Moody s Muni Bond Rating Criteria & KS Local Government Trends

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1 Moody s Muni Bond Rating Criteria & KS Local Government Trends Denise Rappmund, VP Senior Analyst October 2017

2 Agenda 1. Introduction to Moody s 2. General Obligation Methodology & Scorecard 3. Municipal Utility Methodology & Scorecard 4. Kansas City & County Credit Trends 5. Publication links Kansas City and County Ratings 2

3 1 Introduction to Moody s

4 Moody s Investors Service» Moody s Investors Service (MIS) provides credit ratings on bonds issued by commercial & government entities» MIS has analysts that specialize in specific sectors, determined by pledged security Local Government States Infrastructure Higher Education, Housing, Heath care» In Kansas, our local government team rate cities, counties, school districts, CCDs, park districts, and utility systems» The credit rating methodologies we are using in Kansas are largely General Obligation and Municipal Utility Kansas City and County Ratings 4

5 What is a Bond Rating?» A Moody s bond rating speaks to the probability of default and loss given default.» The rating is one source of information for investors to use when evaluating a credit. Kansas City and County Ratings 5 5

6 2 General Obligation Methodology & Scorecard

7 Moody s GO Rating Overview» The GO rating methodology focuses on the following factors Economy & Tax Base (30%) Finances (30%) Management (20%) Debt/Pensions (20%) Kansas City and County Ratings 7

8 Economy & Tax Base (30%)» Considerations generally include Tax base size, growth rate & tax rates Institutional presence & diversity Major employers Tax base concentration Population and migration trends Wealth & income indices (MFI, unemployment, poverty) Kansas City and County Ratings 8

9 Finances (30%)» Considerations generally include General Fund operating history (e.g. deficits or surpluses) General Fund balance and cash reserves Operating Fund balance and cash reserves Outsized liabilities or aged receivables Additional liquidity outside the Operating Funds Expectations for future performance Formal policies (e.g. minimum General Fund balance) Kansas City and County Ratings 9

10 Management (20%)» Considerations generally include Policies (financial, debt, investment) Tenure & stability of staff Budgeting practices & ability to manage challenging situations Institutional Framework (IF) score The IF score represents a local government s legal and statutory ability to raise revenues & cut expenditures In Kansas, all cities and counties receive an IF score of Aaa Kansas City and County Ratings 10

11 Debt & Pensions (20%)» Considerations generally include Direct debt burden as a percent of full value Principal amortization Remaining authorization & future debt plans Overlapping debt Asset and infrastructure condition Moody s-calculated pension burden as a percent of full value & as a percent of operating revenues Fixed cost burden Kansas City and County Ratings 11

12 GO Scorecard Example Kansas City and County Ratings 12

13 GO Scorecard - Notching Factors Adjustments/Notching Factors Economy/Tax Base Institutional presence Regional economic center Economic concentration Outsized unemployment or poverty levels Other analyst adjustment to Economy/Tax Base factor (specify) Finances Outsized contingent liability risk Unusually volatile revenue structure Other analyst adjustment to Finances factor (specify) Management State oversight or support Unusually strong or weak budgetary management and planning Other analyst adjustment to Management factor (specify) Debt/Pensions Unusually strong or weak security features Unusual risk posed by debt/pension structure History of missed debt service payments Other analyst adjustment to Debt/Pensions factor (specify) Other Credit event/trend not yet reflected in existing data sets Direction up up down down up/down down down up/down up/down up/down up/down up/down down down up/down up/down Kansas City and County Ratings 13

14 Use of Methodology Scorecards Purpose and Use of Methodology Scorecards: Enhance the transparency of our rating process Capture the key considerations that correspond to particular rating categories Not an exhaustive list of factors that we consider in every rating assignment Scorecards are mostly quantitative, but include some qualitative metrics May adjust up or down from scorecard-indicated outcome based on additional factors Scorecard acts as a starting point for a more thorough and individualistic analysis Final rating is determined by a Rating Committee after consideration of all relevant facts Kansas City and County Ratings 14

15 The State s Credit & Impact on Local Governments» Kansas GO rating is Aa2/Stable Downgraded from Aa1/STA in April 2014 Outlook revised to negative in May 2016 Outlook revised to stable in June 2017» Moody s does not have any Kansas local government ratings that are notched off of the state s ratings» We view the city and county ratings as independent from the state but consider the following factors: Economic ties to the state from an employment perspective in certain areas Responsibilities or costs that are passed from the state to municipalities Overlapping tax burdens as state increases taxes Institutional framework score for KS cities and counties (moved to Aaa in 2017) Kansas City and County Ratings 15

16 Contingent Liabilities» Most of rated Kansas cities and counties leverage their GO pledge for a number of self-supporting entities or projects Utility Airport Special districts Tax Increment» We back out pension and debt burden liabilities related to essential purpose enterprises (such as water and sewer) if they have consistent positive cash flow» May apply additional notching for outsized enterprise or contingent liability risk Competitive enterprise such as hospitals, sports arenas Economic development projects in early stages Debt service that exceeds 20% of operating revenues; history of coverage falling below 1.1 times Kansas City and County Ratings 16

17 Pension Liability Among Many Rating Factors» Pensions directly affect three of the four key areas of our credit analysis» Debt burden pension obligations exceed bonded debt in many jurisdictions, with escalating payments, and may be on legal parity with GO bonds» Financial performance underfunding annual contributions may mask a structurally imbalanced budget» Management key assumptions used, strategies to control costs, degree of local control and flexibility to implement reform» Given the variety of pension plans across all local governments, to improve comparability from issuer-to-issuer we have standardized pension liabilities using a market-based discount rate» Citibank Pension Liability Index 3.86% as of July 2017» The Moody s-calculated adjusted net pension liability (ANPL) is often larger than what issuers report in their audits Kansas City and County Ratings 17

18 Increased Emphasis on Tread Water and Fixed Costs» Tread water payment: the calculation to determine the amount a local government should contribute to avoid increases to its pension burden The tread water payment is calculated using the plan s existing assumptions» Fixed costs: pension contribution (@ tread water) + debt service + OPEB divided by operating revenues This measures the portion of the operating budget that is fixed Kansas City and County Ratings 18

19 3 Municipal Utility Methodology & Scorecard

20 Characteristics of a Municipal Utility - Monopolistic Service Sector Stability - Highly essential service Sector Challenges - Political will to increase rates with public resistance - Limitations for support to/from general government - Operating systems highly regulated - Resource constraints - Relatively affordable service - Mandated standards can result in significant debt - Ability to compel payments to direct user - Risk of general government distress, even if separately secured or governed Kansas City and County Ratings 20

21 Municipal Utilities Scorecard Weighted Factors Broad Scorecard Factors Factor Weighting Rating Sub-Factor Sub-factor Weighting Asset Condition (Remaining Useful Life) 10.0% System Characteristics 30% Service Area Wealth (Median Family Income) 12.5% System Size (O&M) 7.5% Annual Debt Service Coverage 15.0% Financial Strength 40% Days Cash on Hand 15.0% Debt to Operating Revenues 10.0% Management 20% Legal Provisions 10% Rate Management 10.0% Regulatory Compliance and Capital Planning 10.0% Rate Covenant 5.0% Debt Service Reserve Requirement 5.0% Total 100% Total 100% Kansas City and County Ratings 21

22 Municipal Utility Scorecard Example Kansas City and County Ratings 22

23 Municipal Utility Scorecard - Notching Factors Adjustments/Notching Factors System Characteristics Additional service area economic strength or diversity Significant customer concentration Revenue-per-Customer greatly over/under regional average Exposure to weather volatility or extreme conditions Resource vulnerability (1/3 or greater) Sizable or insufficient capacity margin Other analyst adjustment to System Characteristics (Specify) Financial Strength Debt Service Coverage (Annual or MADS) below key thresholds: Additional Bonds Test and 1.00x coverage Constrained liquidity position due to oversized transfers Oversized ANPL relative to debt or significant ARC under-payment Significant exposure to puttable debt and/or swaps or other unusual debt structure Other analyst adjustment to Financial Strength factor (Specify) Legal Provisions Structural Enhancements/Complexities Other analyst adjustment to Legal Provisions factor (Specify) Management Unusually strong or weak operational or capital planning Other analyst adjustment to Management factor (Specify) Other Credit Event/Trend not yet reflected in existing data set Direction up down up/down down down down up/down down down down down up/down up/down up/down up/down up/down up/down Kansas City and County Ratings 23

24 Relationship with GO Rating» A municipal utility s credit quality is related to the strength of its associated local government entity. Examples of credit linkages include:» Economy: Coterminous or overlapping economic base and service area» Finances: Cash can often flow between the two entities» Debt: Revenues to support GO and utility paid by the same group of constituents» Management and Governance: Management teams may be the same or have close ties» Capital Markets: GO and utility need to access the same capital markets for funding» Rating levels are usually similar (within 2 notches) due to these linkages Kansas City and County Ratings 24

25 4 Kansas City and County Credit Trends

26 Overview of Moody s Ratings in Kansas» Moody s maintains GO ratings on 34 cities & 16 counties Additionally, 4 water and sewer systems and 1 water district» The median city GO rating is Aa3; nationally, the median is Aa3» The median county GO rating is Aa3; nationally, the median is Aa2 Distribution of Ratings - Kansas Cities & Counties Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 Cities Counties Kansas City and County Ratings 26

27 Moody s Outlook for Local Government Nationally is Stable» Healthy property tax growth and stable reserves» Growing balance sheet leverage remains manageable for most Kansas City and County Ratings 27

28 Kansas Credit Characteristics - Cities Strengths» Tax bases are generally slightly smaller but stable & modestly expanding» Median Family Income is average relative to the US while affordability remains favorable» Reserves are on par with peers at around 30% of revenues» Institutional Framework is above average at Aaa due to high legal flexibility, stable revenues and expenses and generally manageable fixed costs» Pension contributions generally above tread water Challenges» Direct debt burden is higher than peers nationally at 2.7% versus 1.7%» Marginally elevated pension burden (ANPL) relative to peers at 2% of FV versus 1.7%» Moderate but manageable fixed costs around 25% of operating revenues Kansas City and County Ratings 28

29 Kansas Credit Characteristics - Counties Strengths» Median Family Income is average relative to the US while affordability remains favorable» Institutional Framework is above average at Aaa due to high legal flexibility, stable revenues and expenses and generally manageable fixed costs» Direct debt burden is on par with peers nationally at 0.5%» Pension burden (ANPL) about on par with peers at 1.1% of FV» Low fixed costs at around 13% of operating revenues; generally above tread water Challenges» Tax bases are generally much smaller but stable & modestly expanding» Reserves are on below peers at around 23% of revenues versus 31% Kansas City and County Ratings 29

30 5 Publications

31 Relevant Publications GO Medians Tax Base Growth Reinforces Sector Stability as Pension Troubles Remain, March M_ Utility Medians Sound Financial Metrics Signal Continued Stability, March M_ Kansas City and County Ratings 31

32 Denise Rappmund 600 N Pearl St. Dallas TX Denise.Rappmund@moodys.com moodys.com

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