Education Funding

Woes of Bond-Insurance Industry Latest Fiscal Concern for Districts

By Michele McNeil — February 19, 2008 4 min read
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Schools districts that rely on bond insurance to help them save money on the borrowing they do for construction projects and special programs could be affected by major ups and downs in that industry, at a time when many districts are already nervous about state budget cuts and a sagging national economy.

“It’s worrisome,” said John Musso, the executive director of the National Association of School Business Officials, based in Reston, Va. “If [the cost of] bond insurance goes up significantly, that translates into additional costs for the district, which translates into additional costs to the taxpayers.”

While a relatively arcane part of school finance, bond insurance is an important part of borrowing money and building schools for many districts—and volatility in that market could drive up districts’ costs even though the root of the problems has nothing to do with schools.

U.S. Rep. Paul E. Kanjorski, D-Pa., the chairman of the House Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises, touched on that anxiety in a Jan. 23 letter to Ben S. Bernanke, the chairman of the Federal Reserve Board.

“I am especially concerned about the implications for state and local governments that rely on bond insurance when putting together deals to pay for roads, schools, and other construction projects,” Rep. Kanjorski wrote.

Subprime Fallout

The main culprit is the subprime-mortgage industry, whose widely publicized woes are having a ripple effect across the economy. Big losses for creditors in that industry mean that bond insurers could be forced to cover those losses. That’s putting pressure on the bond-insurance market, which has seen its own credit ratings lowered. Those taking the biggest hits include the nation’s largest insurer, the Municipal Bond Insurance Association, or MBIA, and the American Municipal Bond Assurance Corp., or AMBAC.

The bond-insurance industry is in such a potential meltdown, with state regulators—especially in New York—nipping at its heels, that last week the billionaire investor Warren E. Buffett offered a potential rescue plan. The reaction from the insurance companies was tepid, according to media accounts.

Bond-Insurance Primer

• What is bond insurance?
A guarantee that the issuer of the bond—such as a school district—will make timely loan payments to the bondholders.

• Why do districts need it?
School districts that do not have the highest, or AAA, bond rating (which means the district has excellent credit) can buy insurance from a bond-insurance company with the AAA rating, which allows the district to get the lowest interest rate.

• How much money is involved?
In 2007, $107 billion in education-related bonds were issued, with about half backed by bond insurance. That includes bonds from school districts, student-loan companies, and higher education institutions. Districts accounted for $54 billion in bonds.

• What’s the problem with the bond-insurance market?
The credit ratings of some bond-insurance companies are being downgraded. It’s part of the fallout from problems in the subprimemortgage market, but it’s not a result of problems with educationrelated or government bonds.

• How could this affect school districts?
If the number of AAA-rated bond-insurance companies drops, the price of the insurance may increase. Should schools and local governments be unable to get insurance, they might have to pay more to borrow because of higher interest rates.

SOURCE: Education Week, The Bond Buyer

The effect of all the trouble and uncertainty may be to make bond insurance less helpful to public entities wanting to boost their own credit ratings.

Just like consumers with good credit, school districts with the best credit pay the lowest interest rates on their bonds. Districts with less-than-perfect credit, however, can buy bond insurance to help secure the lowest rates.

And school bonding is big business.

The education sector—which includes school districts, higher education institutions, and student-loan companies—issued $107 billion in bonds in 2007, with individual school districts accounting for $54 billion, according to The Bond Buyer, a New York City-based daily newspaper that covers public finance. About half of all education-sector bonding was backed by bond insurance, provided by some of the those big-name companies such as MBIA, AMBAC, and the Financial Guaranty Insurance Co.

Most school districts have only an indirect relationship with bond-insurance companies because they work with financial firms that take care of the financing and any needed insurance.

For example, earlier this month, voters in the 12,500-student Upland school district in California approved a $103 million bond issue, which will be backed by bond insurance. Steve Cary, the district’s assistant superintendent for business, said the district, which is near San Bernardino, has a long-standing relationship with a public-finance firm.

“I called them when I first heard about this [trouble in the industry], and I asked, ‘What does this mean for us?’ ” Mr. Cary said last week. “But it turns out it’s not affecting us at all.”

But he said he will naturally keep an eye on the market.

“Bond insurance is an important thing for the community because it does improve our [bond] rating,” Mr. Cary said.

Not every district takes that view, though.

Although the booming, 308,000-student Clark County, Nev., school district, which includes Las Vegas, has a bond rating of AA—which is lower than the highest rating, AAA—it doesn’t buy bond insurance. Sometimes, the difference between the cost of insurance and a slightly higher interest rate is negligible. In addition, larger school districts with more assets may also get more favorable interest rates. “But it’s an option for us in the future,” said Leah Marchione, a district spokeswoman.

Watchful Eye

Still, even districts that don’t get bond insurance are watching the markets. In fast-growing Gwinnett County, Ga., voters this month approved a $750 million bond referendum. The 160,000-student district is AAA-rated so it doesn’t need bond insurance.

However, said district spokeswoman Sloan Roach, “we do keep tabs on what’s going on in the bond-insurance market.”

Mr. Musso, of the school business officials’ organization, said that even if the turmoil in the bond-insurance industry continues, districts that have sound credit ratings and are in good financial health will likely be spared any increase in bond-insurance costs.

Still, it’s likely that district officials are becoming more aware of bond-insurance problems as they continue to make headlines. “If this issue isn’t on their radar screens now,” Mr. Musso said, “then it probably will be.”

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A version of this article appeared in the February 20, 2008 edition of Education Week as Woes of Bond-Insurance Industry Latest Fiscal Concern for Districts

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