Bond ratings can be a crucial factor impacting the interest cost on bonds, so it’s no wonder that municipalities strive to receive a top-tier rating. However maintaining or improving municipal bond ratings can be challenging. DebtBook turned to a long-time rating agency analyst veteran, turned issuer to discuss what role technology can potentially play in attaining (or improving upon) a positive bond rating.
What Role do Bond Agencies Play?
When a local government wants to issue new debt, although not required, they may turn to a rating agency for an assessment of their creditworthiness and, in-turn, access more favorable loan terms.
According to Forbes, bond rating agencies work somewhat like credit bureaus in that they both research financial information to determine creditworthiness. But instead of assessing an individual’s likelihood of repaying their debts, a bond rating agency determines whether the issuers of debt securities like bonds are likely to fulfill their promises to pay interest and repay the principal you loaned them.
The objective of the rating agency is to assign a municipal bond a credit rating to make it faster and easier for market participants to evaluate risk. The key players in the rating process are Moody’s Investors Service, S& P Global Ratings, and Fitch Ratings. Local governments can choose to receive a rating from one or multiple agencies, as each agency may assess the risk slightly differently, producing a different score.
The agency’s opinions of that creditworthiness—in other words, the issuer's financial ability to make interest payments and repay the loan in full at maturity—is what determines the bond's rating and also affects the yield the issuer must pay to entice investors. Lower-rated bonds generally offer higher yields to compensate investors for the additional risk, according to Fidelity.
How are Bond Rates Determined?
Each of the rating agencies uses its own criteria when issuing bond ratings, but all look closely at three factors in particular:
- The stability of the issuer’s revenue stream. The more robust and predictable the revenue stream that will be used to repay the bond, the higher the bond rating will usually be. For example, property taxes are usually a more reliable revenue stream than revenue from more speculative projects (e.g., convention centers).
- The demographics of the jurisdiction. Bonds issued by municipalities with growing populations and wealthy residents usually earn better ratings than bonds issued by municipalities with stagnant populations and less-affluent residents.
- The issuer’s financial management and governance practices. The rating agencies like to see that issuers produce their financial reports on time, maintain an emergency reserve fund, manage cash flows effectively, have a clear capital budgeting plan, and have policies to prepare for financial contingencies.
The agency will access these factors and determine a rating they feel best reflects the information they have evaluated.
- Aaa (referred to as “triple-A”): This is the highest rating and represents the strongest category of creditworthiness.
- Aa (referred to as “double-A”): This is the second highest tier and implies very strong creditworthiness.
- A (referred to as “single-A”): This is the third highest tier and implies above average creditworthiness.
- Baa: (referred to as “B double-A”): This is the fourth highest tier and the lowest tier of what is generally considered ‘investment grade’. This rating implies average creditworthiness
- Moody’s has 5 additional categories, with the lowest rating being C.
- AAA (pronounced “triple-A”): This is the highest rating and denotes extremely strong creditworthiness.
- AA (pronounced “double-A”): This is the second highest tier and implies very strong creditworthiness.
- A (pronounced “single-A”): This is the third highest tier and implies strong creditworthiness.
- BBB (pronounced “triple-B”): This tier implies adequate creditworthiness and is considered to be the lowest of what is known as an investment-grade bond rating.
- S & P has 5 additional categories, with the lowest rating being C.
- AAA (pronounced “triple-A”): This is the highest rating and is given to those with the lowest default risk relative to all other issuers or obligations in the same country.
- AA (pronounced “double-A”): This tier denotes expectations of very low default risk relative to other issuers or obligations in the same country.
- A (pronounced “single-A”): This tier denotes expectations of low default risk relative to other issuers or obligations in the same country.
- BBB (pronounced “triple-B”): This tier denotes a moderate default risk relative to other issuers or obligations in the same country.
- Finc has 5 additional categories, with the lowest rating being C.
How Can Technology Potentially Influence Your Bond Rating?
Ted Damutz, Treasury Manager for the City of Raleigh, North Carolina, and former Senior Credit Officer at Moody’s Investor Services, sat down with DebtBook to share some expert insights.
“With rating criteria, for example on General Obligation Bonds, the factors that make up the rating are the local economy, outstanding debt, financial standings, and--often the most difficult to quantify management. Technology platforms like debt management software can assist with showcasing if a municipality is practicing sound debt management,” said Damutz.
So what factors make up good debt management practice you may ask? Damutz had a few insights to share.
- Good financial reporting. As reporting requirements become more onerous, utilizing a debt management software can help you maintain financial notes and reports that meet Excellence in Financial Reporting standards and get you out of spreadsheets.
- A strong website. Your website can help you improve transparency for your constituents and investors, providing them with updated information on your current debt obligations.
- Disclosure. Rating agencies need disclosure -- the less information they have then the lower your rating will likely be due to lack of information available to them. It’s in a local government’s best interest to provide as much disclosure as possible and get ahead of the requests for more information.
- Payment reminders. Utilizing a technology that can remind you of upcoming payments before they are due can reduce the risk of human error in possibly missing an important payment.
“While utilizing technology may not give you a better rating in and of itself, it can speak to your debt management and highlight good practices with a greater chance of being viewed as a credit positive.”