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MOODY'S ASSIGNS UNDERLYING Aa3 RATING AND STABLE OUTLOOK TO DENVER SCHOOL DISTRICT NO. 1, COLORADO, CERTIFICATES OF PARTICPATION 2011A AND 2011B

Global Credit Research - 30 Mar 2011

MOODY'S ALSO AFFIRMS Aa2 RATING ON APPROXIMATELY $1.0 BILLION OF UTGO DEBT

Denver City & County S.D. 1, CO
Primary & Secondary Education
CO

Moody's Rating

ISSUE

RATING

Taxable Certificates of Participation Variable Rate Refunding Series 2011 A-1

Aa3

  Sale Amount

$100,000,000

  Expected Sale Date

04/05/11

  Rating Description

Certificates of Participation

 

Taxable Certificates of Participation Variable Rate Refunding Series 2011 A-2

Aa3

  Sale Amount

$100,000,000

  Expected Sale Date

04/05/11

  Rating Description

Certificates of Participation

 

Taxable Certificates of Participation Variable Rate Refunding Series 2011 A-3

Aa3

  Sale Amount

$100,000,000

  Expected Sale Date

04/05/11

  Rating Description

Certificates of Participation

 

Taxable Certificates of Participation Variable Rate Refunding Series 2011 A-4

Aa3

  Sale Amount

$100,000,000

  Expected Sale Date

04/05/11

  Rating Description

Certificates of Participation

 

Taxable Certificates of Participation, Fixed Rate Refunding Series 2011B

Aa3

  Sale Amount

$400,000,000

  Expected Sale Date

04/05/11

  Rating Description

Certificates of Participation

 

Opinion

NEW YORK, Mar 30, 2011 -- Moody's Investors Service has assigned an underlying Aa3 rating with a stable outlook to the Denver School District No. 1, Colorado Taxable Certificates of Participation Series 2011A and 2011B expected to be issued in the approximate amount of $400 million for each series. At this time, Moody's has also affirmed the district's underlying Aa2 general obligation rating, affecting $1.04 billion in debt outstanding, as well as the Aa3 rating on the district's outstanding certificates of participation (COPs) ($26.1 million). Although referred to collectively as the "2011 COPs", the 2011A and 2011B COPs are secured under separate lease agreements and indentures with the Denver School Facilities Leasing Corporation. The leases are subject to annual appropriation and annual renewal at the option of the district. The district is issuing the 2011 COPs to refinance all of the district's previously issued 2008 COPs with a combination of letter-of-credit backed synthetic fixed-rate (2011A) and fixed-rate (2011B) obligations. The current sale is being issued to restructure and re-offer existing pension-related certificates of participation.

RATING RATIONALE

The Aa3 rating primarily reflects the essential nature of the leased assets, a surety-provided debt service reserve for the 2011A certificates and no debt service reserve requirement for the 2011B certificates, and significantly, the general credit characteristics of the district including the regional economic importance of the Denver service area, sizeable tax base, and recently improved financial operations and reserve levels, as well as above average debt levels.

STRENGTHS

-Sizeable tax base with diverse economic drivers

-Recently improved financial reserve levels

CHALLENGES

-Currently challenged local economy, weighed down by housing market

-Above average exposure to variable rate debt obligations

- Somewhat high general fund lease burden

DETAILED CREDIT DISCUSSION

CERTIFICATES WILL RESTRUCTURE EXISTING PENSION-RELATED OBLIGATIONS

The current offerings are being issued to restructure all of the district's previously issued Series 2008 COPs ($750 million outstanding) and finance swap termination payments (approximately $50 million). The Series 2011A COPs are being issued as variable rate demand obligations with direct-pay letters of credit being provided by three banks. The Series 2011B COPs will refund the remaining 2008 COPS, include swap termination and issuance costs, and positively, are being issued as fixed rate obligations.

For the 2011A COPS, liquidity providers all maintain ratings within the Aa-category and are as follows: JPMorgan Chase Bank, N.A. (Aa1 negative outlook; $200 million LOC), Wells Fargo Bank, N.A. (Aa2 negative outlook; $100 million LOC and counterparty for the 2011A-3 for a notional amount of $100 million) and Royal Bank of Canada (Aa1 stable outlook; $100 million LOC and counterparty to the 2011A-4 for a notional amount of $100 million); counterparty to Series 2011 A-1 and Series 2011 A-2 for a combined $200 million notional amount is Bank of America (Aa3 negative outlook).

COPs SECURED BY ANNUAL BASE RENTAL PAYMENTS; 2011A COPs DEBT SERVICE RESERVE FUNDED BY A SURETY, 2011B COPS TO BE ISSUED WITH NO DEBT SERVICE RESERVE REQUIREMENT

Given the generally essential nature of the leased assets and above average, although manageable lease debt burden, Moody's believes that the possibility of non-appropriation is remote. Importantly, each of the district's four series of COPs, Series 1996,1997, 2011A and 2011B, are secured under separate lease purchase agreements and indentures between the district (lessee) and Denver School Facilities Leasing Corporation (lessor) with individual pools of leased assets. The certificates are secured by the district's pledge to annually appropriate base rental payments equal to debt service to the trustee under the lease purchase agreement, subject to annual termination at the option of the district. Should the district choose not to appropriate, the district is required to vacate the properties within 90 days. The leased assets collateralizing the 2011A and 2011B COPs are essential facilities with insured building and estimated property values at approximately 110% of the par value of the certificates, net of investments from previously issued general obligation bond proceeds, which must be repaid from first proceeds in the event of sale. Leased buildings across the 2011A and 2011B collateral pools provide for 31% of enrolled students. With the current offering, approximately 45% of the district's debt portfolio consists of lease obligations subject to annual appropriation, nearly all of which are related to the district's pension. Net of the debt service for the 1996 COPs which are paid from capital reserve funds, the average ($69.1 million) and peak ($76.2 million) lease debt burden represents a high, but affordable 10.3% and 11.4% of fiscal 2010 General fund revenues.

The 2011A debt service reserve (DSR) requirement is equal to the lesser of 10% of par, 125% of average annual debt service, or peak debt service and will be funded by a surety policy provided by Assured Guaranty (Aa3, negative outlook). In the event Assured Guaranty is downgraded below Aa3 by Moody's and AA- by Standard and Poor's, the district is required to cash fund the requirement in equal monthly installments over a nine-month period beginning the fourth month post-downgrade by both rating agencies; the monthly installments would equal approximately $4.4 million per month or 8.4% of FY 10 general fund expenditures over the nine-month period which Moody's views as a significant additional cost. Bank documents associated with the letter of credit also stipulate the district will incur an additional LOC penalty fee annually (increased 100 bps per annum) if the district chooses not to cash fund the DSR requirement in month four. Payment of the LOC penalty fee would cost the district an additional $4 million the first year which, although less than the monthly contribution scenario, would signify significantly reduced district financial flexibility. A substantial increase in short-term costs associated with the district's variable-rate debt could lead to rating pressure. Management notes, in the event of a downgrade of Assured Guaranty by both rating agencies, the third and likely scenario would be to issue additional COP debt within the four months post-downgrade. Although this last scenario would increase long-term costs to the district, it would still be a reduced short term burden relative to the nine-month funding requirement.

The 2011B COPS will be issued with no DSR requirement which Moody's views as a credit weakness. However, the lease agreement provides for a partial mitigant in that the district is required to deposit the full annual 2011A and 2011B lease amount with the trustee within 90 days of the new fiscal year, or no later than September 30th, which would provide an adequate set-aside of funds prior to December and June payment dates. Also, given the leased assets in both collateral pools are each subject to a single appropriation and affect roughly 31% of the student population makes timely appropriation an essential component of district operations.

Although not listed as a covenant, full title insurance commitments were obtained on all properties. Legal provisions also provide for a swap rate stabilization reserve fund for each of the Series 2011A COPs to help address basis risk.

2011A CERTIFICATES TO BE OFFERED WITH AN INTEREST RATE SWAP

Moody's believes that the swaps associated with the 2011A COPs pose a manageable level of credit risk due to adequate cash levels in the general fund and the presence of a stabilization fund despite absence of a formal swap policy. The 2011A COPs will be offered at a weekly-rate mode with a maximum interest rate of 15% per annum; the maximum interest rate on any 2011A certificates when put to the banks would be 18%. All of the swap agreements are similar on the key terms except for the notional amounts, mentioned above. The swap agreements will terminate December 15, 2037, tracking the amortization of the bonds. Under the swaps, the district will pay a fixed rate and receive 100% of 1-month LIBOR. The regularly scheduled swap payments are included in the base rental payments and are expected to be insured by Assured Guaranty. To help mitigate basis risk, the district has established interest rate swap stabilization funds equal to $3.0 million for the 2011A certificates. The stabilization fund will be cash funded from amounts released from the indentures for the redeemed 2008 COPs; any draws on the reserves must be repaid in equal monthly payments by the district in the following budget year. The district is not obligated to post collateral. To address the termination risk, termination payments are secured only from a subordinate lien on the pledged lease property and are not insured. Only the district, with the consent of Assured Guaranty, retains the right to terminate the swap at its option. The district may optionally terminate without Assured Guaranty's consent if it demonstrates to Assured that it has sufficient available funds to pay any associated termination payment. Additional termination events include an event of non-appropriation by the district and the counterparties' credit rating failing to be maintained at least at the high Baa-rated range; there is no rating trigger based upon the district's bond or certificate ratings. In any event of default or termination event, neither the district nor the swap counterparties may terminate the swaps without Assured Guaranty's consent unless Assured Guaranty has failed to perform under the swap insurance policy or has been downgraded to below the A-rated range. In the event the rate went to the maximum 18%, the interest payment alone would go up to an estimated $60.0 million or an additional 9.7% of general fund expenditures. The district does not currently have a swap policy; however, the district does review its variable rate and swap exposure on a regular basis both internally and externally.

MODERATELY HIGH DEBT BURDEN; HIGH, BUT MANAGEABLE EXPOSURE TO VARIABLE RATE DEBT

The district is issuing the 2011 COPs to refinance all of the district's previously issued 2008 COPs with a combination of letter-of-credit backed synthetic fixed-rate (2011A) and fixed-rate (2011B) obligations. Including the current offering, the district's direct and overall debt burdens are high, but manageable relative to other peer rated districts at 2.3% and 3.7%. Net of pension-related COPs (approximately 44% of outstanding district debt) the district's direct debt burden is 1.3%. Amortization of all of the district's debt including current and outstanding COPs and G.O. bonds is a somewhat slow 27.1% in ten years; amortization of G.O. bonds only is 39.6%. The district has no remaining voter-approved debt authorization and believes the soonest it would return to voters for additional borrowing authorization is 2012, the borrowing amount is unknown at this time.

Although the current transaction reduces the district's exposure to variable rate exposure, Moody's believes significant but manageable risks remain. Important factors contributing to this assessment include the legal provisions under the documents governing the certificates discussed above, direct-pay letters of credit and bond insurance which do not provide for an acceleration of district repayment of un-remarketed certificates, and the fact that swap termination payments are secured only by a subordinate lien on the pledged lease assets. After the current refinancing the district's variable rate debt will represent a lower but still significant 23% of total obligations, and will consist entirely of the 2011A COPs (approximately $400 million) which are insured by Assured Guaranty Municipal Corp (AG Muni formerly Financial Security Assurance Inc.) (Aa3 with negative outlook). Liquidity support for the 2011A COPs will be provided by three separate letters of credit (LOC). The LOCs supporting the 2011A COPs are provided by three banks: JPMorgan Chase (Long-Term rating Aa1), Wells Fargo (Aa2) and Royal Bank of Canada (Aa1) all three LOCs expire in April 2014.

HIGHER THAN BUDGETED INTEREST COSTS FOR VARIABLE RATE DEBT AND STATE RECISSION LED TO REDUCTIONS IN FY09 RESERVES; FY10 RESERVE LEVELS REBOUNDED AND FY11 IS EXPECTED TO IMPROVE AGAIN

Due to state funding reductions ($2.6 million) and a second year of higher than anticipated interest costs (estimated at $24.0 million for the year) related to the pension certificates of participation (PCOPs), the district's fiscal year (FY) 2009 general fund balance declined by $6.3 million. District officials were able to offset a portion of the budget gap with greater than anticipated enrollment growth, fuel savings, deferral of capital spending and the full utilization of $9 million in dedicated reserves ($3 million from a certificate stabilization fund and $6 million in other district funds) budgeted to mitigate interest rate risk on the certificates. The FY09 total general fund balance was $28.6 million (4.5% of revenues) with $21.4 million unreserved and above the board's policy of maintaining a 3% of revenue contingency reserve.

Positively, management improved the FY10 total general fund balance to $63.2 million (9.5% of general fund revenues). A significant portion of the improvement was supported by an above average increase in property tax revenues, as well as conservatively budgeted interest rate costs. The revenue increase was supported by the state's 2007 imposition of a mill levy freeze in order to reduce state education funding combined with a solid increase in the 2010 assessed value. Management also attributes the improvement to savings from the district's pension financing and other cost control measures. In addition, average total interest costs for the district's variable rate pension certificates were below the budgeted 7.5%. However, Moody's notes in the event total interest costs for the district's $400 million variable rate COPs again go above management's assumptions, this would result in significantly constrained financial flexibility. Moody's will continue to monitor the district's ability to budget appropriately for this variable cost.

Officials have indicated that the board is committed to retaining the 3% revenue contingency reserve as outlined by district policy. Moody's notes the district's general fund balance still remains below the Aa2-rated national school district median and IS relatively low in light of a still above average exposure to variable interest rate costs and likely near-term state budget cuts. The district is also less than mid-way with its teachers union settlement providing some level of cost certainty through August 2012. Management indicates reserve levels for FY11 will increase over the prior year but budgeted to be reduced in FY12. Although the district currently retains an additional $75 million in available mill levy override capacity it remains unknown if the district will go to voters to tap into this additional revenues source. Positively, voters approved that the district be permanently de-bruced in 1999.

RESERVES OUTSIDE OF THE GENERAL FUND ARE SIZEABLE, BUT BULK OF FUNDS ARE RESTRICTED

Although sizeable, Moody's believes the majority of reserves outside of the general fund do not significantly increase the district's financial flexibility given that the funds are restricted and not available for general operating purposes. As of FY10, district officials have identified reserves outside of the general fund which totaled $96.0 million on a GAAP basis. The bulk of these funds ($66.7 million) reside within a special revenue fund restricted for a pay-for-performance plan known as the Professional Compensation System For Teachers (ProComp). Management believes that the ProComp assets will drive general fund revenue growth by improving academic outcomes from improved recruitment and retention of effective teachers. In 2005, voters approved a $25 million annual (increasing with inflation in future years) ProComp mill levy override which may only be used for additional performance bonuses awarded beyond amounts agreed upon under collective bargaining agreements. The ProComp trust balance has grown at a greater rate than projected due in part to a slower than anticipated enrollment in the program. Management notes that while this fund balance does continue to increase ($3.3 million over the prior year), growth has begun to slow as all teachers hired after January 2006 are automatically enrolled in the program. In addition, teachers employed by any Colorado school district have full portability of pension benefits district-to-district given DPS's retirement system merger with Colorado Public Employees' Retirement Association (PERA) in January 2010. The remaining $29 million in unrestricted balances were in cash for capital reserve ($14.9 million), food services ($7.0 million) and a combined internal services fund ($10.7 million).

DISTRICT RETIREMENT SYSTEM MERGED WITH STATE PENSION SYSTEM; DISTRICT WILL CONTINUE RESPONSIBILITIES FOR PCOPs

After several unsuccessful attempts over the last decade, the district's pension plan merged with the PERA effective January 1, 2010. Previously, Denver Schools maintained an independent pension program in Colorado, unlike all other school districts in the state which belong to PERA. District management views the merger as positive given that the merger allows for full portability for teachers and administrators without fear of forfeiting pension benefits previously earned. The district will continue to be responsible for its own unfunded pension liability and PCOPs, receiving a credit in its employer contribution rate for the proceeds of the 2008 PCOPs deposited into the PERA plan.

The district issued its first series of pension certificates in 1997 to fund the unfunded liability of its pension plan. Over the following decade, the funded ratio for the plan declined due to several factors including the board's decision to increase benefits to match PERA, poor investment performance during a weak stock market environment, and the district's decision not to make the full annual pension contribution payments from 2002 to 2007. In April 2008, the district issued additional pension certificates to fully fund its pension. In conjunction with the 2008 PCOPs issuance, the district's board adopted a resolution to make full annual pension contributions going forward. Due to declines in investment portfolio values since 2008, PERA's most recent official report released December 31, 2009 indicates a pension funding ratio of approximately 88% based on the market value of the pension assets; further such reports note that this is a greater funding ratio than PERA's division covering Colorado's other school districts. Importantly, officials have indicated that the district will not be pursuing additional financing plans to address the UAAL.

As of July 1, 2008, the district's combined OPEB unfunded actuarial accrued liability (UAAL) totaled a manageable $11.4 million. Due to state legislative changes, the district now meets its 3% TABOR reserve requirement through a combination of $1.8 million in cash reserves and designations of real property; the district had previously met the requirement with a letter of credit agreement which presented some renewal risk for the district.

DENVER SCHOOL DISTRICT IS SECOND LARGEST IN THE STATE

Although the recession has been relatively mild for Denver residents, the metropolitan area has not been immune to job losses and a significantly weakened housing market. The district's boundaries are roughly coterminous with the City and County of Denver (GO rated Aaa with a stable outlook) and it is the second largest district in Colorado with 79,423 students for fiscal 2011. Between 2005 and 2010 the district's full market value increased an average 4.7% annually. However, during that time the number of residential and commercial building permits declined precipitously and along with continued foreclosures the district's full market value declined in 2011, albeit only 2.3%. Despite the decline, the sizeable $80.9 billion tax base remains well above similarly-rated national school districts. The ten largest property tax payers comprise a moderate 10.4% of 2010 assessed value (AV) and are made up of several real estate entities (5.4% of 2010 AV), two utilities (3.3%0 and airlines (1.7%). Although construction activity has improved, statewide estimates of a nearly 7% decline in taxable values is likely for 2012 and reflects a nearly 18 month lag in the assessment cycle. As of the 2005-2007 census, socioeconomic indicators for the City and County of Denver remained stable, suggesting similar trends for the district, with per capita and median family incomes measuring 108.9% and 89.9% of the U.S. respectively.

As of December 2010, the district's unemployment rate of 9.6% was at its highest since 2000 and above the state (8.6%) and nation (9.1%). Moody's anticipates that the region's current sluggish recovery will begin to pick up some momentum in the next year and will eventually outperform the nation over the medium- and long-run horizons given the metropolitan area's skilled workforce and large research base.

Outlook

The long term credit outlook on the district's obligations is stable. The stable outlook reflects the expectation that the district's service area will recover from the recession and continue to expand at moderate levels over the long term. Future credit reviews will focus on management's ability and willingness to maintain satisfactory reserves relative to other Aa2 rated schools nationally, and its balance financial operations by securing voter support or making budget adjustments as necessary. The stable outlook also incorporates the expectation that district management will continue to maintain strong internal knowledge and oversight of its complex financial and debt instruments. The outlook further assumes that officials will manage future debt issuances in a manner that moderates the impact on the district's debt profile.

WHAT COULD MAKE THE RATING GO - UP

-Significant improvement in, and maintenance of, general fund reserve levels

-Prolonged, significant growth in assessed value

-Lower debt levels and significantly reduced exposure to variable rate obligations

WHAT COULD MAKE THE RATING GO - DOWN

-Significant increase in short-term costs associated with variable-rate debt

-Drawdown of reserve levels

-Prolonged, significant declines in assessed value

-Significant issuances of debt resulting in above average debt burden relative to medians

KEY STATISTICS

2010 Estimated population: 618,650

2011 Estimated full market value: $80.9 billion

Full value per capita: $130,784

2005-2007 Per capita income for City and County of Denver: $28,534 (+/-$657) (108.9% of U.S.)

2005-2007 Median family income for City and County of Denver: $54,333 (+/-$1,471) 89.9% of U.S.)

Direct debt burden: 2.3%

Overall debt burden: 3.7%

Variable rate debt as % of total obligations: 23%

Principal payout on all debt in ten years: 27.1%

FY10 total general fund balance: $63.3 million (9.5% of revenues)

FY10 Unreserved general fund balance: $52.2 million (7.8% of revenues)

The principal methodology used in this rating was The Fundamentals of Credit Analysis for Lease-Backed Municipal Obligations published in October, 2004.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, public information, and confidential and proprietary Moody's Analytics information.

Moody's Investors Service considers the quality of information available on the credit satisfactory for the purposes of assigning a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Analysts

Dan Steed
Analyst
Public Finance Group
Moody's Investors Service

Bryan A. Quevedo
Backup Analyst
Public Finance Group
Moody's Investors Service

Matthew A. Jones
Senior Credit Officer
Public Finance Group
Moody's Investors Service

Contacts

Journalists: (212) 553-0376
Research Clients: (212) 553-1653


Moody's Investors Service
250 Greenwich Street
New York, NY 10007
USA

MOODY'S ASSIGNS UNDERLYING Aa3 RATING AND STABLE OUTLOOK TO DENVER SCHOOL DISTRICT NO. 1, COLORADO, CERTIFICATES OF PARTICPATION 2011A AND 2011B
No Related Data.

 

© 2014 Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

 


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