Fitch Analysis of San Diego Unified School District Bonds Could Impact Future Ratings of Local GO Debt in California

In their ratings reports on San Diego Unified School District General Obligation Bonds, Moody’s, S&P and Fitch have all noted the District’s large, diverse tax base, and improving economy as well as its inconsistent financial performance and operating challenges. Despite those consistent descriptions of the District, there is a now a divergence in the District’s ratings. While Fitch has assigned its highest ratings for the GO debt, AAA, Moody’s and S&P have assigned lower ratings, Aa2 and AA-, respectively.

The GO bonds are backed by an unlimited property tax pledge of the District, a dedicated tax that was approved by District voters and is levied specifically for debt service. Those dedicated tax revenues are collected by the County Tax Collector and paid to bondholders, bypassing the District’s general fund. While Moody’s and S&P acknowledge the strength of the District’s tax base and the strength of the voter-approved unlimited tax G.O. pledge, their lower ratings take into account the District’s financial operations, even though those operations are funded through a process that is totally separate from the flow of funds used for debt service. Over the last few years, both Moody’s and S&P have downgraded the District’s GO debt due to its financial operations.

Why the divergence with Fitch’s ratings? Ironically, it centers on bankruptcy risk; a risk most analysts and investors would consider remote for the District. But in Fitch’s analysis, they have determined that if the District were to file bankruptcy, the taxes used to pay debt service for the General Obligation bonds would be considered “special revenues,” which are protected in the bankruptcy process. As a result, Fitch has excluded the District’s financial operations in assigning the AAA rating. While acknowledging the District’s operating challenges, they were not a factor in the ratings as Fitch focused on the strength of the tax base actually backing the bonds.

That divergence has implications for future ratings of Local General Obligation Bonds in California. Most Local GO bonds in California,  including school district and community college district GO bonds,  have similar security provisions as the District’s and the legal protection for bondholders is considered one of the strongest of Local GO bonds in the country. We would expect that Fitch would also assign top ratings for numerous other school districts they will be rating in California. As a result, we could see an upward ratings migration for California Local GO bonds, reflecting the true credit risk of pledged revenues.

Source: Fitch, Moody’s, S&P