U.S.

PUBLIC FINANCE

CREDIT OPINION
15 August 2016

Pennsylvania School District Intercept

Rating Update Moody's Upgrades PA School District
Intercept Program to A2 from Baa1; Outlook Stable

Update

Summary Rating Rationale

Moodys Investors Service has upgraded Pennsylvanias school district pre-default
enhancement program to A2 from Baa1. We have also raised the maximum rating on school
district bonds enhanced under Pennsylvania's post-default intercept to A3 from Baa1 (still
maintaining a floor of B1), and increased the maximum uplift from an underlying rating to
two notches from one notch. The outlook is revised to stable from negative.

Contacts
Dan Seymour, CFA
Assistant Vice
President - Analyst
dan.seymour@moodys.com

212-553-4871

Nicholas Samuels
212-553-7121
VP-Sr Credit Officer
nicholas.samuels@moodys.com

Additionally, we have reinstituted the top-down treatment for Pennsylvania school

district bonds whose structures ensure the intercepts would take place prior to default.
All Pennsylvania school district bonds enhanced on a pre-default basis are now rated A2
regardless of the underlying rating. As a result of these changes, we have upgraded the
majority of Pennsylvania school districts enhanced ratings, in some cases by multiple
notches.

Vanessa Youngs
212-553-7127
Analyst
vanessa.youngs@moodys.com

Please click on this link for the List of Affected Credit Ratings. This list is an integral part of
this Press Release and identifies each affected issuer

Orlie Prince
Senior Credit Officer
orlie.prince@moodys.com

The upgrades to the PA School District Enhancement Program (Fiscal Agent Agreement) and
PA School District Enhancement Program (SPSBA) incorporate a law Pennsylvania passed
on July 13 that would provide for state funds to be intercepted and diverted to bondholders
in the event of a default even without appropriations due to school districts. The law
eliminates the doubts about the programs swiftness and effectiveness that arose during
the commonwealths fiscal 2016 budget impasse, during which school districts operated
for months without any appropriations due to them, and therefore no funds available to
be intercepted to prevent or cure a default. With the new law in place, funds will always be
available to prevent or cure defaults, regardless of whether the commonwealth has passed a
budget.

212-553-7738

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Exhibit 1

Pennsylvania's aid to school districts has been increasing

Note: Dollars are in thousands

Source: Pennsylvania Department of Education

Credit Strengths

New law ensuring intercept can work even during a budget impasse

Intercept has been tested several times

Post-default intercept has typically worked in time to prevent default

Recent trend of increased state appropriations to school districts

Credit Challenges

No requirement to notify state of a default in post-default program

History of late budgets, during which enhancement program's effectiveness was in doubt

Significant fiscal stress at a number of Pennsylvania school districts

Rating Outlook
The stable outlook on the intercept program mirrors the outlook on the Commonwealth of Pennsylvania (Aa3 stable). The
commonwealth's stable outlook recognizes that Pennsylvania's problems while sure to persist are unlikely to lead to sharp liquidity
deterioration, major budget imbalances, or other pressures consistent with lower ratings for US states.
Our outlooks on post-default enhanced ratings will follow this rule: For underlying ratings at the post-default ceiling (A3) or higher, the
outlook is the same as the commonwealth's. For underlying ratings one or two notches below the ceiling (Baa1 or Baa2), the outlook is
the lower of the outlook on the underlying or on the commonwealth. For underlying ratings three notches below the ceiling (Baa3) or
lower, the outlook is the same as the underlying. There is one exception: the outlook on the post-default enhanced rating on the Penn
Hills School District (underlying rating B3 negative) is stable. Because Penn Hills' post-default enhanced rating is B1, it is already at the
floor and would be unlikely to go lower even if Penn Hills' underlying rating were to go lower.

Factors that Could Lead to an Upgrade

Upgrade of commonwealth's rating

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on
www.moodys.com for the most updated credit rating action information and rating history.

15 August 2016

Pennsylvania School District Intercept: Rating Update Moody's Upgrades PA School District Intercept Program to A2 from Baa1; Outlook Stable

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Factors that Could Lead to a Downgrade

Downgrade of commonwealth's rating

Key Indicators
Exhibit 2

Aid to School Districts is Normally Adequate to Cover School District Debt Service

Source: Pennsylvania Department of Education

Recent Developments
Pennsylvania passed a law on July 13 that erased the doubts about whether its school district intercept program would work effectively
during a budget impasse.
Article XVII-E. 4 (School District Intercepts for the Payment of Debt Service During Budget Impasse) allows the Department of
Education to intercept school district aid and redirect it to bondholders in the event of a default even if the commonwealth has not
passed a budget. The funds necessary to honor the intercept shall be appropriated once the department submits justification for the
appropriation to the chairs and minority chairs of the House and Senate appropriations committees. These four legislators have 10
days to review and comment on the appropriation, though the law doesn't allow them to reject it.
This new system stands in stark contrast to how the intercept worked during budget impasses until now. Without this law, the
commonwealth couldn't legally spend funds that hadn't been appropriated, making it unable to honor the intercept during the budget
impasse of fiscal 2016. Considering how frequently Pennsylvania is late in passing its budgets, the new law eradicates material risks
facing bondholders and leads to a significant improvement in the certainty regarding the effectiveness of the program, with or without
a budget.

Detailed Rating Considerations

Basis for Pennsylvania's State Aid Intercepts
Three state laws underpin Pennsylvania's school district intercept programs, and provide for the state to divert to bondholders aid due
to school districts in the event of default, either preventing or curing default.
The first law, Section 633 of the Public School Code, states that anytime the state is notified that a school district has missed a debt
service payment, the state shall withhold out of any State appropriation due such school district an amount sufficient to cure the
default, and divert it to bondholders. The second law is Section 785, which clarifies that this intercept can apply to lease payments due
from school districts to the Pennsylvania State Public School Building Authority. The third law is the one authorizing appropriations
during budget impasses, described in the Recent Developments section.
School districts have utilized these laws in a variety of ways. Most commonly, they simply issue bonds. Any Pennsylvania school district
bonds are automatically eligible for the intercept. A bond issued without a provision to trigger the intercept prior to a default would
potentially be eligible for a post-default enhanced rating. With this action, we rate post-default-enhanced bonds up to two notches
higher than the underlying rating, but no higher than A3 and no lower than B1. The B1 floor reflects the fact that we believe any school
district default would result in a full recovery once the intercept is triggered.
School districts have also issued bonds with a paying agent that agrees to notify the commonwealth of a missed sinking fund payment
prior to the debt service date. Also, the commonwealth has agreed to make debt service payments directly on behalf of school districts,
using their appropriated aid. Because we believe these structures result in the interception of aid prior to the default occurring, we rate
these bonds A2.

15 August 2016

Pennsylvania School District Intercept: Rating Update Moody's Upgrades PA School District Intercept Program to A2 from Baa1; Outlook Stable

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New Law is a Significant Positive

The law passed on July 13 substantially changes the way we think about the intercept program and its effectiveness. During the fiscal
2016 budget impasse, the commonwealth did not make several of its direct-pay debt service payments, for instance on behalf of the
Philadelphia School District (Ba3 negative). The commonwealth asked that district and several others to borrow funds elsewhere in
order to make their debt service payments. The commonwealth did make debt service payments on behalf of the Chester-Upland
School District, but it's unclear how or whether the commonwealth would have made payments for many other districts had they been
unable to obtain the funds elsewhere.
As a result of the uncertainties surrounding the program during the budget impasse, we took a number of drastic rating actions to
reflect the fact that we thought a default on pre-default-enhanced bonds was possible and any post-default recovery on post-defaultenhanced bonds would be less swift.
Exhibit 3

Modern History of PA Intercept Rating Actions

*With the December action, we eliminated any pre-default consideration and rated all enhanced ratings as if they were post-default enhancements.
Source: Moody's Investors Service

The new law changed our thinking. We no longer think a default on pre-default-enhanced bonds would be plausible, even during a
budget impasse. And, we think post-default recovery on post-default enhanced bonds would be swift. (In fact, in at least three cases
the recovery has been so swift that it prevented default in the first place.)
Our intercept ratings on Pennsylvania school districts now reflect the following, consistent with the way we rated them prior to 2015:

Pre-default program: Upgraded to A2 stable from Baa1 negative

Post-default cap: Upgraded to A3 from Baa1

Post-default notching: Up to 2 notches up from underlying, compared with previous limit of 1 notch up

Pre-default financing-level ratings: Reinstitute top-down treatment for bonds with pre-default structures. We previously rated
all Pennsylvania school district enhanced bonds on a post-default basis, notching up from an underlying rating. All Pennsylvania
school district bonds enhanced on a pre-default basis are now rated A2.

Pre-default outlook: Same as commonwealth's outlook (stable).

Post-default outlook: For underlying ratings at the post-default ceiling (A3) or higher, the enhanced outlook is the same as
the commonwealth's. For underlying ratings one or two notches below the ceiling (Baa1 or Baa2), the outlook is the lower of the
underlying or the commonwealth. For underlying ratings three notches below the ceiling (Baa3) or lower, the outlook is the same
as the underlying. There is one exception: the post-default enhanced rating on Penn Hills is B1, and its outlook is stable despite the
negative outlook on Penn Hills' underlying rating. That's because Penn Hills' post-default rating is already at the minimum level and
so is unlikely to move lower. The below table clarifies:

15 August 2016

Pennsylvania School District Intercept: Rating Update Moody's Upgrades PA School District Intercept Program to A2 from Baa1; Outlook Stable

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Exhibit 4

Outlooks for Post-Default Enhanced Ratings

(Note: The below is only true with Pennsylvania's rating at Aa3 stable.)

Source: Moody's Investors Service

Here are some examples of the revised enhanced ratings and outlooks on some Pennsylvania school districts given what's described
above:
Exhibit 5

Examples of Revised Enhanced Ratings on Select Pennsylvania School Districts

Source: Moody's Investors Service

Solid Program Funding

This program is now strong. It has been tested several times, and is funded by a level of aid for education that has been increasing.

15 August 2016

Pennsylvania School District Intercept: Rating Update Moody's Upgrades PA School District Intercept Program to A2 from Baa1; Outlook Stable

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U.S. PUBLIC FINANCE

Pennsylvania school districts have about $29 billion of debt outstanding, and pay annual debt service aggregating roughly $2.2 billion.
Total state aid to school districts of more than $10 billion in 2015 covered debt service by 4.5x. While the level of coverage of debt
service by state aid varies widely by district, in most cases annual aid is sufficient to cover debt service. This is particularly true for
financially weaker districts, which tend to get more money from the state.

Legal Security
The legal security for the intercept is spelled out in three statutes, which provide for the commonwealth to intercept aid due to a
school district and redirect it to bondholders in the event of a default. In order to achieve a structure that would prevent a default in
the first place, school districts' bonds sometimes also include provisions for early notification or for the commonwealth to pay debt
service directly.
We rate all Pennsylvania school district bonds on a post-default basis unless a process for triggering the intercept prior to default is
documented.

Use of Proceeds
Not applicable.

Methodology
The principal methodology used in these ratings was State Aid Intercept Programs and Financings: Pre and Post Default published in
July 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

15 August 2016

Pennsylvania School District Intercept: Rating Update Moody's Upgrades PA School District Intercept Program to A2 from Baa1; Outlook Stable

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15 August 2016

Pennsylvania School District Intercept: Rating Update Moody's Upgrades PA School District Intercept Program to A2 from Baa1; Outlook Stable