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U.S. PUBLIC FINANCE

As an example, some school districts issue debt secured by an annual state apportionment of a percentage
or a set amount of total state-wide sales taxes. In these cases, the level of revenue is outside the school
district’s direct control and depends on total sales taxes and the timing of the state’s transfers to the school
district; however, the school district is typically responsible for the payment of the related debt. In addition,
some school districts may face material credit risk from certain long-term liabilities that are not debt or
pensions, e.g., significant claims and judgments or compensated absences.

In addition to the Leverage sub-factors, we may assess the following debt features, which may strengthen or
weaken a school district’s overall credit quality, such as the use of derivatives, which may mitigate some
risks such as exposure to short-term interest rates, but may entail other risks, such as counterparty
exposures and potential collateral posting requirements. In addition, a large amount of short-term notes
without sufficient offsetting liquidity can expose a school district to market access risks.

A school district that is rapidly paying off debt with recurring revenue typically has greater financial
flexibility and may have a conservative financial policy. Conversely, if a school district’s current debt service
costs are very high and causing financial stress that is understated by the implied debt service input to the
fixed costs ratio, the issuer rating may be lower than the scorecard-indicated outcome.

Outsized Contingent Liability Risk
Contingent liabilities, such as a guarantee to pay another entity’s debt or manage the operation of a
separate enterprise, even if that enterprise is currently self-supporting, can reduce credit strength. For
example, where a school district has not regularly budgeted to pay debt service for an entity whose debt it
guaranteed, a sudden call on the guarantee could impact the school district’s credit strength. Other
examples include a school district’s operational exposure to transportation, food service or energy
enterprises that are outside the school district’s scope of operations. We typically would consider the
enterprise’s amount of debt, debt structure and legal issues that could limit the flexibility of the school
district in the event it had to pay the enterprise’s debt or manage its operations.

Expected Decline or Improvement in Instrument-Level Credit Quality
Expectations of a marked decline in credit quality (e.g., debt service coverage) on any debt pledge of a
school district could indicate weakening credit quality of the school district itself that is not yet reflected in
the scorecard. Conversely, an expected material improvement in instrument-level credit quality might
indicate improving credit quality of the issuer. In some cases, there is a material separation between pledged
revenue and the issuer’s operating funds, e.g., through a special purpose vehicle. In other cases, the
transaction structure has an open loop that allows the school district to use excess cash flow after debt
service is paid for other needs. In this case, when pledged revenue decreases, operating revenue to the
school district would also decrease.

History of Missed Debt Service Payments
A past default, whether on rated or unrated obligations, often indicates a heightened risk of failure to meet
financial obligations, especially if the credit drivers of the default have not been cured. In addition, a history
of default can indicate weak or wavering willingness to take necessary steps to avoid a future default. We
include in this category missed or materially late payments on any of a school district’s long-term bonds or
short-term notes reflecting an inability or unwillingness to pay, and we typically include defaults on
contingent obligations, such as moral obligations. The more time that has passed since a default, the less
heavily we weigh this consideration, provided that the issuer has a subsequent track record of paying debt
service on time and in full.

Event Risk
We also recognize the possibility that an unexpected event could cause a sudden and sharp decline in a
school district's fundamental creditworthiness, which may cause actual ratings to be lower than the

20 JANUARY 26, 2021 RATING METHODOLOGY: US K–12 PUBLIC SCHOOL DISTRICTS