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What Lifts Municipal Ratings Up: A Look At U.S. State Credit Enhancement Programs
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What Lifts Municipal Ratings Up: A Look At U.S. State Credit Enhancement Programs

Overview

U.S. state credit enhancement programs provide additional security to bondholders for certain bonds that are also secured by an underlying municipal obligor, such as a school district, municipality, charter school, or higher-education institution. In addition to the intended payment source that program participants pledge to debt service, the state commits itself to paying timely debt service on behalf of the participant, should these revenues fall short.

These credit enhancement programs take a variety of forms, such as general fund pledges, appropriation pledges, state aid withholdings and intercepts, moral obligations, permanent funds, and guarantees.

Chart 1

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When rating these programs, S&P Global Ratings bases its criteria application on the legal features and linkages to each state's general creditworthiness. Most state credit enhancement programs that are linked to the state's general creditworthiness are within scope of the "Issue Credit Ratings Linked To U.S. Public Finance Obligors’ Creditworthiness" (RLOC) criteria, published Nov. 20, 2019, on RatingsDirect. For state guarantees that are unconditional obligations, such as a pledge of the state's full faith and credit, and meet certain standards, we apply our "Guarantee Criteria," published Oct. 21, 2016. Finally, state permanent fund enhancements are rated under our "U.S. Public Finance Long-Term Municipal Pools: Methodology And Assumptions" criteria, published March 19, 2012.

We monitor to see if a participant meets state requirements for eligibility for the credit enhancement. Otherwise, aspects that determine what may be in the scope of our criteria are included in greater detail within our criteria and are not program-specific.

Components of enhancement programs rated with RLOC

The majority of state credit enhancement programs are rated using our RLOC criteria. To be in scope of our RLOC criteria, the state program and underlying issues must meet all of the following features:

  • The program is authorized by state statute or constitution;
  • Bond documents, state statutes, and state policy (or what we view as equivalent) are in place and clearly detail the approval process, outlining the parties involved in receipt, transfer, and disbursement of state aid and specifying the steps necessary to transfer revenues to the paying agent to ensure timely debt service;
  • The flow of funds from the state is directly to the paying agent (there is no commingling of funds with program participants' operating funds);
  • The state is aware of who is participating in the program and the respective debt service associated with each participant; and
  • The timing of payment occurs prior to debt service, and if applicable, includes advance notification to the state of a potential participant default by an independent paying agent.

Relationship with the state and underlying ratings within a program

Credit enhancements that fall within the scope of the RLOC criteria may be notched off of, and typically move in tandem with, the state rating. However, the notching differential varies based on several characteristics and may differ among issues within a given program. If a rating is capped due to features such as weak coverage, the rating might not move in tandem with the rating on the state. Based on our assessment of the additional risks, we could rate the issue lower. We may differentiate ratings among issues based on the proximity of debt service due dates to the beginning of the state fiscal year.

S&P Global Ratings rates credit enhancements for school districts, municipal governments, charter schools, health care institutions, and higher-education institutions. Our criteria allow us to differentiate by sector if we observe different industry risks or issue-specific risks; for example, we might view political or funding risks as elevated for charter schools in a given state.

We might rate state permanent funds enhancing obligations higher than our rating on the state, as they are not linked to the state rating and do not move in tandem with a state's general creditworthiness. These ratings reflect a combination of the program's enterprise and financial risks, including the assessment of loss coverage, operating performance, and financial policies and practices. State credit enhancement guarantee programs (i.e., those where the state's full faith and credit secures the obligation) are equivalent to the state rating.

While state programs might have requirements included in state statutes or constitutional provisions to be considered for eligibility of the enhancement, our analysis of ratings includes a review of issue-level qualification for participation in the program, as well as related bond documents, and examination of factors that might exceed state requirements. We evaluate features such as state support, timing and administrative risks, and coverage as applicable. States generally structure the enhancements to have similar characteristics across program participants, but we also take into account credit-specific attributes such as state support, coverage, timing, or adequacy of a debt service reserve. For example, we might differentiate notching below the state based on coverage or cap a rating below that on the state to reflect our view of an unmitigated appropriation risk.

Chart 2

image

Looking Ahead

An important characteristic of these programs is that, while they are frequently used by local issuers, states have rarely had to step in and cover obligations. Some states even have financial monitoring in place to monitor local issuers' financial status, a characteristic that could help prevent the usage of state programs. However, as long as these program obligations are outstanding, we would expect a state to fulfill its commitment.

These programs generally have minimal changes over time, and new broad-based state credit enhancement programs are not common. We anticipate few changes other than to strengthen or clarify program features, as the tenure of these programs and their effectiveness in supporting market access at lower costs for local issuers is an appealing opportunity for states to provide backing. However, in the unlikely event that there is a change in program mechanics, it may affect our ratings within the program.

Rated State Credit Enhancement Programs

Below is a list of state programs; we note that this list may not be exhaustive. For example, we rate several weak-link and long-term municipal pools that have state aid intercept features. Other state credit enhancements apply to only a small number of issuers. We have chosen to highlight broad-based credit enhancement programs to provide comparability.

Rated state credit enhancement programs
For summaries on each program, please see individually published articles in Related Research.
State   Enhancement program Pledge Criteria
Arizona Public School Credit Enhancement Program  Permanent fund Long-term municipal pools
California Health Facility Construction Loan Insurance Program (Cal-Mortgage) Guarantee Guarantee
Colorado State Aid Intercept Program for Higher Education General fund RLOC
Colorado State Aid Intercept Program (School Districts) General fund RLOC
Colorado Moral Obligation Program for Charter Schools Moral obligation RLOC
Georgia State Aid Intercept Intercept RLOC
Idaho Idaho Enhancement Program for School District Bonds  Permanent fund Long-term municipal pools
Idaho School Bond Guaranty General fund RLOC
Idaho Moral Obligation Program for Charter Schools Moral obligation RLOC
Indiana State Aid Intercept Intercept RLOC
Kentucky State Aid Intercept for Universities Intercept RLOC
Massachusetts Massachusetts Qualified Bond Act General fund RLOC
Massachusetts Massachusetts State College Building Authority Appropriation RLOC
Michigan Local Government Loan Program Revenue Bonds Intercept/Withholding RLOC
Michigan Bond Loan Fund General fund RLOC
Minnesota State Standing Appropriation for Schools General fund RLOC
Minnesota County & City Credit Enhancement General fund RLOC
Mississippi Development Bank and Junior College Intercept RLOC
Missouri Direct Deposit of State Aid Withholding RLOC
Nevada School District Bond Guarantee Program  Permanent fund Long-term municipal pools
New Jersey Support of Free Public Schools General fund RLOC
New Jersey Qualified Bond Program Withholding RLOC
New York State Dormitory Authority; School State Program Appropriation RLOC
North Dakota State Aid Intercept Intercept RLOC
Ohio Market Access Program General fund RLOC
Ohio State Aid Intercept Intercept RLOC
Oregon School Bond Guaranty Program Guarantee Guarantee
South Carolina State Aid Intercept Appropriation RLOC
South Dakota Health and Education Facilities Authority State Aid Intercept Intercept RLOC
Tennessee State School Bond Authority Withholding RLOC
Texas Permanent School Fund  Permanent fund Long-term municipal pools
Utah School Bond Guarantee Program Guarantee Guarantee
Utah Moral Obligation Program for Charter Schools Moral obligation RLOC
Virginia Virginia College Building Authority State Intercept Intercept RLOC
Washington School Bond Program Guarantee Guarantee Guarantee
West Virginia Municipal Bond Commission General fund RLOC

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Savannah Gilmore, Englewood + 1 (303) 721 4132;
savannah.gilmore2@spglobal.com
Oscar Padilla, Dallas + 1 (214) 871 1405;
oscar.padilla@spglobal.com
Secondary Contacts:Geoffrey E Buswick, Boston + 1 (617) 530 8311;
geoffrey.buswick@spglobal.com
Sussan S Corson, New York + 1 (212) 438 2014;
sussan.corson@spglobal.com

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