Credit ratings lowered for 2 school districts with risky investments

By Amy Hetzner of the Journal Sentinel

Two of five Wisconsin school districts that made risky investments in 2006 to help fund post-retirement liabilities have had their credit ratings downgraded, and all five will be monitored for potential future downgrades by Moody's Investors Services.

The credit ratings for the West Allis-West Milwaukee and Whitefish Bay school districts were lowered by Moody's after a European bank called millions of dollars of loans undertaken by district-run trusts. The action could raise the interest rate that the taxpayers in the Whitefish Bay district pay on $22.6 million in debt that voters authorized in November 2009 for building renovations.

Although the credit ratings were not lowered for the Kenosha, Kimberly and Waukesha school districts, which also operate trusts that took out millions of dollars of loans, their ratings could be affected if the districts do not appropriate money toward honoring their moral obligations to repay DEPFA Bank, the credit agency warned.

All five districts were placed on Moody's watch list for possible downgrades last month after DEPFA seized $5.6 million from the districts' trusts and called the loans, about two years after the accounts technically fell into default.

Altogether, the five district-run trusts were lent $165 million by DEPFA that was used to help purchase $200 million in complex investments called collateralized debt obligations that are now believed to be virtually worthless. Alleging they were misled in the transactions, district officials have sued Stifel, Nicolaus & Co. Inc. and the Royal Bank of Canada in Milwaukee County Circuit Court to rescind the investments.

The difference in the recent ratings actions taken by Moody's had to do with the school districts' individual circumstances, including the relative burden that paying back the loans would put on their budgets and the strength of their tax bases, Beth Dougherty, an analyst with Moody's, said Monday.

Prior to last week's downgrade, Whitefish Bay had one of the highest credit ratings awarded to a school district in the state, but the risk it undertook in the $10 million investment was uncharacteristic of municipalities with similarly high ratings, Dougherty said. That said, the district would be able to pay off its trust's $8.8 million debt to DEPFA from existing funds without affecting its annual operating budget, she said.

Highest debt level

Meanwhile, West Allis-West Milwaukee's rating was hurt because it was the most heavily invested of any of the districts, with its trust owing about $60 million to DEPFA on top of $21 million in short-term borrowing for the investments. That amounts to more than 90% of the district's annual operating budget.

"Just looking at their options, it is unlikely they would be able to meet their moral obligation and, if they did, it would put significant pressure on their operating budget," Dougherty said.

C.J. Krawczyk, an attorney representing the districts in their lawsuit, pointed out that not only were three of the districts not downgraded, but those that had been downgraded probably would have faced lower ratings even if they had repaid the money owed to DEPFA.

"The action that Moody's took and didn't take last week was good news for the districts," said Krawczyk, while acknowledging the districts could suffer more negative credit consequences if they don't put money toward the debt in their upcoming budgets.

A recalibration in Moody's rankings for Wisconsin municipalities over the weekend also meant that West Allis-West Milwaukee and Whitefish Bay were returned to their previous credit ratings - A1 and Aa2, respectively - and the other three districts saw their ratings raised even higher, Krawczyk noted.

But Dougherty said the recalibration is part of an effort to put all of the agency's U.S. municipal ratings on its global rating scale and should not be considered upgrades because the ratings for all Wisconsin school districts were similarly altered. The A1 rating given to West Allis-West Milwaukee is the lowest rating given to a Wisconsin school district, while Whitefish Bay's Aa2 is a middle rating, under the new Moody's system.

"The recalibration does not reflect a change in credit quality," Dougherty said.

The impact of the change in the credit rating - or even the threat of a change - may take some time to materialize.

Historically, the ratings drop suffered by the Whitefish Bay district would add 0.05 to 0.1 of a percentage point to its borrowing rate, said Jim Miller, senior vice president of Hutchinson Shockey Erley & Co., which is advising the district on its upcoming referendum-related bond issue. How that translates into dollars depends on how the debt payments are structured, he said.

"There's a difference, but there's not a substantial difference," Miller said. "Obviously, you'd like to achieve the highest rating possible."

Although his district's rating wasn't affected by the latest Moody's action, Waukesha Superintendent Todd Gray said the district would like to avoid potential negative consequences to its credit rating.

But district officials first need to meet with their attorneys and get advice on possible remedies before committing to a solution such as refinancing the debt to DEPFA with a longer-term loan. The district already is wrestling with how to avoid a potential $2 million budget deficit for the 2010-'11 school year, Gray said.

"We've discussed, you know, what options are out there right now, but we don't have anything definitive as far as what we might do or not," he said.

Last year, Moody's downgraded the credit ratings for the Waukesha and West Allis-West Milwaukee based on their CDO investments.