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Moody's Approach to Local Government Credit Analysis

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Moody's Approach to Local Government Credit Analysis Moody’s Approach to Local Government Credit Analysis Eric Hoffmann, Senior Vice President / Manager, February, 2019 Public Finance Department Agenda 1. Moody’s Credit Rating Basics 2. Initial Credit Rating Process 3. Maintenance of the Rating 4. General Obligation Methodology 5. Lease, Appropriation, Moral Obligation Methodology 6. Municipal Utility Revenue Debt Methodology Moody’s Approach to Local Government Credit 2 Analysis Moody’s Credit Rating 1 Basics The Meaning of a Moody’s Credit Rating » An indication of the relative risk that 1) a municipal debtor may not fully make its debt service payments as scheduled and 2) in the event of non-payment, investors likely financial losses Types of Credit Ratings: » Long-term and short-term » Underlying, enhanced, fully-supported, insured » Issuer Rating » Indicative rating Moody’s Approach to Local Government Credit 4 Analysis Moody’s Global Long-Term Rating Scale Lowest Risk Highest Risk Moody’s Approach to Local Government Credit 5 Analysis Moody’s Short-Term Rating Scales Moody’s Approach to Local Government Credit 6 Analysis Initial Credit Rating 2 Process The 6-Step Rating Process Step 1: Step 2: Step 3: Step 4: Step 5: Step 6: Assignment Methodology Analysis Discussions Committee Publication Assignment Methodology Analysis Discussions Committee Publication The rating The Lead The Lead The Lead The Lead The Lead process starts Analyst identifies Analyst gathers Analyst holds a Analyst Analyst informs with the the appropriate information and credit discussion develops a the marketplace assignment of a methodology begins to with the Issuer recommendation of any rating Lead Analyst analyze the (in-person/ and presents it actions by credit conference call) to a committee publishing a of senior report analysts Moody’s Approach to Local Government Credit 8 Analysis Methodologies -- Publicly Available on Moodys.com Moody’s Approach to Local Government Credit 9 Analysis Methodologies: Consistency & Nuance » Three broad methodology types: cross-sector, sector, and security » Most commonly used methodologies: – US Local Government General Obligation Debt – Lease, Appropriation, Moral Obligation and Comparable Debt of US State and Local Governments – US Municipal Utility Revenue Debt » Sector and security specific methodologies general structure: – A “scorecard” that provides guidance on likely rating level for the typical credit – A list of common adjustments that might be made to the scorecard guidance, reflecting state, sector or security specific variations from the typical credit – Allowance for additional considerations that may not be common » All ratings are ultimately determined by vote in a rating committee Moody’s Approach to Local Government Credit 10 Analysis Methodologies: Consistency & Nuance » Typical general obligation: Contractual full faith and credit pledge of unlimited ad valorem taxing power of the local government » California local government GO bonds are not “typical” – Directly voter approved – Benefit from statutory lien – Some have a third-party “lockbox” – May have “special revenue” status in bankruptcy » California local government GO bonds above-average GO security results in a half to full notch automatic adjustment upward in the scorecard rating guidance » California also uses a relatively unusual legal theory for lease-backed obligations (“abatement” rather than “annual appropriation”) Moody’s Approach to Local Government Credit 11 Analysis Moody’s Issuer Guide Moody’s Approach to Local Government Credit 12 Analysis Maintenance of the 3 Rating US PFG Monitoring Framework » We review every rating at least annually » Initial surveillance process involves multiple, quantitative screens » Most ratings are deemed appropriate through the various screening and review steps – Some proceed to a rating committee for possible rating action Quantitative screens (Threshold Filtering and Analyst Batch Review) Review by an analyst (Individual Review) Analysts reach out to issuers when necessary, but always if Rating rating committee will be held Committee Moody’s Approach to Local Government Credit 14 Analysis US PFG Monitoring Framework » For credits that go to a rating committee, the rating process is the same for initial ratings as it is for reviews of existing ratings » We have one combined group responsible for initial ratings and surveillance » Analysts reach out to issuers for additional information when necessary and will always contact the issuer if a credit could go to a rating committee » Financial advisors, auditors, bond counsel, etc. are welcome to participate in the credit discussion with the issuer Moody’s Approach to Local Government Credit 15 Analysis General Obligation 4 Methodology Methodology Scorecard: Analytical Starting Point Moody’s Approach to Local Government Credit 17 Analysis Methodology Scorecard: Analytical Starting Point Moody’s Approach to Local Government Credit 18 Analysis GO Scorecard Guidance Adjustment/Notching Factors Description Direction Economy/Tax Base Institutional presence up Regional economic center up Economic concentration down Outsized unemployment or poverty levels down Other analyst adjustment to Economy/Tax Base factor (specify) up/down Finances Outsized contingent liability risk down Unusually volatile revenue structure down Other analyst adjustment to Finances factor (specify) up/down Management State oversight or support up/down Unusually strong or weak budgetary management and planning up/down Other analyst adjustment to Management factor (specify) up/down Debt/Pensions Unusually strong or weak security features up/down Unusual risk posed by debt/pension structure down History of missed debt service payments down Other analyst adjustment to Debt/Pensions factor (specify) up/down Other Credit event/trend not yet reflected in existing data sets up/down Moody’s Approach to Local Government Credit 19 Analysis Lease, Appropriation, 4 Moral Obligation 5 Methodology Lease Ratings are “Notched” off the GO Rating Standard California abatement leases have a “moderate” legal structure Moody’s Approach to Local Government Credit 21 Analysis Examples of More and Less Essential Leased Assets Moody’s Approach to Local Government Credit 22 Analysis Municipal Utility 4 Revenue Debt 6 Methodology Municipal Utilities Scorecard Factors Broad Scorecard Factors Factor Weighting Rating Sub-Factor Sub-factor Weighting Asset Condition (Remaining Useful Life) 15.0% System Characteristics 35% Service Area Wealth (Median Family Income) 12.5% System Size (O&M) 7.5% Annual Debt Service Coverage 15.0% Financial Strength 35% Days Cash on Hand 12.5% Debt to Operating Revenues 7.5% Rate Management 10.0% Management 20% Regulatory Compliance and Capital Planning 10.0% Rate Covenant 5.0% Legal Provisions 10% Debt Service Reserve Requirement 5.0% Total 100% Total 100% Moody’s Approach to Local Government Credit 24 Analysis 1. System Characteristics (35%) System Characteristics (35%) Aaa Aa A Baa Ba B and Below Asset Net Fixed Assets/Annual Net Fixed Assets/Annual Net Fixed Assets/Annual Net Fixed Assets/Annual Net Fixed Assets/Annual Net Fixed Assets/Annual Condition Depreciation : Depreciation : Depreciation : Depreciation : Depreciation : Depreciation : (15%) > 75 years 75 years ≥ n > 25 years 25 years ≥ n > 12 years 12 years ≥ n > 9 years 9 years ≥ n > 6 years ≤ 6 years Service Area Wealth > 150% of US median 150% ≥ US median > 90% 90% ≥ US median > 75% 75% ≥ US median > 50% 50% ≥ US median > 40% ≤ 40% of US median (12.5%) Water Only / Sewer Only / Water Only / Sewer Only / Water Only / Sewer Only / Water Only / Sewer Only / Water Only / Sewer Only / Water Only / Sewer Only / Water & Sewer / Combined Water & Sewer / Combined Water & Sewer / Combined Water & Sewer / Combined Water & Sewer / Combined Water & Sewer / Combined Utility / Solid Waste: Utility / Solid Waste: Utility / Solid Waste: Utility / Solid Waste: Utility / Solid Waste: Utility / Solid Waste: O&M > $70M $70M ≥ O&M > $40M $40M ≥ O&M > $17M $17M ≥ O&M > $10M $10M ≥ O&M > $5M O&M ≤ $5M System Size (7.5%) Stormwater: Stormwater: Stormwater: Stormwater: Stormwater: Stormwater: O&M > $15M $15M ≥ O&M > $7.5M $7.5M ≥ O&M > $4M $4M ≥ O&M > $2M $2M ≥ O&M > $1M O&M ≤ $1M Gas or Electric: Gas or Electric: Gas or Electric: Gas or Electric: Gas or Electric: Gas or Electric: O&M > $115M $115M ≥ O&M > $65M $65M ≥ O&M > $30M $30M ≥ O&M > $15M $15M ≥ O&M > $8M O&M ≤ $8M Moody’s Approach to Local Government Credit 25 Analysis 2. Financial Strength (35%) Financial Strength (35%) Aaa Aa A Baa Ba B and Below Annual Debt Service Coverage (15%) > 2.00x 2.00x ≥ n > 1.70x 1.70x ≥ n > 1.25x 1.25x ≥ n > 1.00x 1.00x ≥ n > 0.70x ≤ 0.70x Days Cash on Hand (12.5%) > 250 days 250 days ≥ n > 150 days 150 days ≥ n > 35 days 35 days ≥ n > 15 days 15 days ≥ n > 7 days ≤ 7 days Debt to Operating Revenues (7.5%) < 2.00x 2.00x ≤ n < 4.00x 4.00x ≤ n < 7.00x 7.00x ≤ n < 8.00x 8.00x ≤ n < 9.00x ≥ 9.00x Moody’s Approach to Local Government Credit 26 Analysis 3. Management (20%) Management (20%) Aaa Aa A Baa Ba B and Below Strong rate-setting record; Average rate-setting record; Adequate rate-setting Excellent rate-setting Below average rate-setting Record of insufficiently Rate Rates and cost adjustments in Rates and cost adjustments record; Rates and cost record; Rates and cost record; Sizeable General adjusting rates; Large Management 21 - 50 days; Small and well- 51 - 80 days; Moderate adjustments 81 - 120 days; adjustments in 20 days or Fund transfer not governed General Fund transfer not (10%) defined General Fund
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