Criteria Governments Request for Comment: Limited-Tax General Operating Debt Analytical Contacts: Blake E Yocom, Chicago (1) 312-233-7056; blake.yocom@spglobal.com Lisa R Schroeer, Charlottesville (1) 434-220-0892; lisa.schroeer@spglobal.com Apple Lo, Dallas (1) 972-367-3357; Apple.Lo@spglobal.com Criteria Contacts: Liz E Sweeney, New York (1) 212-438-2102; liz.sweeney@spglobal.com Laura J Feinland Katz, CFA, New York (1) 212-438-7893; laura.feinland.katz@spglobal.com Table Of Contents SUMMARY AND OVERVIEW IMPACT ON OUTSTANDING RATINGS Key Publication Dates QUESTIONS RESPONSE DEADLINE RELATED CRITERIA AND RESEARCH WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 7, 2017 1
Criteria Governments Request for Comment: Limited-Tax General Operating Debt S&P Global Ratings is requesting comments on proposed revisions to its methodology for rating limited property tax general operating (LTGO) debt. The criteria are being updated to provide general guidance and transparency on S&P Global Ratings' view of limited property tax debt to the market. If the proposed changes are adopted, the new criteria will fully supersede "Standard & Poor's Refines Its Limited-Tax GO Debt Criteria" published Jan. 10, 2002, and partially supersede "Special Tax Bonds", published June 13, 2007. SUMMARY AND OVERVIEW 2. The proposed criteria would complement our U.S. public finance general obligation debt criteria. Where pledged revenues are secured primarily by a limited ad valorem property tax, we begin our analysis with the relevant general obligation debt criteria, which we apply to establish our view of the obligors' general creditworthiness, expressed by a general obligation (GO) or issuer credit rating (ICR) of the obligor. Please see the section "Related Criteria and Research" for a list of the general obligation debt criteria that are used as a starting point for this criteria. For the remainder of this proposal, we will refer to the ICR as the starting point. Once the ICR is established, we use this criteria to determine whether to assign an issue credit rating at or below the level of the ICR. 3. The proposed criteria would apply to U.S. ratings on limited tax operating debt issued by municipal governments, school districts, or other U.S. public finance obligors where the debt is primarily secured by a limited ad valorem tax or a general obligation of an issuer that is subject to a limitation on property tax rates (collectively, "limited tax general operating", or LTGO, debt). Under this proposal, S&P Global Ratings will generally rate LTGO bonds on par with unlimited-tax general obligation (UTGO) bonds of the same obligor, and at the same level as the ICR, subject to exceptions that are outlined in this proposal. This represents a relatively modest change in our current approach, primarily representing our view that limited property tax pledges, whether or not the pledged language includes phrases such as "general obligation" and "full faith and credit", are likely to be paid when the operations of the municipality are sound, and are at risk of nonpayment when operations are stressed, and thus are integrally related to the general creditworthiness of the issuer, which we assess through our general obligation debt criteria. To the extent an issuer has limitations in its ability to raise property tax rates, or has revenue-raising constraints of any other kind, such constraints are already factored into our general obligation criteria. In this proposal, the terms 'general obligation' and 'general operating' are used interchangeably. 4. Ad valorem property taxes play a unique role in municipal finance, and we believe that it is impractical to attempt to segregate property taxes from the operation of a municipal government, as described more fully below. As a result, when ad valorem property taxes are pledged, we generally view the pledge as a general operating pledge, even if the pledge does not include the traditional "full faith and credit" language. Assuming no significant changes to the final criteria, we would no longer rate bonds secured by a limited property tax under our "Special Tax Bonds" criteria. Therefore, paragraph 39 of the criteria would be superseded. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 7, 2017 2
5. Not included in the scope of these proposed criteria are bonds secured by limited property taxes that that are not ad valorem, such as special assessments, because the assessments are generally levied only on a defined group of property holders that are deemed to benefit from infrastructure improvements. 6. Not included in the scope of these criteria are tax increment revenues, which only reflect incremental tax revenues above a defined baseline and relate only to a defined group of properties. 7. For more information on our approach to rating special assessments and tax increment debt, please see our criteria "Special-Purpose Districts", published June 14, 2007. IMPACT ON OUTSTANDING RATINGS 8. S&P Global Ratings maintains approximately 3,200 ratings on limited ad valorem property tax general operating debt included in the scope of the proposed criteria. Assuming that the obligations maintain their current credit characteristics, testing suggests that approximately 96% of the ratings would be unchanged, 3% would be raised or lowered one notch, and 1% of the ratings would be raised or lowered by multiple notches. A small number of ratings (estimated at less than 50) would be raised by one notch to equalize the LTGO rating with the GO/ICR. The majority of the multinotch rating changes would be due to reassessing approximately 270 transactions that are currently rated under the Special Tax Bonds criteria. Those transactions would be rated under the combination of GO criteria and this criteria, as described above. Key Publication Dates Original Publication Date: June 7, 2017 Response Deadline: Aug. 1, 2017 Effective Date: Immediately upon publication of final criteria. These criteria address the fundamentals set out in "Principles Of Credit Ratings", published on Feb. 16, 2011. QUESTIONS 9. S&P Global Ratings is seeking responses to the following questions: What is your view of the scope of the criteria, that is, the description of the types of debt that would be evaluated as LTGO pledges? Specifically, are there certain legal features in an obligation you believe should be excluded from this proposal or that should be added to the proposal? What is your view of the proposal to rate LTGO and UTGO pledges on par with each other and at the same level as the ICR under most circumstances? What are your views of the examples provided of circumstances in which we generally would notch a LTGO below the ICR? In your view, are there other circumstances for notching which you would add to this list? Are there any other views regarding this criteria proposal that you would like to bring to our attention? WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 7, 2017 3
RESPONSE DEADLINE 10. We encourage interested market participants to submit their written comments on the proposed criteria by Aug. 1, 2017, to http://www.standardandpoors.com/en_us/web/guest/ratings/rfc where participants must choose from the list of available Requests for Comment links to launch the upload process (you may need to log in or register first). We will review and take such comments into consideration before publishing our definitive criteria once the comment period is over. S&P Global Ratings, in concurrence with regulatory standards, will receive and post comments made during the comment period to the web address above (click on "View Comments"). Comments may also be sent to CriteriaComments@spglobal.com should participants encounter technical difficulties. All comments must be published but those providing comments may choose to have their remarks published anonymously or they may identify themselves. Generally, we publish comments in their entirety, except when the full text, in our view, would be unsuitable for reasons of tone or substance. 11. We propose to generally rate LTGO bonds on par with UTGO bonds of the same obligor, and at the same level as the ICR, as explained below, subject to exceptions that are outlined below. 12. Property taxes are unique in that they attach a lien to the property subject to taxation. The conferral of a lien creates a tangible asset, whose collections are a function not only of economic activity, but also of management practices and policies, including tax rate management and enforcement of tax liens. Property taxes levied for all purposes share the lien on the property being taxed, making it harder, in our view, to separate revenues pledged for different purposes WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 7, 2017 4
such as operations, LTGO debt, and UTGO debt. A common lien on tangible assets is unique to the property tax sector, and ties incentives for collection on priority lien property taxes directly to those for general property taxes. The performance of ad valorem property tax debt over time tends to be strongly correlated with the obligor's willingness and ability to actively manage its own financial flexibility and debt burden, accurately project property tax collections, and identify and act upon delinquent accounts. In this respect, ad valorem property tax revenue and collections appear like a function of the obligor's general creditworthiness. 13. In determining that a pledge is a general operating pledge, whether it is backed by a limited or unlimited property tax, we believe continued debt service payment is dependent on the successful operation of the entity. Any limitation imposed on the obligor's ability to raise revenue is already embedded in the obligor's financial and economic condition, and in the factors that we assess for that obligor. Our view of the strength of the pledge is embedded in the calibration of GO criteria. For example, taxing limits are already evident in the revenue base of the municipality and the service delivery choices they make. In our local government GO criteria, the obligor's revenue constraints are already inherent in our assessment of structural balance; statutory revenue raising constraints are measured in institutional framework; ability and willingness to raise taxes when needed is measured in budgetary flexibility. 14. Additionally, we have observed that under stress, obligors generally use all of their revenue and expenditure powers to continue operation and to service debt without much prioritization in the treatment of UTGO and LTGO debt. For example, Detroit's, UTGO and LTGO debt faced the same stress and defaulted at the same time. 15. We have also observed that when the limited tax levy is insufficient to meet debt service payment, which is rare, obligors generally use their financial flexibility to generate sufficient revenues from all sources to pay the debt. Therefore, we do not conduct coverage tests in our criteria. Rather, the obligor's ability to meet debt service and continue to operate successfully is embedded in our GO analysis. 16. Following are some situations where we propose to rate a LTGO below the ICR. On an exceptional basis, there may be additional situations we haven't yet observed that are not outlined below, but could also result in an issue credit rating below the ICR: The pledged revenue is from a measurably narrower tax base than the obligor, i.e. represents only a relatively small portion of the entity's geographic footprint or taxable value; The pledged revenue is derived from a tax base having exposure to risks that are significantly different or disproportionate to those reflected in the unlimited-tax GO rating (for instance, if the pledged tax base is in an area prone to natural disasters or presents unique concentration risks compared to the risks affecting the entity as a whole); Significant limitations on the fungibility of resources, such as legal restrictions that specifically exclude the use of any available funds generated from operations outside of the limited property tax revenues to repay debt, or other significant limitations on the fungibility of the issuer's resources. This would include issuers that actively and specifically exclude available reserves from supporting obligations. Management displays an unwillingness to support the obligation if a tax collection shortfall occurs. In rating these obligations using GO criteria as the starting point, we assume that management is willing to support the obligation. Where management actively states or demonstrates a lack of willingness to support the obligation, we would generally cap the rating in the 'B' category. A tax collection shortfall has occurred or we believe a shortfall is likely in the next few years (e.g. due to lack of WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 7, 2017 5
taxing flexibility under the rate limit or a decline in the tax base), such that collections are, or will be, below debt service requirements, and these risks are not adequately captured in the ICR. In some cases, a declining property tax base may have only a modest impact on the ICR but could pose a greater risk to the issue credit rating. To the extent we believe the risk to the limited property tax pledge from a declining tax base is already factored into the ICR, and management displays a willingness to support the obligation, we may not notch for this condition 17. In these examples, we would generally rate the limited-tax bonds one or more notches below the ICR. The amount of notching would be based on our view of the severity of the condition. For instance, in the first example above, the level of notching would generally be based on our view of how narrow the tax base is compared with the entity's broader tax base, and the taxpayer characteristics, such as taxpayer diversity, of the pledged tax base. Glossary: Limited ad valorem property tax: a property tax that is based on the value of the taxed property and that has a limitation, such as a cap on the tax levy based on a percentage of the property's value. RELATED CRITERIA AND RESEARCH Articles to be superseded or partially superseded by the proposed criteria: Special Tax Bonds, June 13, 2007 (only paragraph 39 to be superseded). Standard & Poor's Refines Its Limited-Tax GO Debt Criteria, Jan. 10, 2002 (to be fully superseded) Articles complementing the proposed criteria: U.S. State Ratings Methodology, Oct. 17, 2016 Local Government GO Ratings Methodology And Assumptions, Sept. 12, 2013 Principles Of Credit Ratings, Feb. 16, 2011 Methodology And Assumptions: Rating Unlimited Property Tax Basic Infrastructure Districts, March 17, 2009 GO Debt, Oct. 12, 2006 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as S&P Global Ratings assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 7, 2017 6
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