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Public Finance Ratings Update

Public Finance Ratings Update. LASBO Spring Conference March 17-20 Bossier City, LA. Standard & Poor’s Corporate and Government Ratings. Malachy Fallon, Managing Director 214 871 1402 mal_fallon@sandp.com. S&P’s steps to further manage potential conflicts of interest, strengthen

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Public Finance Ratings Update

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  1. Public Finance Ratings Update LASBO Spring Conference March 17-20 Bossier City, LA. Standard & Poor’s Corporate and Government Ratings Malachy Fallon, Managing Director 214 871 1402 mal_fallon@sandp.com

  2. S&P’s steps to further manage potential conflicts of interest, strengthen the ratings process, and better serve the markets • Governance • Establish Ombudsman office to address claims related to potential conflicts of interest and analytical and governance processes • Conduct periodic, independent, external reviews of Ratings’ compliance and governance processes to be shared with MHP and S&P management and the Audit Committee of MHP Board of Directors • Conduct regular business reviews with MHP Board Audit Committee to discuss compliance and governance functions; review: • Measures of ratings quality & compliance effectiveness • Queries & resolution of claims addressed by Ombudsman • Independent assessments of compliance & governance functions • Formalize and separate from Ratings’ business the functions of policy governance, compliance, criteria management and quality assurance • Establish a Risk Assessment Oversight Committee to assess risk that could impact Ratings’ business and consider feasibility of rating new security types • Implement look back reviews of ratings assigned by an analyst that chooses to resign and work for an issuer • Institute analyst rotations • Further align analyst compensation with quality and compliance • Increase training on policies & compliance requirement Information • Include “what if” scenarios in rating reports; explain key rating assump-tions & potential impact of positive or negative events on a rating • Work with market participants to improve disclosure of collateral underlying structured securities. Implement procedures to better understand issuers and originators ability to detect fraud and assess data accuracy and integrity • Better explain the comparability of ratings across asset classes • Make available a Landmark Deal Report summarizing new structures and major issues; distribute widely • Establishing greater minimum portfolio disclosure criteria for issuance of ratings on structured securities • Develop early warning indicator to investors that a key credit quality attribute (e.g. delinquencies; losses) of an issue or issuer differs from our expectations & has or may trigger a full review by S&P surveillance. • Add identifier to ratings of securitizations to highlight to the market that: (a) the rating is on a securitization and (b) the rating is on a new type of rating structure or securitization • Enhance access to S&P’s code of ethics and disclosures through link to regulatory affairs section of S&P.com • More broadly disseminate long- & short-term rating performance data • Simplify and provide broader market access to ratings criteria, underlying models and analytical tools Analytics • Improve surveillance process through strengthened surveillance functions; improve timeliness & effectiveness through addition of improved surveillance tools • Establish a Model Oversight Committee to assess and validate the quality of our models and tools • Enhance analytical education programs, increase annual training requirements, establish an analyst certification program • Complement analysis by highlighting factors that may influence valuation of rated securities; provide assessments on ratings’ vulnerability to event risk Education • Publish Credit Ratings User Manual & Investor Guidelines to promote better understanding of ratings process & role of ratings • Launch market outreach program to promote better understanding of complex securities we rate • Establish Ratings Advisory Council comprising risk managers, academics, former government officials and others; provide guidance on complex issues and market education • Broaden distribution of analysis & opinions via web and other media • Work with other NRSROs to promote Ratings Quality; introduce best practices and issuer disclosure standards

  3. Investment Grade Ratings AAA • An obligation rated 'AAA' has the highest rating assigned by Standard & Poor's. The obligor's capacity to meet its financial commitment on the obligation is extremely strong. AA • An obligation rated 'AA' differs from the highest-rated obligations only to a small degree. The obligor's capacity to meet its financial commitment on the obligation is very strong. A • An obligation rated 'A' is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor's capacity to meet its financial commitment on the obligation is still strong. BBB • An obligation rated 'BBB' exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation. Plus (+) or minus (-) The ratings from 'AA' to 'CCC' may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories.

  4. Municipal Ratings on a Global Scale • Credit ratings facilitate the process of issuing and purchasing bonds and other debt issues by providing an efficient, widely recognized, and long-standing measure of credit risk. Investors and other market participants can use the ratings as a screening device to match the relative credit risk of an issuer or individual debt issue with their own risk tolerance or credit risk guidelines in making investment and business decisions. • The global credit markets benefit from standards and benchmarks that are understood by all, which is why we use the same scale across all sectors.

  5. S&P Municipal Ratings and Default Rates S&P has been systematically reviewing and upgrading a large number of U.S. public debt instruments over the last several years in response to their generally lower default rates. The result has been higher ratings for those bonds that truly deserve it. • In 1986, only about 20% of municipal bonds rated by S&P held AAA or AA ratings; by 2008, more than 40% were rated that highly. • More than 99% of rated municipal issuers are investment grade, compared with less than 20% of corporate issuers that S&P has rated in recent years.

  6. Rating Distribution U.S. PF vs. U.S. Corporates 1/1/1986

  7. Rating Distribution U.S. PF vs. U.S. Corporate Finance 2008 U.S. PF U.S. Corporate Data as of 12/1/2008

  8. Standard and Poor’s Rating Distributions

  9. Recent Criteria Refinements • Location, Location, Location: What Does It Mean For My Community’s Rating? • While we believe participation in, or access to, a larger metropolitan economy can provide significant credit strengths, a municipality without such access can still be highly rated. • The key to our analysis is demonstrated stability, both economic and financial. • Does Bigger Always Mean Better? Sizing Up The Impact Of Size On Municipal Ratings • We consider a municipality with fewer than 15,000 residents to be small and a total market value of less than $500 million to constitute a small or limited tax base. • Standard & Poor’s Ratings Services will reduce the significance of size in its analysis where the circumstances warrant and adjust ratings as we believe appropriate.

  10. Financial Management Assessment - FMA • Introduced by S&P as a criteria enhancement in June of 2006 • Better transparency to aspects of the analysis that have existed all along • Better communication and disclosure of the environment in which financial decisions are made • Highlights in a consistent manner the most transparent aspects of management that are common to most governments

  11. The Financial Management Assessment An analytical methodology that evaluatesestablished and ongoing management practices and policies in the seven areas most likely to affect credit quality. • Revenue and expenditure assumptions • Budget amendments and updates • Long term financial planning • Long term capital planning • Investment management policies • Debt management policies • Reserve and liquidity policies “Strong” or “Standard” or “Vulnerable” Currently applicable only to general government tax- and appropriation-backed issues, excluding special districts.

  12. S&P Ratings Continue to Evolve • S&P will revise and refresh criteria as appropriate to best reflect rating performance. • We anticipate further migration up the rating scale in the USPF sector, assuming that creditworthiness, particularly of governmental credits, remains strong. • It is distinctly possible that, over time, much of the public finance-rated universe will be weighted to the 'A' category or better. • We would not expect the same trend in housing, health care, toll roads, or other sectors that exhibit more risk characteristics.

  13. OPEB Asset & Liability Management Management has two options: • Increase / enhance assets • Mitigate / manage the liability

  14. Asset Enhancement Strategies Increase / Enhance Assets: • Increase payments toward retiree healthcare; move toward ARC funding • Employee contributions may be initiated or increased • Establish a trust • Infusion of assets (bonds, cash contribution, asset sale)

  15. Asset Enhancement Strategies Potential Benefits: • A higher discount rate in a trust under GASB 45 guidelines • Receives the benefit of investment earnings from the trust • Increases the benefit security to employees Potential Challenges: • Higher cost structure for benefits which could divert resources from other budget priorities • Bonding could potentially limit capacity for other capital requirements

  16. Types of Trusts Typically Used for OPEB • 501(c) 9 VEBA trust • (Voluntary Employee Beneficiary Association) • Must have a board with employees • Upon death funds in trust revert to employee’s estate • Internal Revenue Code Section 115 Integral Part Trust • No board requirement • 401 (h) Account • Typically set up as an adjunct to an existing retirement board • Annual contributions cannot exceed 25% of contributions to associated pension fund

  17. Mitigate / Manage Liabilities Options to reduce liabilities may include: • Lower the level of retiree healthcare benefits granted outright • Offer new employees (or new retirees) a reduced benefit level • Place a cap on total (OPEB and pension) employer-provided benefits • Closing the current plan • Changing to a Defined Contribution model from a Defined Benefit model

  18. Mitigate / Manage Liabilities Potential Benefits: • Cost savings could be significant • Reduced Liabilities Potential Challenges: • Legal framework for altering benefits is uncertain • Political obstacles • May require tradeoffs in other areas that would create budget challenges

  19. How OPEB/GASB 45 fits into the rating process • OPEB touches ratings in three of the four key areas considered in general obligation bond analysis: • Management, • Finances, and • Debt

  20. OPEB Rating Factors: Management • Are the consequences of OPEB obligations fully understood by management or will the results of a GASB 45 actuarial valuation come as surprise? • If liabilities are material, is management actively pursuing alternatives to soften the impact? • Where does the OPEB problem rank in relation to other planning priorities? • How conservative (or aggressive) are the methods and assumptions being used to determine OPEB liabilities and plan for the future?

  21. OPEB Rating Factors: Financial • What is the current cost of funding pension and OPEB costs on an annual basis? • Can the budget afford the pension and OPEB ARC or even an escalating PayGo scenario for OPEB? • What revenue and budget flexibility exists to accommodate increasing pension/OPEB costs? • Will total carrying charges of bond debt service, pension contributions, plus OPEB contributions be sustainable given existing (or projected) resources? This will include an analysis of the current year as well as any projections if they are available.

  22. OPEB Rating Factors: Financial • OPEB and Pension ratios include (but are not limited to): • ARC / member • ARC / GF expenditures • ARC / PAYGO • PAYGO / member • PAYGO / GF expenditures • UAAL / Covered Payroll • UAAL / Per Capita • UAAL / Plan Member • UAAL / GF expenditures • UAAL / Market Value In the tax-backed area, we will continue to calculate typical debt ratios for all issuers, which may include OPEBOB and POB debt. Issuers need to be cognizant of these ratios if credit quality is to be maintained.

  23. OPEB Rating Factors: Debt • Source of payment for OPEB debt? • Are market conditions favorable (debt rate is less than expected returns on long-term investments in health care trust fund)? • Legal obligation of the employer (how “debt-like”) to meet retiree healthcare obligations: i.e. to make contributions…. to pay benefits? • How does OPEB alter the total long-term liability landscape for the employer: bonded debt + pension liabilities + OPEB liabilities? • Does OPEB put the employer at a comparative disadvantage in relation to its peers from the standpoint of total long-term liabilities?

  24. Credit Implications of OPEB • While pension liabilities have been established for some time and changes are analyzed annually, we are seeing a wide range of OPEB liability exposure as the actuarial valuations become available • To the extent that OPEB cost pressures, over time, weaken financial position or flexibility, credit quality may suffer. We believe the key to preserving creditworthiness in the face of pension/OPEB pressures will be how these liabilities are managed

  25. www.standardandpoors.com Analytic services and products provided by Standard & Poor’s are the result of separate activities designed to preserve the independence and objectivity of each analytic process. Standard & Poor’s has established policies and procedures to maintain the confidentiality of non-public information received during each analytic process.

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