The fiscal impact of the pandemic has bond rating agencies digging deeper.

By Reagan Holliday & Michael Sorth
Managing Directors – St. Louis
Public Finance
HilltopSecurities

The pandemic’s lockdowns and social distancing orders have caused state and local governments—and their agencies—to incur revenue shortfalls that may affect their ability or willingness to pay.

Since the start of the pandemic, bond rating agencies have downgraded several state and local governments, as well as shifted to negative and stable outlooks on many others. In fact, we believe these downgrades are still in a lagging state and that, much like in the Great Recession, downgrades will outpace upgrades in 2020.

As a result of the fiscal strain facing issuers, rating agencies are ramping up their surveillance process, conducting more involved conversations, and submitting lengthy and comprehensive questionnaires.

What is Bond Rating Agency Surveillance?
Credit ratings are forward-looking and meant to exist over the life of the bond issuance. Rating agency analysts understand the financial condition of issuers will likely change over the life of a bond issuance. To account for this, and to keep investors informed, the rating agencies conduct surveillance of conferred credit ratings on average at least once a year.

This review changes based on the municipal sector and type of security. On one end of the spectrum, the rating agency may review publicly available information like an issuer’s annual audit, budget, or other filings in the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access platform(EMMA). On the other end of the spectrum is a more involved review process, which is what many issuers are seeing in the current economic environment.

Proactively Managing Your Bond Rating
It’s important to remember that being prepared and working alongside your agency is a fundamental part of the surveillance process, especially since surveillance can result in an adjusted rating and impact your ability to borrow at the most competitive rates possible in the future. The following are five proactive ways issuers can work with rating agencies to maintain their rating.

1. Contact your municipal advisor
   If your rating agency reaches out to you, the first thing you should do is contact your municipal advisor. Outside of you and the people on your team, they know the ins and outs of your financials. Plus, your municipal advisor works with many issuers and interacts with rating agencies on a regular basis. They’re familiar with the information agency analysts commonly request, so they can help you prepare for a call with the rating agency and frame your responses in a way that accurately conveys your entity’s story.

   If you don’t have a financial advisor, now is a great time to consider engaging one. Unlike an underwriter who has a duty to purchase your issue at a fair price, a financial advisor has a fiduciary duty, obligating them to provide advice that’s in the best interest of your entity. It’s a duty that goes beyond issuance and can extend to the bond rating and rating agency surveillance process.

2. Monitor press coverage
   Rating agencies often use news-monitoring services when reviewing your current rating(s). In a time when the news media is heavily reporting on the financial implications of COVID-19 and how it’s affecting issuers in various municipal sectors, data like sales taxes, housing numbers, and other figures are being heavily publicized on regular basis.

   If you’ve had any press coverage where information about your entity has been reported incorrectly or in a misleading way, it’s a good idea to proactively reach out to your rating agency even if they’ve yet to contact you. Remember, the goal is to manage your rating, and partnering with the rating agencies to provide them with correct and timely information is a key part of that process.

3. Assess your initial credit rating report
   Outside of monitoring press coverage for misleading reporting, another way to proactively manage your rating is to review your initial rating report/commentary and refamiliarize yourself with the strengths and/or weaknesses outlined by your agency analysts. This will give you a good idea of the factors you should focus on when speaking with your agency analyst or answering a questionnaire.

   As you initially went through the rating process, there was a story told about your community and about your issuance. And if that story has substantially changed or improved, it’s your duty to your taxpayers, ratepayers, and investors to inform your rating agency.

4. Review your agency’s rating methodology
   While you’re reviewing the report, you should also look at the methodology your agency analysts used when they determined your bond rating. Rating agencies have become increasingly more transparent and now publish issuer score cards that outline the rating factors that determine their ratings and how they weight them. Some factors that are common among most credits include financial management, liquidity, debt management, and accounting practices.

   By reviewing your rating agency’s methodology or scorecard, you can quantitatively determine which metrics worked in your favor and which metrics worked against you, as well as assess the progress you’ve made since your initial rating. These aspects of your rating are key benchmarks you should proactively highlight and discuss with your rating agency.

5. Answer rating agency inquiries promptly
   With many of us still working from home or going into the office intermittently, it’s easy for important tasks to slip through the cracks. However, failing to respond to your rating agency in a timely manner could negatively affect your credit rating.

   If your rating is impacted—whether positively or negatively—and you have continuing disclosure obligations, make sure to notify investors of the rating change by filing it on EMMA within ten business days.

Maintaining Your Credit Rating
You should keep in mind that rating agencies typically don’t abruptly change their ratings. If you have a strong bond rating, it’s common that your agency will issue a rating review or outlook to inform investors a change may be forthcoming. In that case, you’ll have time to communicate with your agency and share any vital information that can help maintain your rating.

Being proactive when it comes to surveillance is a crucial part of managing your rating. A municipal advisor can help guide you through this process by anticipating many of the questions asked during rating agency calls or in questionnaires. If you have any questions about bond rating agency surveillance, call 214.953.4156 or email our Public Finance team today.

Hilltop Securities Inc. (HTS) is a registered broker-dealer, registered investment adviser and municipal advisor firm that does not provide tax or legal advice. This document is intended for educational/informational purposes and institutional use only. This document does not constitute legal or investment advice, nor is it an offer or a solicitation of an offer to buy or sell any investment or other specific product or service. HTS is not recommending an action to you as the municipal entity or obligated person. HTS is a wholly owned subsidiary of Hilltop Holdings, Inc. (NYSE: HTH) located at 1201 Elm Street, Suite 3500, Dallas, Texas 75270. Member: NYSE/FINRA/SIPC.