© 2010 mcnair law firm, p.a. michael j. seezenmichael w. burns shareholder, columbiashareholder,...

© 2010 McNair Law Firm, P.A.

Michael J. Seezen Michael W. BurnsShareholder, Columbia Shareholder,

Greenville

Why Bond Ratings Matter and How to Improve Yours

(You’re Better Than You Think You Are!)

October 19, 2010

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.

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I. Ratings BasicsII. How Do I Get a Rating?III. The Ratings ProcessIV. Keeping/Maintaining a RatingV. Questions Rating Agencies

Won’t Answer DirectlyVI. Recent Events/Other

Considerations

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I. Ratings Basics

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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.

5

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

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C. Why do I want a rating?

0 bp

25 bp

50 bp

75 bp

100 bp

125 bp

150 bp

175 bp

200 bp

225 bp

250 bp

275 bp

300 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

BAA Spread A Spread AA Spread

Ratings Basics

Source: Merchant Capital, LLC

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Ratings Basics

D. Do I need a rating?1.Private Placements vs. Public Offerings2.Short term (BAN/TAN) vs. Long term maturity3.Size of the deal4.Type of deal

a. Insuranceb. Letter of Creditc. Standby Bond Purchase Agreement

5.How recent was your last rated deal?6.How many ratings do I need?

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Ratings Basics

F.What are ratings scales?S&P -

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Ratings BasicsMoody’s -

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II. How Do I Get a Rating?

How Do I Get a Bond Rating?

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Who are the contacts at the Rating Agencies?

S&P: Richard Marino

55 Water StreetNew York, New York [email protected]

Moody’s: Julie Beglin

7 World Trade Center250 Greenwich StreetNew York, New York [email protected]

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Who are the contacts at the Rating Agencies?

Fitch: Dan ChampeauOne State Street PlazaNew York, NY 10004

Tel: (212) 908-9188E-mail: [email protected]


Who contacts the Rating Agencies?

Your Financial Advisor

Your Bond Counsel

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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.

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How much will it cost to get a rating?

S&P:

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How much will it cost to get a rating?

Moody’s:

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Who pays for the bond rating? Issuer

How and when is the bond rating paid? Cost of issuance Out of bond proceeds

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III. The Ratings Process

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The Ratings Process

Step 1: Develop the Plan of Finance

Discussions with: Financial Advisor Bond Counsel Underwriter Underwriter’s Counsel Bond Insurer

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The Ratings ProcessStep 2: Prepare

Preliminary Official Statement

Drafted by: Bond Counsel or Underwriter’s Counsel

Input and review by Finance Director Financial Advisor Others

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The Ratings ProcessStep 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 ProcessRequested 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

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The Ratings ProcessStep 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 successes30


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

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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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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

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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

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The Ratings Process

Step 5: Issuance of the rating

How Long Does it Take for the Rating to be Generated after Interaction?

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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 ProcessStep 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

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The Ratings ProcessStep 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

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Keeping/Maintaining a RatingA. 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)

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)

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Moody’s: Four key factors and 16 sub-factors:I.ECONOMIC STRENGTH (40%)II.FINANCIAL STRENGTH (30%)III. MANAGEMENT AND GOVERNANCE

(20%)IV. DEBT PROFILE (10%)

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I. ECONOMIC STRENGTH (40%)a. Size and growth trendb. Type of economyc. Socioeconomic and demographic profiled. Workforce profile

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II. FINANCIAL STRENGTH (30%)a. Balance sheet/liquidityb. Operating flexibilityc. Budgetary performance

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Keeping/Maintaining a RatingIII. MANAGEMENT AND GOVERNANCE

(20%)a. Financial planning and budgetingb. Debt management and capital planningc. Management of economy/tax based. Governing structuree. Disclosure

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IV. DEBT PROFILE (10%)a. Debt burdenb. Debt structure and compositionc. Debt management and financial impact/flexibilityd. Other long-term commitments and liabilities

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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 FactorsGeneral Obligation Bonds Economy Financial Performance and

Flexibility Debt Burden Management

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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)

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Keeping/Maintaining a Bond RatingFinancial 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 RatingDebt 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)

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Keeping/Maintaining a Bond RatingManagement Powers of issuer (autonomy) Background and experience of key

members of administration Financial Management Assessment

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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

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Keeping/Maintaining a Bond RatingDon’t do this

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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

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Keeping/Maintaining a Bond RatingS&P FactorsWater & Sewer System Revenue

Bonds Monopolistic Steady demand 6 factors

Economic considerations Financial data / CIP Rate setting philosophy and

practices Operational characteristics Management Legal provisions

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Keeping/Maintaining a Bond RatingS&P FactorsParking 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 matter58

Keeping/Maintaining a Bond RatingS&P Factors

TIF Bonds Factors affecting

economic growth of project area

Taxpayer concentration in project area

Historical assessed valuation growth

Future assessment growth

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Fitch – Major Credit Factors• Debt and Capital Plan• Financial Performance• Management, administrative,

legal factors• Local tax base and economy

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Keeping/Maintaining a Bond RatingThings 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”

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Keeping/Maintaining a Bond RatingSurveillance 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

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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?

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VI.Recent Events/Other Considerations

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Recent Events/Other Considerations

A. Whose Rating is it Anyway?• Credit Enhancement/Liquidity Support

Bond InsurersDecember 2007 October 2010

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Fitch Moody's S&PAmbac AAA Aaa AAAAssured AAA Aaa AAABerkshire not rated Aaa AAACIFG AAA Aaa AAAFGIC AAA Aaa AAAFSA AAA Aaa AAAMBIA AAA Aaa AAARadian AAA Aaa AAAXL AAA Aaa AAA

Fitch Moody's S&PAmbac withdrawn Caa2 RAssured withdrawn Aa3 AAABerkshire not rated Aa1 AA+CIFG withdrawn withdrawn withdrawnFGIC withdrawn withdrawn withdrawnFSA/ Assured merged merged mergedMBIA / NPFGC withdrawn B3/ Baa1 BB+/ ARadian withdrawn Ba1 BB-XL / Syncora withdrawn Ca withdrawn

Source: ratings agencies

Fitch, Moody’s, S&P


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• 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.

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AAA


Key Determinants of JDA Rating –• Probability of default of each of obligor and LOC

bank• Default dependence between obligor and LOC banka. Revenue overlapb. Financial/operational link b/w obligor and bankingc. Liquidity of obligors/access to capital markets• Support of LOC bank• Structure of transactiona. Auto transfer from obligor to trusteeb. Transfer from obligor upon request of trustee

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B. Recent Events• Surety bonds• Recalibration/Don’t call it an upgrade!• LOC and SBPA Renewals• SEC Rule 15c2-12 Amendments

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(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 category2.At least as high as bond’s/bond insurer’s ratings3.No rating requirement?

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(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)

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(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


Recalibration/Don’t call it an upgrade!Upward Shift in Ratings (# of notches)/May 2010 (Moody’s)

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MunicipalScale Rating

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 Foundation

s

Health Care; Housing; Private K-12 & Charter Schools; Private Universities & Other Non-For-

Profits; Transportation & Other Infrastructure enterprises

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


Recalibration/Don’t Call it an Upgrade!• Fitch – April 20101. 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.

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Recalibration/Don’t Call it an Upgrade!Fitch (% changes):

AAA AA A BBB Below BBB

Current 6 46 40 7 1Recal. 15 67 15 2 1

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(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

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(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 = KEY4. Facilities have shorter terms (1 year);

more expensive78


• 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 -

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0

50

100

150

200

250

300

350

400

Q4 2010 Q1 2011 Q2 2011 Q3 2011 Q4 2011


• Impacts?1.Banks more selective about renewals (e.g.,

fewer facilities and/or more expensive)2.Portfolio borrowings - BQ Rules Expiring in

20103.Basel III/Dodd-Frank Bill4.Jeopardizes new borrowings?5.Bank Bonds vs. Refinancings/fixed rate

conversions?

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(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

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Questions?

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Michael J. Seezen, Esq.

Michael W. Burns, Esq.

McNair Law Firm, P.A.

McNair Law Firm, P.A.

1221 Main Street 104 South Main Street

Columbia, SC 29201

Greenville, SC 29601

(803) 753-3257 (864) 271-4940

[email protected]

[email protected]

© 2010 mcnair law firm, p.a. michael j. seezenmichael w. burns shareholder, columbiashareholder,...

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