Despite budget issues, California school deal generates strong orders

A California Bay Area school district that recently made waves for failing to pass a budget on time sold $352 million of general obligation bonds last week.

The district entered the market with a downgrade to its underlying rating, but the deal was bolstered with a bond insurance wrap that covered most maturities.

West Contra County School District was at risk of having its finances taken over by the Contra Costa County Office of Education after it failed to pass a budget by the end of its fiscal year on July 1.

Board members balked at approving the local control funding formula, which created a domino effect in which they were not able to approve a budget. Ultimately the district retained control of its finances after the school board approved on Aug. 28 a 2024-25 budget in a 4-1 vote.

“The journey to revise the previously rejected LCAP plan placed us in unprecedented territory — not only for our county but also for the entire state,” Superintendent Kenneth “Chris” Hurst said in a recorded message to the community in early September.

Hurst announced on Sept. 30 his decision to retire in December after more than three years as superintendent, citing family issues.

This month’s deal was preceded by an S&P Global Ratings downgrade to A-plus from AA-minus in September, joined with a negative outlook.

“The downgrade reflects our view the district’s growing structural deficit within district operations,” S&P Global Ratings analyst Li Yang said in a statement. “The deficits are driven by declining enrollment trends and a high truancy rate resulting in materially lower average daily attendance levels in recent years.”

But most of the maturities carried a Build America Mutual wrap, and the accompanying AA rating from S&P.

“Voter-approved California school district general obligation bonds are secured by specific tax revenues that cannot be used for any purpose other than to repay this debt, and which are paid directly from the county tax collector to the bond trustee,” Shelby San Vicente, a vice president in BAM’s West Region Public Finance group, said of why BAM was comfortable insuring the school district’s debt. “The state also has a thorough, well-established process for identifying school district fiscal stress and working with the counties to intervene.”

Indeed, the district’s default and attempted 1991 bankruptcy, when it was known as the Richmond Unified School District, provided the impetus for California to create an intervention system for schools in fiscal trouble.

“Those factors protect bondholders from volatility tied to the operating budget and put more value on analyzing the underlying economic and demographic conditions that will ultimately determine the district’s ability to repay the bonds,” Vicente said. “The West Contra Costa school district has a large and growing tax base and population, and benefits from the robust Bay Area economy, which all support long-term credit stability.”

J.P. Morgan priced the $352.3 million of GOs on Oct. 16. Nixon Peabody was bond and disclosure counsel and KNN Public Finance was financial advisor.

The school district benefited from stability in the market on the day of the sale, said Blake Boehm, principal/managing director with KNN Public Finance.

“This week, the market has seen increases in MMD rates, while last week there were bumps in MMD and a more stable market tone to price debt,” Boehm said.

The school district’s bonds experienced over- subscriptions on nearly every maturity.  The new money portion of the transaction received over $1.83 billion in orders for $250 million in available bonds, he said. It was also the only sizable California deal on the schedule last week.

West Contra Costa USD has not fully implemented its financial solvency plan, which was cited in S&P’s ratings report when it downgraded the credit. That plan involves expenditure cuts in positions and other items. While the school district hasn’t executed the entire plan, it has shown some success in executing on parts of it.

The bonds are backed by Measure R, a bond measure approved by voters on March 3, 2020, which authorizes the district to issue up to $575 million in GOs, according to the preliminary offering statement. The measure was approved by 58.73% of eligible voters.

The board was expected to have roughly $250 million in remaining capacity after the bond sale, according to bond documents.

Proceeds from the 2024 series B and C new money GO bonds will finance capital improvements to the district’s facilities. The series A and series B GO refunding bonds will be used to purchase some or all of targeted bonds that holders tendered for purchase as the district sought cost savings.

Nearly the entire deal was insured.

“It ended up being economically advantageous to have insurance on most maturities to improve the pricing outcome for the district,” Boehm said.

“Issuers and underwriters are constantly assessing investor demand for insurance and where it offers the most benefit,” said Grant Dewey, head of capital markets for BAM. “The vast majority of BAM transactions are fully insured, but it’s not uncommon to see partial coverage that excludes shorter maturities, particularly on large transactions, where insured spreads are typically the tightest.”

The 2025 and 2026 maturities in the Series B bonds were the only bonds sold without insurance, according to BAM. Overall, BAM insured $286 million of the $340 million issue.