PRESENTATION3 Credit Quality and the New Dynamics of Credit Ratings Dari Barzel Nikolai J. Sklaroff...
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Transcript of PRESENTATION3 Credit Quality and the New Dynamics of Credit Ratings Dari Barzel Nikolai J. Sklaroff...
PRESENTATION3
Credit Quality and the New Dynamicsof Credit Ratings
Dari BarzelNikolai J. Sklaroff
California Debt and Investment Advisory CommissionMunicipal Debt Essentials
Oakland, CaliforniaFebruary 2, 2010
PRESENTATION3
Rating Agencies and Credit Ratings
PRESENTATION33 Credit RatingsCDIAC Municipal Debt Essentials Seminar
The Rating Agencies
Independent firms – so each is different
• Different definitions of what a rating is
• Different criteria
• But are opinions not formulas
Moody’s indicates there are $80 trillion of rated bonds and other fixed-income securities and “dozens” of rating agencies around the world; another website lists 73
Principally focused on three here in U.S. public finance: Moody’s Investors Service, Standard & Poor’s and Fitch Ratings
PRESENTATION34 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Regulatory Definitions
Credit Rating Agency Reform Act in 2006
Provided the SEC with authority to:
• Impose registration, recordkeeping, and reporting rules on credit rating agencies registered as Nationally Recognized Statistical Rating Organizations (NRSRO).
• Currently 11 credit rating agencies are registered with the Commission as NRSROs.
PRESENTATION35 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Who are the NRSROs?
Nationally Recognized Statistical Rating Organizations - SEC Orders Granting NRSRO Registration
• Egan-Jones Rating Company (Release No. 34-59056)
• Realpoint LLC (Release No. 34-58000)
• LACE Financial Corp. (Release No. 34-57300)
• A.M. Best Company, Inc. (Release No. 34-56507)
• DBRS Ltd. (Release No. 34-56508)
• Egan-Jones Rating Company (Release No. 34-57031)
• Fitch, Inc. (Release No. 34-56509)
• Japan Credit Rating Agency, Ltd. (Release No. 34-56510)
• Moody's Investors Service, Inc. (Release No. 34-56511)
• Rating and Investment Information, Inc. (Release No. 34-56512)
• Standard & Poor's Ratings Services (Release No. 34-56513)
PRESENTATION36 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Moody’s Investors Service
John Moody published Manual of Industrial and Corporation Securities in 1900
1909 introduced ratings with Aaa through C
Worldwide offices, 3,900 employees, more than 1,000 analysts
Parent company is Moody's Corporation (NYSE: MCO) www.moodys.com
PRESENTATION37 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Standard & Poor’s
www.standardandpoors.com
Traces roots to 1860; Henry V. Poor published guide to U.S. Railroads
Began rating bonds in 1916 - symbols AAA to D
Global outstanding debt rated by S&P in 100 countries is about US$32 trillion
In 2008, S&P published more than 1,150,000 ratings (new and revised)
PRESENTATION38 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Fitch Ratings
www.fitchratings.com
Established in 1913; rating symbols AAA to D in 1924
Developments
• 1989: Recapitalized
• 1997: IBCA Merger
• 2000: Duff & Phelps
• 2002: “Fitch Ratings”
Part of Fitch Group a majority-owned subsidiary of Fimalac, S.A., France
PRESENTATION39 Credit RatingsCDIAC Municipal Debt Essentials Seminar
More Competition for Rating Agencies?
Recent Press Clippings:
Financial Times: “Kroll aims to bring investigative powers to credit rating industry”
Financial Times: “Analyst [Oppenheimer’s Meredith Whitney] to rival Moody’s and S&P with own rating agency”
Bond Buyer: “National Public Finance Offers Credit Reports”
PRESENTATION310 Credit RatingsCDIAC Municipal Debt Essentials Seminar
What IS a Rating?
“is a forward-looking opinion about the creditworthiness of an obligor with respect to a specific financial obligation, a specific class of financial obligations, or a specific financial program (including ratings on medium-term note programs and commercial paper programs). It takes into consideration the creditworthiness of guarantors, insurers, or other forms of credit enhancement on the obligation and takes into account the currency in which the obligation is denominated. The opinion reflects Standard & Poor's view of the obligor's capacity and willingness to meet its financial commitments as they come due, and may assess terms, such as collateral security and subordination, which could affect ultimate payment in the event of default.”
PRESENTATION311 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Moody’s “Universal Approach to Credit Analysis”
“Because it involves a look into the future, credit rating is by nature subjective. Moreover, because long-term credit judgments involve so many factors unique to particular industries, issuers, and countries, we believe that any attempt to reduce credit rating to a formulaic methodology would be misleading and would lead to serious mistakes.”
“Moody's credit ratings represent a rank-ordering of creditworthiness, or expected loss. Expected loss is a function of the probability of default and the expected severity of loss given a default. Ratings are forward looking in that the rank ordering is designed to hold across multiple horizons.”
“While a rating summarizes the credit risk characteristics of an obligor or obligation, it is not a statement as to which obligors or obligations will default in the future. Rather, it is expected that lower rated entities and obligations will default, on average, at a higher frequency than more highly rated entities and obligations”
PRESENTATION3
Ratings Basics
Credit Quality and the New Dynamics of Credit Ratings
April 2010
June 2010 1414
Rating Symbols and Definitions, January 2011
June 2010 151515
…easier-to-see summary…
AaaHighest quality, minimal credit
risk
InvestmentAa1/Aa2/Aa3 High quality, very low credit risk
GradeA1/A2/A3
Upper-medium grade, low credit risk
Baa1/Baa2/Baa3
Moderate credit risk. Medium grade,
certain speculative characteristics
Below InvestmentGrade
Ba1/Ba2/Ba3Speculative elements,substantial credit risk
B1/B2/B3Speculative,
high credit risk
Caa1/Caa2/Caa3Poor standing,
Very high credit risk
June 2010 161616
The Rating Process
Rating Releasedto Moody’s website
Annual Surveillance
ApplicationDocuments Received
Conference Call/Management/Site Visit
Rating Committee
R A T I N G
Analysis Begins
Further Analysis; Rating Recommendation
Draft Rating Report Reviewed
Rating Report Released
Continuing Disclosure Information
Requested/Received
Note: Surveillance process may not necessarily involve a call/site visit, and may not result in a formal update of the rating on the website or in a rating report
June 2010 1717
Rating Factors: General Obligation Bond/Issuer Rating – Economy – 4 Factors
Rating Methodology: General Obligation Bonds Issued by U.S. Local Governments, October 2009
June 2010 1818
Rating Factors: General Obligation Bond/Issuer Rating -- Economy
As of 1/25/2011 Aaa Aa1 Aa2 Aa3 A1
CA Cities 9 12 32 7 5
Assessed Value ($billions) 21.9 14.0 9.4 12.2 3.1
PCI as % of US 225 156 122 99 77
MFI as % of US 211 157 122 99 79
CA Counties 1 7 13 1 4
Assessed Value ($billions) 144 68 106 7 79
PCI as % of US 167 124 95 97 73
MFI as % of US 161 130 100 89 76
Unemployment % 9 10 12 13 15
June 2010 1919
Rating Factors: General Obligation Bond/Issuer Rating -- Finances
As of 1/25/2011 Aaa Aa1
Aa2 Aa3
A1
CA Cities 9 21 32 7 5
Total GF Fund Balance as % of Revenues 53 64 30 39 33
Unreserved GF Fund Balance as % of Revenues
49 41 21 32 22
CA Counties 1 7 13 1 4
Total GF Fund Balance as % of Revenues 32 30 22 15 14
Unreserved GF Fund Balance as % of Revenues
27 19 15 3 4
June 2010 2020
Rating Factors: General Obligation Bond/Issuer Rating -- Debt
As of 1/25/2011 Aaa
Aa1 Aa2
Aa3 A1
CA Cities 9 21 32 7 5
Direct Debt as % of AV 0.2 0.2 0.3 0.7 0.9
CA Counties 1 7 13 1 4
Direct Debt as % of AV 0.2 0.3 0.3 0.1 0.2
June 2010 2121
Rating Factors: General Obligation Bond/Issuer Rating -- Management
June 2010 22
Rating Factors: GO/Issuer Rating – Weighting + Lease Financing
4 Factors
weighting in GO/Issuer Rating:
22
Lease financing additional considerations: •Assets being financed•Terms and conditions of lease•Lease burden
Generally 2-notch rating distinction between issuer’s General Obligation/Issuer Rating and CA abatement leaseRating Methodology: The Fundamentals of Credit Analysis for Lease-Backed Municipal Obligations, October 2004
June 2010 23
Rating Factors – Water/Wastewater
23
Water/sewer financing additional considerations: •4 factors +•Debt affordability/debt service coverage +•Capital Improvement Plan +•Regulatory compliance +•Terms/structure of financing +Rating Methodology: Analytical Framework for Water and Sewer System Ratings , August 1999
As of 1/25/2011 All Rating Levels
Water 57
Coverage of Maximum Annual Debt Service (x)
1.7
Unrestricted Reserves as % of O&M 101
Sewer 49
Coverage of Maximum Annual Debt Service (x)
1.6
Unrestricted Reserves as % of O&M 147
June 2010 24
Municipal market is large and highly differentiated
24
June 2010 25
Information Needed for Initial Rating and Surveillance• Based on Methodologies – for both initial rating and surveillance
• Methodologies available on our website: www.moodys.com
• If we needed it for the initial rating, there’s a good chance we’ll need it for surveillance
• If you already have a rating, you can get a sense of what’s important by reviewing your prior rating report(s)
• The Official Statement also is a good source to consult in determining what’s important, e.g. updates and changes to key charts and tables
• Feel free to talk to your rating analyst if you have questions prior to a call or meeting
• If key information is not included in continuing disclosure, surveillance analyst may call and ask for it
• Surveillance analyst also may call to follow up on disclosure information, e.g. for explanation of large and/or unanticipated changes
25
June 2010 2626
Dari BarzelVice President
Moody’s Investors ServiceOne Front Street, SF, CA 94111
June 2010 2727
© 2009 Moody’s Investors Service, Inc. and/or its licensors and affiliates (collectively, “MOODY’S”). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. Under no circumstances shall MOODY’S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY’S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY’S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling.
Moody’s Investors Service, Inc. (“MIS”), a wholly-owned credit rating agency subsidiary of Moody’s Corporation (“MCO”), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS’s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading “Shareholder Relations — Corporate Governance — Director and Shareholder Affiliation Policy.”
PRESENTATION3
Why Do Ratings Matter?
PRESENTATION329 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Ratings Are Used in Many Ways
Ratings
Borrowers
Investors
PortfolioStakeholders
Regulators
NonStakeholders
PRESENTATION330 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Factors in the Pricing of Bonds
BondPricing
EconomicExpectations
Demand forBonds
CreditRatings
Supply ofBonds
LegalStructure
MarketConstraints
PortfolioNeeds
InterestRates
RedemptionProvisions
PortfolioConstraints
PRESENTATION331 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Market Perceptions of Rating Agencies
Role of the RatingAgencies is More
Important than Ever
Role of the Rating?
RegulatoryOversight
Global FinancialCrisis
Potential NewCompetitors
PRESENTATION332 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Do ratings predict defaults? S&P Default Study
PRESENTATION333 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Ratings and the Global Financial Crisis Financial crisis has created
calls for regulation* U.S. Congress* U.S. Regulators* International
SEC Chairman Schapiro. " it is incumbent upon us to do all that we can to improve the reliability and integrity of the ratings process and give investors the appropriate context for evaluating whether ratings deserve their trust."
PRESENTATION334 Credit RatingsCDIAC Municipal Debt Essentials Seminar
0%
1%
2%
3%
4%
5%
6%
7%
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29Year
Rat
e
AAA (pure) Insured AA A BAA
Interest Rates by Credit Ratings Before the Crisis (October 9, 2007)
Interest Rates by Credit Ratings Before the Crisis (October 9, 2007)
Only 0.50% separatedthe top and bottom“investment grade” rated bonds in 2007
Impact of Credit Ratings – Before the Financial Crisis
Source: Municipal Market Data
PRESENTATION335 Credit RatingsCDIAC Municipal Debt Essentials Seminar
0%
1%
2%
3%
4%
5%
6%
7%
2012 2016 2021 2026 2031 2036 2041Year
Rat
e
AAA (pure) Insured AA A BAA
Interest Rates by Credit Ratings Today (January 24, 2011)Interest Rates by Credit Ratings Today (January 24, 2011)
Now 1.47% separatesthe top and bottom“investment grade”
bonds today
Impact of Credit Ratings – Today
Source: Municipal Market Data
PRESENTATION336 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Credit Spreads
What has the Credit Spread between Aaa/AAA and BBB/Baa General Obligations Been?
• January 2007 33 basis points
• January 2009 258 basis points
• January 2011 147 basis points
Credit worries heighten credit spreads
PRESENTATION337 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Bond Insurers Helped Get Ratings to Aaa/AAA/AAA
Borrower’s could purchase bond insurance to “insure” debt service on the bonds.
The following bond insurers enjoyed Aaa/AAA/AAA Ratings:
PRESENTATION338 Credit RatingsCDIAC Municipal Debt Essentials Seminar
WithdrawnR
Negative OutlookCa
Watch Developing
WithdrawnWithdrawnWithdrawn
WithdrawnCC
Negative WatchCaa2
Negative Watch
WithdrawnBBB-
Negative WatchBa1
Stable Outlook
WithdrawnA
Watch DevelopingBaa1
Watch Developing
WithdrawnCC
Watch DevelopingCaa2
Watch Developing
AANegative Outlook
AAANegative Outlook
Aa3Negative Watch
AA-Negative Outlook
AAANegative Outlook
Aa2Negative Watch
N/ AAAA
Negative OutlookAa1
Stable Outlook
FitchS&PMoody’sInsurer
WithdrawnR
Negative OutlookCa
Watch Developing
WithdrawnWithdrawnWithdrawn
WithdrawnCC
Negative WatchCaa2
Negative Watch
WithdrawnBBB-
Negative WatchBa1
Stable Outlook
WithdrawnA
Watch DevelopingBaa1
Watch Developing
WithdrawnCC
Watch DevelopingCaa2
Watch Developing
AANegative Outlook
AAANegative Outlook
Aa3Negative Watch
AA-Negative Outlook
AAANegative Outlook
Aa2Negative Watch
N/ AAAA
Negative OutlookAa1
Stable Outlook
FitchS&PMoody’sInsurer
Assurance CorporationAssurance Corporation
Formerly MBIA
Assured Guaranty and FSA merged
effective 7/ 1/ 2009
Bond Insurers Lose Their Triple-A Ratings
Rating Downgrades
Ratings Withdrawn
Litigation
• Recent positive news for MBIA in appeals court
Only Assured Guaranty Municipal and Assured Guaranty Corp wrote insurance in 2010
• $22.7 billion for 1,700 issuers
New firms considering formation
PRESENTATION339 Credit RatingsCDIAC Municipal Debt Essentials Seminar
The Rise and Fall of Municipal Bond Insurance
0
50
100
150
200
250
300
350
400
450$ b
illions
2001 2003 2005 2007 2009
Insured Total
From nearly 57% in 2005 to 6% in 2010
Source: SourceMedia; The Bond Buyer
PRESENTATION340 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Outlook for Rating Agencies
Remain vital and relevant
Changes are coming around the globe
Regulatory focus
Congressional focus
Internal changes and introspection
PRESENTATION3
Tips For Working with Rating Agencies
PRESENTATION342 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Tips for Working with Rating Agencies
Selecting a Rating Agency
Selecting the Number of Ratings
Managing the Rating Request and Process
• What are you asking for?
Tips for Communicating with Rating Analysts (and Other Credit Analysts)
• How to deal with bad or negative news
Presentations and Site Tours
Maintaining the Rating After the Bonds Are Sold
PRESENTATION3
Interactive Discussion
PRESENTATION344 Credit RatingsCDIAC Municipal Debt Essentials Seminar
Interactive Discussion
How is the process changing?
Variable rate debt and concerns?
Public finance ratings in the current environment?
Audience Questions?