S&P Announces New Bond Rating Criteria

Moody’s is also proposing new criteria and is accepting comments now.
(Published Sep 30, 2013)

Standard and Poor’s (S&P) has implemented new bond rating criteria for cities, counties, and townships in Minnesota and across the country, effective immediately. S&P had originally proposed the criteria in early 2012.

Moody’s Investors Service has proposed new criteria and is seeking comment now.

Ehlers has prepared questions and answers on the rating changes, with particular emphasis on S&P’s actual criteria, Moody’s proposed criteria, and how they will affect Minnesota local governments.

What will be the impact of the new S&P criteria on ratings?
S&P will use a scorecard of seven rating factors to determine the rating with “1” being the best rating and “5” being the worst. The rating analysts and committee will be able to adjust the scores with both qualitative and quantitative “overriding” and minor adjustments. The S&P testing suggests 60 percent of credits are expected to stay the same, 30 percent moving up, and 10 percent moving down (generally one notch adjustments).

What are the criteria?
These charts show the new criteria for S&P and Moody’s proposed criteria.

New bond rating criteria for S&P

Proposed new bond rating criteria for Moodys

It seems like many of these factors are external. Are there any areas within our control?
While the Institutional Framework (10 percent) and Economy (30 percent) scores make up a large portion of the S&P rating and focus on areas largely outside of a municipality’s control, the majority of the rating is comprised of internal factors such as Management (20 percent), Financial (30 percent), and Debt (10 percent). S&P’s Financial Management Assessment examines your budget planning and monitoring, existing financial policies, and long-term planning practices to determine the impact management decisions can have on other key credit factors. Financial measures include budget flexibility, ongoing budget performance, and the availability of cash or cash equivalents to service debt or other expenditures. Consideration of available sources of repayment and debt amortization are key components to S&P’s debt score, which measures a municipality’s annual debt service against expenditures, and total tax-supported debt against revenue position.

How will my rating calls be different under the new criteria?
It appears that local governments will need to have a thorough understanding of the activity in all governmental funds and enterprise funds as reported in your last financial statements. Whereas previously the rating agencies focused on the general fund, three of the factors will include the broader “governmental funds” category, which can include special assessment funds, EDA/HRA funds, construction funds, etc. S&P will make adjustments to exclude one-time expenditures such as capital costs, the use of bond proceeds or non-recurring transfers, but it is important for you to be able to explain the rationale behind the adjustments.

S&P will also ask more questions about the liquidity of your investments, particularly how much matures in less than one year, since liquidity is also 10 percent of your rating.

Finally, the categories in your audit of assigned, unassigned, and designated fund balances will be more thoroughly vetted to determine how much flexibility your governing board has to access these funds in the short-term. The calls are not expected to occur any earlier or to last much more than an hour unless S&P has not rated your community in several years. It is also expected that primary analysts will release questions tailored to the new criteria ahead of rating calls.

What if I do not plan to issue debt for a few years and how will I know if I am part of the 10 percent that will be downgraded?
Other than new rating requests, S&P will conduct a 12-month review of the 4,000+ affected government entities starting with those with populations greater than 1 million and those expected to move up or down by multiple notches. It does not appear that S&P is accepting requests for expedited review.

Mostly likely, local governments that have consistently poor performance in governmental and enterprise funds with little flexibility to adjust reserves or structural imbalances will be most vulnerable to downgrades, particularly if the community has low or declining income and property tax values.

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