In July of 2015, the City of Chicago, Illinois sold $393,060,000 in long-term General Obligation (GO) taxable bonds at a 7.75% interest and $189,560,000 in long-term GO tax-exempt bonds at 5.5%. At the time of those sales, Chicago carried a BBB+ (negative outlook) bond rating from Standard & Poor's (S&P) as well as Fitch, and an A- (stable outlook) rating from Kroll Bond Rating Agency (KBRA). The Federal Reserve reported that long-term tax-exempt General Obligation State and Local tax-exempt bonds were averaging at 3.82% for mixed-credit quality issuers that week. Using this as the market baseline, Chicago paid a 1.68% premium due to the bond market's assessment of the elevated risk that was reported in their relatively low bond rating. The 1.68% premium on the combined taxable and tax-exempt issuances will cost the taxpayers of Chicago roughly $140 million in interest over the next 20 years.
Sixteen months earlier, Chicago sold $450,790,000 in long-term GO taxable bonds at a 6.314% interest rate and $186,700,000 in long-term GO tax-exempt bonds at 5%. At the time of the 2014 sales, Chicago was rated A+ (negative outlook) by S&P, A- (negative outlook) by Fitch, and a Baa1 (negative outlook) by Moody's. Additionally, the 2014 bonds were credit enhanced with by a AA-rated bond insurer. The Federal Reserve reported average rate at that time was 4.51%, for a 0.49% "Chicago Premium" on the 2014 bonds, even with bond insurance. Taking into account both a better credit rating on bond insurance in 2014, taxpayers in Chicago paid a premium of $43.7 million on the 2014 bonds due to perceived credit risk. With just these two issuances in 2014 and 2015, Chicagoans will pay $183.7 million over 20 years in interest premium above the average bonds sold during the same time period. That's $9.1 million annually. While that amount may seem insignificant compared to Chicago's $3.9 billion annual budget, it's nearly equivalent to the total annual expenditures for Chicago's Office of the Mayor or could be used to repair tens of thousands of potholes every year. Instead, it's paying an interest rate premium due what the market perceives to be a higher than average credit risk.
Moreover, in the course of those 16 months, Chicago's interest rate premium has more than tripled due to the market's reaction to the elevated credit risk as pointed out by the major credit rating agencies. Chicago is not Detroit. Chicago is not Greece. Chicago is not filing for bankruptcy nor has it suggested that it will not be paying its debt service. Due to a variety of circumstances, some of which are outside of local control, Chicago is challenged with a lower than average creditworthiness and is paying a significant premium because of it.
This post is not about Chicago. Chicago's recent debt premium is just a way to illustrate the high cost of credit risk for any community. If your local government issues debt, the community's creditworthiness and therefore its bond ratings matter. Unfortunately very few outside of the credit rating industry understand the multi-faceted approach that the bond rating agencies use to assess and report on a community's creditworthiness
Beyond Fund Balance and Budget Performance
Just about every local government manager knows that available fund balance and recent budget performance are important for bond ratings. In reality, these two factors only account for about 25% of the final credit rating for any community. Generally, the ratings agencies analyze a wide variety of data for your community, and then apply their own methodology to that data. The data can be generally lumped into the areas of:
The local economy and strength of your tax base.
The political and regulatory environment within which you operate.
The recent financial performance of the community.
Outstanding debt and contingent liabilities.
After crunching the numbers, the agencies then apply their own qualitative analysis to the community before arriving at your final rating.
What Every Local Government Manager Can Do Now to Maximize Bond Ratings
While there is no way in the short-term to overcome troublesome underlying financials, there are some things that you can do before your next debt issuance that can make a difference.
Many cities do not place enough emphasis on working with the rating agencies to make sure that the analysts are well positioned to take the data into context. The ratings call or ratings meeting that you get with your assigned analysts is a critical aspect of the overall rating. In my experience, many cities use that meeting only to answer the specific questions that the analysts provide in advance. However, that meeting is likely the only time that you will get to show the analysts that you are very well aware of your financial position and outlook, that you fully understand and appreciate the risks that your community poses to the markets, and that you are well equipped to deal with those risks as an organization over time. Before you request your next rating, it may be beneficial to do the following:
Know and understand what the rating agencies will view as a potential credit risk for your community. Showing a fundamental understanding of what the market views as credit risk (whether you agree it's a risk or not) is a great first step.
Produce a plan to address every credit risk weakness that you have identified. Sometimes this is as simple as accounting for your available cash in a different fund. Other times it can be as complex as showing a multi-generational plan to fully fund your pension benefits. Either way, showing the rating agencies that you are serious about reducing credit risk is important.
Create a long-term relationship with the rating agencies by providing them your plan to address credit risk and pro-actively sending them reports on the progress of your plan. This is also a great communication tool for elected officials and citizens in general.
I remain convinced that how the analysts perceive the community's Chief Appointed Official's appreciation of and willingness to address inherent credit risks has more to do with your community's final rating than any other single element of the ratings process. Don't just answer questions in the ratings meeting. Don't leave it to your Financial Advisor and Finance Director (although both should certainly be a part of the team). Use it as your opportunity to show how well you and your team are managing the credit risks presented by the community to the market. While some argue that the ratings agencies do not always accurately assess actual credit risk, ratings are one of the few bits of information that bond buyers have to price your bonds against the other available bonds in the market that day. Bond ratings certainly still matter to bond buyers. Take control of your bond ratings to ensure that your community is not unnecessarily paying an interest rate premium.
At the JDGray Group, one of our core services is to help cities maximize their financial efficiency. We can provide a full Bond Rating Assessment that provides actionable insights and strategies to maximize your bond rating - for a tiny fraction of the cost of high credit risk.