Transcript Slide 1

Why Bond Ratings Matter and How to
Improve Yours
(You’re Better Than You Think You Are!)
October 19, 2010
Michael J. Seezen
Shareholder, Columbia
Michael W. Burns
Shareholder, Greenville
The information contained herein is not legal advice. This information does not create an attorney-client
relationship between you and McNair Law Firm, P.A. Please contact an attorney if you have a legal issue that
you wish to discuss.
© 2010 McNair Law Firm, P.A.
I.
II.
III.
IV.
V.
Ratings Basics
How Do I Get a Rating?
The Ratings Process
Keeping/Maintaining a Rating
Questions Rating Agencies Won’t
Answer Directly
VI. Recent Events/Other Considerations
2
I. Ratings Basics
3
Ratings Basics
A. What is a rating?
• Opinion about relative credit risk.
• Not investment advice or buy, hold or sell
recommendation.
• Not indication of market liquidity/price.
• Not guarantee of credit quality or future
credit risk.
4
Ratings Basics
B. Who issues ratings?
Independent third parties, not employees
or agents of issuers, underwriters or
bond purchasers
• Standard & Poor’s (S&P)
• Moody’s Ratings Service
• Fitch Ratings
5
Ratings Basics
C. Why do I want a rating?
300 bp
275 bp
250 bp
225 bp
200 bp
175 bp
150 bp
125 bp
100 bp
75 bp
50 bp
25 bp
0 bp
Jan-07 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10
Source: Merchant Capital, LLC
BAA Spread
A Spread
AA Spread
6
Ratings Basics
D.
Do I need a rating?
1.
2.
3.
4.
5.
6.
Private Placements vs. Public Offerings
Short term (BAN/TAN) vs. Long term maturity
Size of the deal
Type of deal
a.
Insurance
b.
Letter of Credit
c.
Standby Bond Purchase Agreement
How recent was your last rated deal?
How many ratings do I need?
7
Ratings Basics
F. What are ratings scales?
S&P -
8
Ratings Basics
Moody’s -
9
Ratings Basics
Moody’s -
10
Ratings Basics
Moody’s -
11
Ratings Basics
Moody’s -
12
II. How Do I Get a Rating?
13
How Do I Get a Bond Rating?
14
How Do I Get a Bond Rating?
Preparation of
Preliminary Official
Statement and other
Information
Presentation by
Analyst to Rating
Agency Credit
Committee and vote
on the rating
Notification to Issuer
of Rating Decision
Issuer Representative
Submits Rating
Request to Rating
Agency
Interaction with
Analyst (by phone,
on-site visit, or trip to
New York)
Review of Rating by
Issuer
Analyst from Rating
Agency is assigned to
the Issue
Analyst does
preliminary research
Release of Rating
And
Surveillance
15
How Do I Get a Bond Rating?
Who are the contacts at the Rating
Agencies?
 S&P:
Richard Marino
55 Water Street
New York, New York 10041
[email protected]
212.438.2058
 Moody’s:
Julie Beglin
7 World Trade Center
250 Greenwich Street
New York, New York 10007
[email protected]
212.553.4648
16
How Do I Get a Bond Rating?
Who are the contacts at the Rating
Agencies?
 Fitch:
Dan Champeau
One State Street Plaza
New York, NY 10004
Tel: (212) 908-9188
E-mail: [email protected]
17
How Do I Get a Bond Rating?
Who contacts the Rating Agencies?
 Your Financial Advisor
 Your Bond Counsel
18
How Do I Get a Bond Rating?
How much lead time do the Rating
Agencies need?
 S&P: 3 weeks prior to bond sale.
 Moody’s: 2 weeks prior to bond sale.
19
How Do I Get a Bond Rating?
How much will it cost to get a rating?
 S&P:
20
How Do I Get a Bond Rating?
21
How Do I Get a Bond Rating?
How much will it cost to get a rating?
 Moody’s:
22
How Do I Get a Bond Rating?
23
How Do I Get a Bond Rating?
Who pays for the bond rating?
 Issuer
How and when is the bond rating paid?
 Cost of issuance
 Out of bond proceeds
24
III. The Ratings Process
25
The Ratings Process
Step 1: Develop the Plan of Finance
 Discussions with:
 Financial Advisor
 Bond Counsel
 Underwriter
 Underwriter’s Counsel
 Bond Insurer
26
The Ratings Process
Step 2: Prepare
Preliminary Official
Statement
 Drafted by:
 Bond Counsel or
 Underwriter’s Counsel
 Input and review by
 Finance Director
 Financial Advisor
 Others
27
The Ratings Process
Step 3: Submit Information to
Rating Agencies




Preliminary Official Statement
Notice of Sale (if competitive)
Legal opinion
Annual Reports or Audits for past 3
years
 Most Recent Operating Budget
 Other materials, depending on the type
of bond and security therefor
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The Ratings Process
Requested Information Includes:









10 Year Assessed Value
10 Largest Taxpayers
Population trends
Tax Collection Procedures
Debt Limits
Future Debt Plans
Number of Building Permits
Unemployment Rates
Leading Employers
29
The Ratings Process
Step 4: Interaction with
Ratings Agencies
 Telephone conference
 Pros
 Less time and expense
 Advances in technology (web
conferencing)
 Refundings – good candidate
 Cons
 Less formal
 More difficult to “show off” recent
project successes
30
The Ratings Process
Step 4: Interaction with
Ratings Agencies
 Visit from the Ratings
Agencies
 Pros
 Relatively inexpensive for issuer
 Issuer able to showcase recent
“success stories”
 Need to see the particular project
 Not another stack of paper on the desk
 Show them the unique things about
your community
31
The Ratings Process
Step 4: Interaction with
Ratings Agencies
 Visit from the Ratings Agencies
 Cons
 they will see it all
 “Hide it out in the open” – don’t
try to hide it.
 Uninvited guests.
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The Ratings Process
Step 4: Interaction with
Ratings Agencies
 In-person meeting at the
Ratings Agencies
(“do I get to go to New York?”)




More expensive than other options
Control the message
Control who interacts with analysts
Let them see your impressive
management team
 Not another stack of paper on the desk
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The Ratings Process
Step 4: Interaction with Ratings
Agencies
 Follow up information or calls
 Address “deflected” questions
 Provide additional or updated data
 Correct any mistakes
34
The Ratings Process
Step 5: Issuance of the
rating
 Credit Analyst will take the
information, analyze it and
present it to Rating
Agency’s credit committee
for a vote on the rating
35
The Ratings Process
Step 5: Issuance of
the rating
 How Long Does it
Take for the Rating to
be Generated after
Interaction?
36
The Ratings Process
Step 5: Issuance of the
Rating
 What Type of Report is
Generated?
 S&P: Letter + Rationale
 Moody’s: Letter + Memo
 Fitch: Letter + Discussion
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The Ratings Process
Step 5: Issuance of the
Rating
 Opportunity to Review and Comment
to the Ratings
 “Oh…no…no, I
strenuously object!”
 Reconsideration - rare - usually
only if there is material new info
 Be careful. Don’t say “you’re
wrong”. You’ll have to work with
these folks again
38
The Ratings Process
Step 6: Dissemination of the
Rating
 After opportunity for issuer to review
rating, it is disseminated through print
and electronic media and in response to
verbal requests to the Rating Agencies’
desks.
 Issuer can spread the word, too.
 Rating Agencies - Protected by 1st
Amendment freedom of press.
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IV. Keeping/Maintaining a Rating
40
Keeping/Maintaining a Rating
A. What Rating Agencies Like and Don’t Like
Moody’s – Methodology re: GO Bonds Issued by U.S. Local
Governments (October 2009)
S&P -
Public Finance Criteria: Financial Management
Assessment (June 2006); updated by Request for
Comment: Methodology for U.S. State Ratings
(May 2010)
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Keeping/Maintaining a Rating
•
•
•
Overview of Moody’s Local Government
General Obligation Ratings
8,200 local governments
Investment grade only
GO backed by strongest credit (Full Faith and
Credit; established by law – unconditional
pledge and Constitutional debt limits)
42
Keeping/Maintaining a Rating
Moody’s: Four key factors and 16 sub-factors:
I.
II.
III.
IV.
ECONOMIC STRENGTH (40%)
FINANCIAL STRENGTH (30%)
MANAGEMENT AND GOVERNANCE (20%)
DEBT PROFILE (10%)
43
Keeping/Maintaining a Rating
I.
ECONOMIC STRENGTH (40%)
a. Size and growth trend
b. Type of economy
c. Socioeconomic and demographic profile
d. Workforce profile
44
Keeping/Maintaining a Rating
II. FINANCIAL STRENGTH (30%)
a. Balance sheet/liquidity
b. Operating flexibility
c. Budgetary performance
45
Keeping/Maintaining a Rating
III. MANAGEMENT AND GOVERNANCE (20%)
a. Financial planning and budgeting
b. Debt management and capital planning
c. Management of economy/tax base
d. Governing structure
e. Disclosure
46
Keeping/Maintaining a Rating
IV. DEBT PROFILE (10%)
a. Debt burden
b. Debt structure and composition
c. Debt management and financial impact/flexibility
d. Other long-term commitments and liabilities
47
Keeping/Maintaining a Rating
S&P Factors
 Rating = opinion on an
issuer’s
capacity
and
willingness to pay its
financial obligations on a
timely basis.
 S&P Factors – depend on the
type of issue.
 www.standardandpoors.com
table of contents
48
Keeping/Maintaining a Bond Rating
S&P Factors
General Obligation Bonds




Economy
Financial Performance and Flexibility
Debt Burden
Management
49
Keeping/Maintaining a Bond Rating
Economy








Employment base (concentration and volatility)
Tax base and concentration (concentration and volatility)
Growth prospects
Geography and proximity to transportation hubs
Affordability
Range of services provided
Quality of infrastructure
Population (age, education, skills, income, wealth)
50
Keeping/Maintaining a Bond Rating
Financial Performance and Flexibility
 Accounting and reporting methods (GAAP, CAFR)
 Revenue and expense structure and patterns
 Fees may be good – match cost to use
 Annual operating and budgeting performance
 Financial leverage and equity position
 Budget and financial planning
 Contingent financial obligations (Pension and OPEB
liability)
51
Keeping/Maintaining a Bond Rating
Debt Burden
 Nature of the pledged security
 Repayment structure
 Current debt service burden
 Future capital needs
 Matching of debt with useful life of financed assets
 25% repaid in 5 years, 50% in 10 years
 Remaining debt capacity (emergency)
 Capital Improvement Plan (and regular review thereof)
 Debt burden (debt service of 15% – 20% of combined operating
and debt service fund expenditures is considered high)
52
Keeping/Maintaining a Bond Rating
Management
 Powers of issuer (autonomy)
 Background and experience of key members of
administration
 Financial Management Assessment
53
Keeping/Maintaining a Bond Rating
Financial Management Assessment
[Strong/Good/Standard/Vulnerable]







Revenue and expenditure assumptions
Budget amendments and updates
Long term financial planning
Long term capital planning
Investment management policies
Debt management policies
Reserve and liquidity policies
54
Keeping/Maintaining a Bond Rating
Don’t do this
55
Keeping/Maintaining a Bond Rating
S&P Factors
 Short Term (BANs, TANs)
 TAN




Security pledged to retire notes
Historical and projected cash flow
Reliability of revenues sources
Overall fiscal health
 BAN
 Access to capital markets to term out
 Issuer’s fundamental credit strength,
reflected in bond rating
56
Keeping/Maintaining a Bond Rating
S&P Factors
Water & Sewer System Revenue Bonds
 Monopolistic
 Steady demand
 6 factors






Economic considerations
Financial data / CIP
Rate setting philosophy and practices
Operational characteristics
Management
Legal provisions
57
Keeping/Maintaining a Bond Rating
S&P Factors
Parking System Revenue Bonds






Demand is KEY
Broaden the parking “system”
Start-up garage is suspect
One closing can be disastrous
Willingness to modify rates
Economic development – may never
occur
 Parking consultant demand study
 Gross v. net revenue pledge – may not
matter
58
Keeping/Maintaining a Bond Rating
S&P Factors
TIF Bonds
 Factors affecting
economic growth of
project area
 Taxpayer concentration in
project area
 Historical assessed
valuation growth
 Future assessment growth
59
Keeping/Maintaining a Bond Rating
Fitch – Major Credit Factors
• Debt and Capital Plan
• Financial Performance
• Management, administrative, legal factors
• Local tax base and economy
60
Keeping/Maintaining a Bond Rating
Things Rating Agencies
Don’t Like
 Non-payment of obligations
(even if subject to annual
appropriation)
 Unresponsiveness to requests for
information
 Don’t try to hide issues. Instead
– “we saw this issue coming, and
here’s how we’re addressing it”
61
Keeping/Maintaining a Bond Rating
Surveillance
 Submit Audit/CAFR to Rating Agencies
 Comply with Continuing Disclosure
Requirements
 EMMA
 Annual Reports
 Material Events
 Changes
 Outlook (6 – 24 months)
 CreditWatch (90 days)
 Immediate
62
Questions Rating Agencies Won’t Answer
 Is it ok to draw on our reserves? How
much? For how long?
 How much fund balance should we keep?
 Will we get “dinged” if we have a bad year
or two?
 How much debt is too much debt?
 How can we get an upgrade?
63
VI.Recent Events/Other Considerations
64
Recent Events/Other Considerations
A. Whose Rating is it Anyway?
• Credit Enhancement/Liquidity Support
Bond Insurers
December 2007
Ambac
Assured
Berkshire
CIFG
FGIC
FSA
MBIA
Radian
XL
Fitch
AAA
AAA
not rated
AAA
AAA
AAA
AAA
AAA
AAA
Moody's
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
Aaa
October 2010
S&P
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
AAA
Fitch
Ambac
withdrawn
Assured
withdrawn
Berkshire
not rated
CIFG
withdrawn
FGIC
withdrawn
FSA/Assured
merged
MBIA / NPFGC withdrawn
Radian
withdrawn
XL / Syncora
withdrawn
Moody's
Caa2
Aa3
Aa1
withdrawn
withdrawn
merged
B3/Baa1
Ba1
Ca
S&P
R
AAA
AA+
withdrawn
withdrawn
merged
BB+/A
BBwithdrawn
Source: ratings agencies
Fitch, Moody’s, S&P
65
Recent Events/Other Considerations
A
AAA
AAA
66
Recent Events/Other Considerations
• Underlying Ratings
• Joint Ratings
Joint Default Analysis (JDA) approach recognizes the
potential benefit of dual support and as such,
transactions may achieve a long-term rating that is
higher than either the obligor or the LOC bank. The
range of long-term rating outcomes for transactions
based on the JDA approach could be 0 to 2 notches
above the higher of the LOC provider’s or obligor’s
long-term rating.
67
Recent Events/Other Considerations
A
AAA AA
68
Recent Events/Other Considerations
Key Determinants of JDA Rating –
•
•
•
•
Probability of default of each of obligor and LOC bank
Default dependence between obligor and LOC bank
a. Revenue overlap
b. Financial/operational link b/w obligor and banking
c. Liquidity of obligors/access to capital markets
Support of LOC bank
Structure of transaction
a. Auto transfer from obligor to trustee
b. Transfer from obligor upon request of trustee
69
Recent Events/Other Considerations
B. Recent Events
•
•
•
•
Surety bonds
Recalibration/Don’t call it an upgrade!
LOC and SBPA Renewals
SEC Rule 15c2-12 Amendments
70
Recent Events/Other Considerations
(1) Surety Bonds
• DSRF required to market bonds
• Funded with cash (1 year’s worth of debt service) or
surety bond/letter of credit
• Bond docs require providers to be rated:
1. In highest rating category
2. At least as high as bond’s/bond insurer’s ratings
3. No rating requirement?
71
Recent Events/Other Considerations
(1) Surety Bonds
• Upon downgrade, DSRF has to be replaced with
cash or another qualifying security? When?
• Issuers may be asked to replace DSRF or refund
bonds to remedy (fund DSRF with bond proceeds;
private placements)
72
Recent Events/Other Considerations
(2) Recalibration/Don’t call it an upgrade!
• Historic disparity between Municipal Ratings and
Corporate Ratings Scales
• Recognition that Default Rates among Municipal
Issuers is Much Lower than Corporate Issuers
• 10–year cumulative default rate:
a. AAA-rated corporate bonds – 0.5208%
b. All investment-grade municipal bonds (GO and
W/S) – 0.2883%
73
Recent Events/Other Considerations
Recalibration/Don’t call it an upgrade!
Upward Shift in Ratings (# of notches)/May 2010 (Moody’s)
Health Care; Housing; Private K12 & Charter Schools; Private
Universities & Other Non-ForProfits; Transportation & Other
Infrastructure enterprises
General Obligation; Water
& Sewer; Distribution-only
utilities; Municipal Utility
Districts (MUDS)
Special Tax (NON-GO); Mass
Transit; Non-Utility
Enterprises; Tax Increment
Financing Districts (TIFs);
Grant Anticipation Revenue
Bonds (Garvees)
Public
Universities
and Public
University
Foundations
Aaa
0
0
0
0
Aa1
0-1
1
0-1
0
Aa2
1
1
1
0
Aa3
1
1
1
0
A1
2
1
1
0
A2
2
1
1
0
A3
2
1
1
0
Baa1
3
1
1
0
Baa2
3
0
1
0
Baa3
2-3
0
1
0
Municipal
Scale
Rating
74
Recent Events/Other Considerations
Recalibration/Don’t Call it an Upgrade!
• Fitch – April 2010
1. State and local general obligation ratings and those
dependent on them (e.g. appropriation-backed debt) will be
adjusted upward: (a) two notches if the current GO rating is
‘A’ to ‘BBB-’ and (b) one notch if the current GO is ‘A+’
or higher.
2. Water/sewer and public power distribution-only credits will
be adjusted upward in the same manner as GO ratings.
3. Unaffected bonds include (among other things) healthcare
and private nonprofits/education.
75
Recent Events/Other Considerations
Recalibration/Don’t Call it an Upgrade!
Fitch (% changes):
AAA AA
A BBB Below BBB
Current
6
46
40
7
1
Recal.
15
67
15
2
1
76
Recent Events/Other Considerations
(3) LOC and SBPA Renewals
• VRDB have long maturities (20-30 years) but
interest resets weekly/monthly at very low rates
(0.25%). How?
• Bonds secured by LOC or SBPA (liquidity support)
• Holders can ‘put’ bonds on 7 day notice; bonds
must be purchased by liquidity support providers
(last resort)
• Low rate depends upon highest short-term rating
of credit/liquidity support providers
77
Recent Events/Other Considerations
(3) LOC and SBPA Renewals
• Liquidity comes at a price –
1. Bond maturity is 20-30 years but liquidity
support is 2-3 years (max)
2. In aftermath of Sept. 2008 financial events,
banks less willing to extend LOC/SBPA
3. CASH = KEY
4. Facilities have shorter terms (1 year); more
expensive
78
Recent Events/Other Considerations
• Moody’s report (Sept 2010) - In addition to ‘normal’ LOC/SBPA’s coming up
for renewal in 2011, lots of ‘short’ facilities are scheduled to expire in 2011 400
350
300
250
200
150
100
50
0
Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011
79
Recent Events/Other Considerations
• Impacts?
1. Banks more selective about renewals (e.g., fewer
facilities and/or more expensive)
2. Portfolio borrowings - BQ Rules Expiring in 2010
3. Basel III/Dodd-Frank Bill
4. Jeopardizes new borrowings?
5. Bank Bonds vs. Refinancings/fixed rate conversions?
80
Recent Events/Other Considerations
(4) SEC Rule 15c2-12 Amendments
• Issuers make annual filings (audits/operating
statistics) and event-driven filings; analogous to ‘34
Act filings
• Removal of “material” for ratings changes
• Notice given in 10 business days
• New issues/remarketings after 12/1/10
81
Questions?
Michael J. Seezen, Esq.
McNair Law Firm, P.A.
Michael W. Burns, Esq.
McNair Law Firm, P.A.
1221 Main Street
Columbia, SC 29201
(803) 753-3257
104 South Main Street
Greenville, SC 29601
(864) 271-4940
[email protected]
[email protected]
82