Rating Agency Perspectives on Current Credit Issues. Friday, May 6, 2016

Transcription

1 Rating Agency Perspectives on Current Credit Issues Friday, May 6, 2016 Panelists: Moderator: Ted Damutz, Moody s Investors Service Carol Spain, S&P Global Ratings Juliet Huang, Chapman and Cutler LLP

2 I. Impact of State Budgets on Municipalities and Schools I. Perspectives on Lease-Revenue Bonds and other Appropriation-Backed Credits I. Credit Analysis of Pension and OPEB Liabilities

3 I. Impact of State Budgets on Municipalities and Schools

4 A. General relationship between state budgets and municipalities/schools B. Illinois State revenues flow to cities and school districts despite budget impasse (appropriations approved) Delayed state aid payments aren t new Chicago Public Schools is a special case Community colleges and higher education institutions have been more affected than other local governments (Northeastern Illinois University, University of Illinois, Chicago State examples however appropriations just approved)

5 C. Pennsylvania s budget impasse had significant repercussions for local governments Revised the predictability institutional framework component for counties to adequate from very strong Budget impasse caused more school districts and municipalities to cash flow borrow (Luzerne County) S&P Global Ratings has withdrawn the Pennsylvania state intercept enhancement rating D. Recent revenue shortfalls have led to state aid cuts Oklahoma (oil revenue declines) Kansas (slower economic growth than projected) E. Michigan s municipalities affect the state s budget Flint water crisis Detroit Public Schools F. South Carolina ramping back up after previous cuts G. North Carolina in process of teacher pay raises

6 II. Perspectives on Lease-Revenue Bonds and other Appropriation- Backed Credits

7 Moody s Proposed Ratings Shifts for Lease-Revenue Bonds and other Appropriation-Backed Credits New methodology consolidating two existing, related methodologies into one for contingent obligations: The Fundamentals of Credit Analysis for Lease Backed Municipal Obligations (2011) Moody s Approach to the Moral Obligation Pledge (2008) Highlight comparable debt because (non-go) general government obligations payable from the same resources as contingent obligations Different in that appropriation debt is non-contingent obligation Introduces a formal notching guide/scorecard Different from standard methodology scorecards: Weak link factor drives notching, not weighted average of key factors

8 Moody s Proposed Ratings Shifts for Lease-Revenue Bonds and other Appropriation-Backed Credits (cont d) Eliminates additional notch for abatement leases vs. annual appropriation leases Eliminates additional notch for equipment leases vs. real property leases Limits rating uplift provided by dedicated but non-pledged revenues Limits the key rating factors for notching (Essentiality and Legal Structure) Adjustment to the notching guide indicated rating would be based on Additional Considerations Significantly greater but simplified guidance provided for asset essentiality: Binary approach rather than continuum (more/less essential)

9 S&P Perspectives on Lease-Revenue Bonds and other Appropriation-Backed Credits A. Downgrade risk creates incentive to appropriate (Lombard, IL; Vadnais Heights, MN) B. S&P Global Ratings does not evaluate essentiality of the project C. Focus is on willingness to pay and the general creditworthiness of the issuing government D. Maintenance and insurance E. Debt service reserve fund F. Cases where S&P Global Ratings applies more than one notch 1. General appropriations (Grandview and Hazelwood, MO) a) Non-standard terms b) Weak relationship with project c) Elevated economic risk G. Moral obligations

10 III. Credit Analysis of Pension and OPEB Liabilities

11 GASB Standards for Pension Liability Financial Reporting Accounting financial reporting requirements may differ from obligor s statutory funding requirements Prior GASB Standards (GASB Statement No. 25 and No. 27) o Disclosed Actuarially Required Contribution ( ARC ), Unfunded Actuarial Accrued Liability ( UAAL ) and Funded Ratio in notes to financial statements o UAAL = difference between Actuarial Value of Assets ( AVA ) and Actuarial Accrued Liability ( AAL ) o Funded Ratio = AVA divided by AAL (expressed as a percentage) o Prior GASB allowed pension plans to prepare financial reports pursuant to a variety of approved actuarial methods including using a discount rate determined by obligor

12 NEW GASB Pension Standards (GASB Statement No. 67 and No. 68) Eliminates ARC. Replaces UAAL with Net Pension Liability = difference between actuarial present value of pension liabilities ( Total Pension Liability ) and FMV of pension plan assets ( Fiduciary Net Position ) Net Pension Liability differs from UAAL because Fiduciary Net Position is calculated at FMV and New GASB imposes uniformity in actuarial methods (formula uniform, inputs vary) Discount Rate no longer determined by obligor solely on longterm expected rate of return on pension plan; if assets are projected to be insufficient, obligor must use lower tax-exempt municipal bond rate for discount rate during those years

13 NEW GASB Pension Standards (GASB Statement No. 67 and No. 68) (cont d) Recognition of Proportionate Share of Net Pension Liability on Balance Sheet (and disclosure in notes to financial statements) Recognition of Pension Expense on Income Statement Descriptions of the plan and benefits Significant assumptions employed in the measurement of the net pension liability Descriptions of benefit changes and changes in assumptions Assumptions related to the discount rate and the impact on the total pension liability of a 1 percentage point increase and decrease in the discount rate

14 NEW GASB OPEB Standards (GASB Statement No. 74 and 75) Other Postemployment Benefits - benefits other than pensions; usually health care benefits, but also may include life insurance, disability and other services New GASB changes how the long-term obligation and the annual costs of OPEB are measured A requirement to recognize the net OPEB liability on the face of the financial statements, and A requirement to present more extensive note disclosures and related schedules. Statement 74 effective for FY beginning after June 15, Statement 75 effective for FY beginning after June 15, 2017.

15 S&P Perspective on Pensions and OPEB Liabilities A. Local governments 1. Debt and contingent liabilities account for 10% of the rating 2. Negative adjustments that focus on budgetary stress and affordability a) Magnitude b) Time frame c) Trends d) Managerial actions 3. Rating cap of A or lower for very high fixed costs, including pensions 4. Use of one notch flexibility 5. While GASB 67 and 68 changes increase transparency, they have not changed S&P s approach 6. S&P does not calculate an alternative estimate of pension liabilities or contributions

16 S&P Perspective on Pensions and OPEB Liabilities (cont d) B. State governments 1. Debt and liability profile (including pension and OPEB liabilities) accounts for 20% of the rating a) Pension funded ratio, pension funding ratios, pension liabilities per capita/personal income b) OPEB risk assessment 2. Override for pension funded ratio below 40% 3. For states, pension accounting change may reduce ratios but not financial exposure a) A defining feature of a recent change in pension accounting standards (GASB statement 68) is the disaggregation of the net pension liability (NPL) by-employer or contributor b) In some cases, however, states continue to have a funding responsibility for the pension systems that goes beyond what is implied by the reported NPL c) California, Michigan, and Oklahoma examples

17 Moody s Perspective on Pensions and OPEB Liabilities Pensions are just one credit factor of many (continuing to grow in significance) Contributions are broadly weak because they do not cover the annual compound interest accruing under reported basis assumptions A municipality is treading water if obligor is covering the actuarial present value of benefits earned in current year as well as interest on obligor s existing pension liability Tread Water indicator allows improves comparability and assessment of the relative strength/weakness of government contributions New GASB reporting standards have only minimal credit impact (do not impact the underlying economic obligation)

18 Moody s Perspective on Pensions and OPEB Liabilities (cont d) New GASB accounting is an improvement because of better information (primarily service cost, which enables the tread water calculation), but still need balance sheet adjustments Government accounting continues to link liability discount rates with assumed rates of return Moody s adjustments sever this linkage, and discount the promises independent of asset mix and expectation Moody s balance sheet adjustments improve comparability, and seek to measure the exact same pension promises on the same date, the same for all types of rated entities (governments, not for profits, corporations)