State and local governments often engage one or more credit rating agencies with respect to the issuance of debt. A rating reflects the independent opinion of a particular agency on the credit worthiness of the issuer to make timely payments of principal and interest on the debt. If engaged, a credit rating agency will assign its rating to a particular debt issue and also to all the outstanding debt issued under the same security or credit pledge. In addition, institutional investors are often restricted from purchasing unrated debt or debt below a certain rating threshold. Accordingly, obtaining one or more credit ratings may provide a material benefit to an issuer’s cost of borrowing.
The Government Finance Officers Association (GFOA) recommends that issuers evaluate the need for obtaining one or more credit ratings and develop appropriate policies and procedures for selecting and managing credit rating agencies.
Evaluating the Need for a Credit Rating
If an issuer’s outstanding debt already has one or more credit ratings, it is common practice to request a new rating on any subsequent debt issued under the same security or credit pledge. However, some issuers have elected not to have their subsequent debt issues rated. Issuers should consider the following factors in evaluating the need for a credit rating:
- Cost of credit rating. Issuers should evaluate the potential economic benefit from a credit rating in the form of lower bond yields compared to the cost of obtaining and maintaining the rating. Credit rating fees vary by agency and issuers should negotiate the fee structure before requesting a credit rating. Issuers should fully understand the potential economic costs and benefits in advance of pursuing a credit rating.
- Administrative burden. Issuers should also consider the administrative burden placed on staff for obtaining a credit rating and maintaining a rating throughout the life of the bonds. Once a rating is requested, the formal credit rating process itself may take as long as 4-6 weeks to complete. The process may include in-person meetings, calls with rating analysts and project site visits, which does not include the time and resources an issuer must commit in advance to prepare for the rating process. Issuers should be aware of the rating process timeline and potentially significant administrative burden placed on staff, particularly for first-time credit rating requests.
- Information required. Issuers are expected to provide a substantial amount of information to the rating agency, which may include: (1) history of issuer; (2) management and governance structure; (3) multi-year budget documents; (4) financial policies and procedures; (5) bond documents and (6) audited financial statements. Issuers should assess the availability of and burden to provide the kind of information typically requested by a rating agency in advance of pursuing a credit rating.
- Size of issuance. In general, a debt issue with a lower par amount may not benefit from a credit rating as much as one with a larger par amount. While credit rating fees often vary with issue size, ratings are generally more cost effective for larger size transactions.
- Frequency of issuance. In general, the more frequently an issuer plans to issue debt, the greater the potential benefit will be from obtaining a credit rating. A more frequent debt issuer may benefit from expanding its investor base in order to successfully finance a large debt program, and a credit rating may help attract a greater number of investors to a particular debt issue.
- Method of sale. A debt issue sold in a public offering (via negotiated or competitive sale) may benefit from obtaining a credit rating, while a rating may not be required or necessary for a private placement or direct purchase.
In addition, issuers should consult with members of their financing team, particularly their municipal advisor (if one is retained) and their underwriters (if sold through a negotiated sale) on the potential economic benefits, as well as the potential costs and administrative burden, of obtaining one or more credit ratings for a particular debt issue.
Selecting and Managing Credit Rating Agencies
If an issuer decides to obtain a credit rating, then it should consider the following factors in developing appropriate policies and procedures in selecting and managing credit rating agencies:
- Multiple credit ratings. Historically, many issuers have sought separate ratings from at least two credit rating agencies. In addition, many institutional investors require a minimum of two ratings. Issuers should consult with their financing team to decide on the optimal number of ratings and from which agencies to seek those ratings.
- Published rating methodologies. Credit rating agencies are required by the SEC to publish their rating methodologies. Issuers should review and compare prospective rating agency methodologies in order to understand potential differences in rating criteria and weighting. Issuers should assess their likely ratings against the various methodologies before requesting a rating and be prepared to address the specific criteria in their meetings with the rating agencies. Issuers should also understand the process for reviewing draft rating opinions prior to publication and be prepared to submit any comments on a timely basis.
- Maintaining a credit rating. Once a credit rating is assigned, the issuer should and will likely be requested to keep the credit rating agency informed of any subsequent material events that may impact its creditworthiness or ability to make timely payments of interest and principal. Issuers are directly responsible for managing the rating agency relationship throughout the term of the bonds and should not delegate this responsibility to any other party (e.g., municipal advisor, underwriters).
- Disclosure of non-public information. During the rating process, issuers may be asked to provide non-public information such as internal revenue forecasts, projections or other forward-looking statements. Issuers should consult with their counsel before disclosing non-public information and request that such information, if provided, remain confidential.
Ending a rating agency relationship. Although still a relatively infrequent occurrence, some issuers have chosen to terminate their relationship with a credit rating agency. In most instances, this decision is driven by a disagreement over an assigned rating opinion. A decision to terminate a relationship may have serious repercussions and adversely impact an issuer’s credit profile and cost of borrowing. Given the long-term and consequential nature of credit ratings, issuers must proactively manage these risks and their relationship with the credit rating agencies.
- GFOA Best Practice: Debt Issuance Transaction Costs, 2010
- GFOA Best Practice: Selecting and Managing the Method of Sale of Bonds, 2014
- GFOA Best Practice: Selecting and Managing Municipal Advisors, 2014
- GFOA Best Practice: Debt Issuance Checklist: Considerations when Issuing Bonds, 2012
- Moody’s Investors Service
- Standard & Poor’s Ratings Services
- Fitch Ratings
- Kroll Bond Rating Agency