officials decided this week to delay a $14 million bond for improvements at Greely High School in Cumberland. The district may try to reissue the bonds in early December, when officials hope the market will be more stable, said Joe Cuetara, a financial advisor on the Greely issuance and a senior vice president at the Boston-based Moors & Cabot Investments.

“The problem is we have no liquidity,” Cuetara said. “It’s not credit risk. It’s liquidity risk . ” School districts are increasingly faced with difficult financial choices and must meet daily operating expenses, like payroll, while delaying higher-priced construction of schools and libraries.

In Colorado, school officials fret that a November ballot measure to approve $2.5 billion in construction bonds for 25 school districts may fail and that the same problem as in Maine may arise — the bonds will not find a buyer at affordable interest rates.

“This credit crunch is the newest wrinkle in the worsening economy,” said Ed Kealy, the executive director of the Committee for Education Funding. “A lot of school districts are in their planning process for the next budget cycle. They were beginning to face concerns about the more general problem of the worsening economy. Now it’s been compounded by the unknown and the scale of the bailout. It’s a new phenomenon.

We’re not sure when it’s going to be resolved.” Cuetara said the $700 billion bailout, if passed, will likely stabilize the credit markets and bring long-term bond rates down to a more affordable 5 percent by November.

Steve Larson, a senior financial advisor at the Illinois-based Ehlers & Associates Inc., advised several school districts in Illinois, Wisconsin and Minnesota to not pay the
higher rates and to delay their bond offerings. In one example, the 30,000-student Plainfield (Ill.) Community Consolidated School District 202 delayed a $13 million bond issuance.

Extra vigilance

School districts must now be extra vigilant about their finances, because failure to do so could lead to a downgrade of their credit rating by Moody’s or Standard & Poor’s, thus limiting their ability to borrow money for capital improvements.

“Some bond insurers have lost their AAA rating,” Larson said. “The credit rating of the school district is now as important as it ever has been. An ‘AA’ rating is now worth a lot more than an ‘A’ rating. Investors are looking for quality without insurance, and they have to look at what the credit agencies are saying about school bonds.”

Inflationary pressures and the upheaval in the home mortgage market have left school districts with increasing worries about repaying debts, said Deborah Rigsby, director of federal legislation at the National School Boards Association.

“State and local governments are seeing a decline in property tax and sales tax revenues, which are used as bond repayment,” she said.

The Built by Bonds Coalition — a group of financial associations, including the National Association of Counties and the Government Finance Officers Association — advised Congress to endorse so-called “advance refundings,” which would allow state and local governments to refinance their bonds when interest rates drop.

Under the 1986 tax law, governmental and 501(c)(3) tax-exempt bond issuers may “advance refund” outstanding bonds.