Fitch Places $6B NJ School Credit Enhancement Program on Rating Watch Neg

Business Wire, June 17, 2003

Business Editors

NEW YORK--(BUSINESS WIRE)--June 17, 2003

Fitch Ratings places the 'AA+' rating of the New Jersey School Credit Enhancement Program's New Jersey School Bond Reserve (the reserve), on Rating Watch Negative. The program rating is assigned, upon request, to long-term local general obligation bonds in New Jersey issued for school purposes based on the reserve's statutory backing of such debt. The reserve is a part of the New Jersey Fund for the Support of Free Public Schools (the fund). The program rating is potentially applicable to approximately $6 billion in outstanding municipal bonds, many of which also are insured.

At the time of Fitch's initial rating assignment (June 15, 2001), the ratio of total assets, including unrealized gains, in the New Jersey Fund for the Support of Free Public Schools (the fund) to reserve holdings ($65 million) was more than 2.5:1. Statutes now effectively require assets within the fund to be designated annually as a reserve and invested in direct or guaranteed U.S. government obligations equal to 1.5% of outstanding local school-purpose debt in the state. This amount could cover an estimated 60 one-year defaults by average-sized school issuers in New Jersey. Fitch's 'AA+' rating has been based on a stress test methodology giving credit to the ability of the reserve to withstand such unprecedented defaults. Credit quality of school district debt remains strong, buttressed by the state's statutory enhancement of debt issued by several large, financially stressed districts.

Two separate factors have led to the probability of negative rating action in the near future: the effects of the bear market on the fund and the prospect of new legislation that would weaken reserve requirements at the same time that the state uses fund resources for budget relief.

The bear market has led to a sustained period of investment losses for the fund since fiscal 2000. Because of more than $60 million in unrealized losses and routine transfers to the general fund, coupled with the anticipated rise in local school debt in the state (in part due to the Abbott v. Burke court mandated construction effort), the ratio of total fund assets to reserve holdings has dramatically declined. At the end of fiscal 2002, the ratio of fund assets to reserve holdings had fallen to 1.5:1, even before additional unrealized losses and more local school debt issuance in fiscal 2003. In addition, state treasury projections indicate that fund transfers to the general fund will increase this year - perhaps to a level equal to more than 20% of total fund assets -- in order to provide budget relief. In short, the ability of the fund to sustain reserve levels at the required 1.5% level has been weakened significantly by the combination of investment losses, increased local debt issuance, and the state's demands on fund resources for budget relief.

In addition, the administration has caused legislation to be introduced that would decrease the required reserve level to 1% under a methodology which would create two separate, but fungible and interlinked, reserves: one for prior school debt at 1.5% of par outstanding and another for future school debt at 1% of par outstanding. The proposed legislation includes a covenant by the state to deposit funds necessary on an annual basis to keep reserves funded at the newly established levels, and the reduction in the reserve percentages would increase the state's ability to keep itself in compliance with these provisions in the short term. Even at the 1% level, which would not be reached until all previous school debt was retired over the next two decades, the reserves would be able to cover an unprecedented number of school defaults.

Given this combination of factors, Fitch anticipates that the program rating could be downgraded one notch to 'AA' at some point in the next several months unless there are more substantial financial changes in the fund or additional legislative provisions. Resolution of the Rating Watch likely will await final disposition of the legislative proposal.