Letter to the Editor: Residents Concerned About Hen Hud Moody's Downgrade

The following is a letter to the editor from a group of residents in the It was addressed to Superintendent of Schools Dr. Daniel McCann, dated Feb. 6 and was emailed to Patch on Feb. 8.

Dear Dr. McCann:

We remind you that we are an independent, ad hoc committee of residents of the area comprising the Hendrick Hudson School District (the “District”) who are deeply concerned about matters relating to education and, more specifically, the provision of quality education on a cost effective basis (the “Committee”).  The Committee is informally aligned with a very large number of residents of the District who share our concerns and who recently expressed their concerns at the ballot box on December 14, 2011 by collectively the ill-fated $25 million bond referendum (the “Bond Referendum”).

In our last letter to you dated January 22, 2012, we disclosed that Moody’s downgraded the bonds issued by the District twice inside of an eighteen month period from July 2010 to November 2011 – a fact that the District had not chosen to share with the community.   We also noted that the District did not share the fact of the two downgrades with potential investors in the prospectus material it issued in connection with the issuance of $11.29 million of bonds on December 13, 2011.

In addition, the prospectus material for this bond issuance also discloses that the District purchased bond insurance from Assured Guaranty Municipal Corporation (“AGM”).  (Under such a contract, the bond insurer guarantees the payment of interest and principal to the holder of the bond if the issuer fails to pay.) The District never disclosed why it purchased the bond insurance and consequently, we do not know if the bond insurance was purchased to get the benefit of a lower interest rate or, more seriously, if the purchase of the bond insurance was a necessary precondition to selling the bonds due to the District’s weakened financial condition.

While the purchase of bond insurance is not at all unusual, what is unusual in this instance is that Moody’s rates AGM’s creditworthiness only one notch higher than the rating assigned by Moody’s to the bonds issued by the District.  For information, Moody’s rates AGM at Aa3 (negative outlook).

Prior to 2008, bond insurers were all rated triple A by both Moody’s and S&P.  If a bond issuer with an A1 rating such as the District purchased bond insurance, it would receive the benefit of the bond insurer’s triple A rating, including an interest rate reflective of a triple A rating.  That all changed when, in 2008, the bond insurance industry began to incur horrific losses stemming from the issuance of billions of dollars of financial guarantees on mortgage-related securities.   While AGM performed relatively well compared to its peers, it lost its coveted triple A rating as a result of losses.  Today, the bond insurance industry is a shadow of its former self.

Unlike its former competitors, AGM still has the capacity to write new business; however, as it would have been unthinkable prior to 2008 to purchase bond insurance from a bond insurer that was not triple A rated, the market perception is that the value of bond insurance purchased from a non triple A rated company is considerably diminished.

The credit enhancement, or insurance, provided by AGM resulted in only a one notch upgrade from the underlying A1 rating of the District’s bonds.  And if AGM is downgraded just one notch (a possibility given the negative outlook designation) the District would receive no benefit from the bond insurance as the rating on the underlying bonds will be equal to the bond insurer’s rating, all other things remaining unchanged.

So we ask: What was the benefit of purchasing the bond insurance?  Would the District have been able to issue the bonds at all in December 2011 if it had not purchased bond insurance?  If AGM is further downgraded, will the District have access to the market for the purpose of issuing new bonds and, if so, at reasonable prices?

Surely, as of December 7, 2011, the day the ill-fated Bond Referendum was soundly defeated, you must have known:

• about the requirement for bond insurance for the $11.29 million bond issuance on December 13, 2011;
• that if the $11.29 million bond issuance scheduled to launch on December 13, 2011 required bond insurance, that the bonds contemplated by the Bond Referendum would also require credit enhancement, or bond insurance. The Committee can recall no mention in any of the District’s voluminous presentation materials that bond insurance would be required in connection with the issuance of the bonds contemplated by the Bond Referendum;
• about the Moody’s downgrade action on November 23, 2011 which cited as factors that could make the rating go down the following: (i) inability to balance the operating budget, (ii) continued declines in cash and General Fund Reserves and (iii) significant increases in the debt burden.  And you must have assumed that the $25 million bond issuance contemplated by the Bond Referendum likely would have been construed by Moody’s as a “significant increase in the debt burden;
• that the District’s budget for 2012-2013 would require significant reductions from the prior year and that you would propose the layoff of many teachers and teacher’s aides in order to accomplish the required budget reductions in order to stay within the Tax Cap;
• that the District was facing a short-term liability to pay in excess of $400,000 in tax refunds in connection with tax certiorari claims, and that the District had no reserves or any other source of cash to pay these claims without issuing new bonds;
• that the District did not have the option to issue $400,000 of short-term Tax Anticipation Notes to fund the cost of the tax refunds because it would require additional cuts of a like amount in the 2012-2013 budget that would, in the words of Mr. Catalan, be “catastrophic”, thereby placing the District in the position of funding current year’s expenses with long-term debt;
• that the District would choose to issue 10 Year Bonds to finance the payment of the tax claims, thus making a mockery of the well established finance principle of financing current operating expenditures within the current year’s budget;
• that, in a situation described by Mr. Catalan as the “tip of the iceberg”, the District will face additional significant tax certiorari claims in the future and that the District had no plan to deal with these other than to issue more long-term bonds.

Quite simply, the District’s annual budget for 2011-2012 is not fully funded and all indications are that the District’s budget for 2012-2013 will not be fully funded.  Looming heavily over the District’s finances for 2012-2013 is $1.2 million of bond anticipation notes maturing in September 2012.   Is the plan to issue yet more bonds to refinance this maturing obligation and kick the can down the road some more?

You attribute the cause of the District’s financial condition to external factors over which you have no control, such as unfunded state mandates.  To test your hypothesis, we examined recent bond issuance transactions executed by neighboring school districts.  Based on the summary data, the Committee concludes that other Districts are on much sounder financial footing and are coping better than the District in dealing with these issues.  For example:

• In February 2011, Lakeland Central School District issued $22.56 million of Refunding Serial Bonds.  Moody’s assigned a rating of Aa2 to the bonds, two notches higher than the District’s current bond rating.
• In June 2010, Croton-Harmon Union Free School District issued $8.15 million of School District Refunding Serial Bonds.  Moody’s rated the bonds Aa2, two notches above the District’s current bond rating.
• In October 2010, Peekskill City School District issued $5.44 million of School District (Serial) Bonds.  Moody’s rated the bonds Aa3, one notch above the District’s current bond rating.

In each case noted above, the bonds were issued without any credit enhancement or bond insurance.  In addition, there is no indication that Moody’s has taken action to subsequently downgrade the bonds cited in the analysis.

Clearly, there is something amiss.  The District’s cash position is now being managed on a hand to mouth basis with long-term borrowings being used to fund current expenses such as  tax refunds which, by the District’s admission, should not be viewed as a one-time event.  The District is contemplating a fairly significant reduction of teachers and aides in order to accomplish necessary spending reductions without implementing any meaningful reductions in administrative staff.

In this context, we are curious as to why the District chose to spend no less than $58,000 on preparation and promotional work for the Bond Referendum and why you choose to retain a public relations staffer on the District’s full time payroll.

Accordingly, we repeat our advice to the District that it should: (i) limit all expenditures, whether or not financed through a bond offering, only to those expenditures that are absolutely necessary; (ii) develop a strategic plan to significantly minimize all currently uncontrollable expenditures; and (iii) develop a financial plan that is intended to restore the strength of the District’s balance sheet in order to regain a Moody’s rating of Aa3.

Very truly yours,

John DeBenedictis, John W. Mattis, Terrence Pierce, Henry Hrdlicka, Raymond A. Reber, Robert P. Tinari, Joseph D. Cerreo, Esq., Erik Andersen