LOS ANGELES — Rating changes are likely for hundreds of credits as Moody's Investors Service prepares a methodology revision for lease-revenue bonds and other appropriation-backed credits.
Moody's expects to place 20% to 25% of its 3,100 rated lease-backed obligations, annual appropriation obligations and moral obligations on review for upgrade or downgrade after it completes a
Under the planned revision, Moody's will eliminate the additional downward notch for lease-backed obligations with abatement risk relative to lease-backed obligations with appropriation risk.
This will have a particular impact in California, where Moody's says local governments exclusively use abatement leases.
Moody's also plans to eliminate the additional downward notch for lease-backed obligations for equipment relative to lease-backed obligations for real property, when the equipment has a similarly essential function to government operations.
Barring any changes stemming from the comments, about half the affected credits would be upgraded and half downgraded.
Moody's began seeking comment Sept. 25.
Any rating changes would come 60 to 90 days after the comment period ends, according to Naomi Richman, a Moody's managing director.
Moody's primarily uses two key factors to determine how far to notch the contingent rating from the issuer's general obligation rating: the financed asset's essentiality and the obligation's legal structure, according to Moody's report announcing its request for comments.
That will not change, but the rating agency is looking at several changes to its methods.
Moody's will merge its system for rating lease-backed municipal obligations and moral obligation bonds.
It will also release a new notching guide explaining the factors it considers to determine the distance between GOs and an issuer's other bond ratings.
The rating scale for bonds backed by general fund revenues, such as lease-revenue bonds, are pegged to Moody's ratings of the issuer's general obligation bonds, which are backed by voter-approved property taxes.
The distance in notching between property tax-backed GOs and general fund-backed bonds can be impacted by the strength of the state's GOs.
For instance, the strength of the pledge on general obligation bonds issued in California "tends to lend itself to greater distance between its general obligation and lease ratings," Richman said.
The strength of the GOs are significant to an issuer's other bonds, because Moody's uses an issuer's GO rating as a starting point for the notching guide it uses to determine where credits fall on the rating scale.
"Currently, 67% of lease-backed obligations and 81% of annual appropriation obligations are rated one notch below the GO rating, while 90% of moral obligations are rated two notches below the GO rating," according to the report.
In many cases, California issuers have a stronger security pledge for general obligation bonds, because there is a lockbox for collecting tax revenues, Richman said. When there is a lockbox, the revenues are held by the county until debt service is paid and never go into the issuer's coffers.
The distinction applies to Colorado as well as California. For certain local governments in both states, the Moody's report says it assigns GO ratings one notch higher than the government's inherent credit fundamentals would otherwise suggest. GO debt issued by these governments "features a statutory lien, or the characteristics of a statutory lien, and a third party lockbox for the GO debt service levy," according to the report.
"Right now, the most extra credit we give for these strong structural elements is one notch," Richman said. "Where a city in another state might be rated Aa1, we might rate the bonds AAA if they have the statutory lien and the lockbox."
The extra notch given local issuers' GOs in California and Colorado doesn't boost the states' general fund-backed debt. Instead, it just creates a wider gap in ratings between the state's GOs and other bond categories.
"When determining the contingent obligation rating, notching from the upward-adjusted GO rating would create an inconsistency between the contingent obligation ratings for issuers in states and sectors with these GO structural elements and those without," according to the report.
As a result, Moody's notches contingent obligation ratings off the GO rating before it is adjusted for the stronger elements.
"This adjustment ensures that our general government contingent obligation ratings do not reflect structural considerations that only apply to GO debt," according to the report.
California lawmakers this year passed a bill that automatically attaches a statutory lien to all future general obligation bonds.
Moody's maintains the same position it established in a report issued in July when Senate Bill 222 passed, said Gregory Lipitz, vice president and managing director.
Although Moody's said the change was a credit positive, "we still have the position that the law clarified what we already thought existed in California, which is that the GO pledge is a statutory lien," Lipitz said.
Moody's came to that conclusion after reviewing the outcome of the Sierra Kings Health Care District bankruptcy in 2010.
It was instrumental in Moody's viewing California GO pledges as a statutory lien, he said.
In that Chapter 9 case, though the judge did not render an opinion, he signed an agreement between the parties that reaffirmed a statutory lien on the ad valorem taxes levied for debt service and recognized them as special revenues, Lipitz said.
"SB 222 just codified what we thought already existed from the King's case," Lipitz said.
The Kings decision generated a lot of excitement, because it was the first time a GO pledge had been said to be "special revenues" protected by a "statutory lien," Lipitz said. Special revenues and a statutory lien are forms of secured status under the Chapter 9 bankruptcy code, according to Moody's July 20 report.
But since there has not yet been an opinion from a judge in any bankruptcy case on what would happen to the GO pledge in bankruptcy, Lipitz said a great deal of uncertainty remains.
Moody's already had included California with other states that had GO bonds secured by a statutory lien, Lipitz said.
"SB 222 just moves California more firmly into that bucket," he said.
Moody's had generated enough commentary from market participants that it put out a report clarifying changes proposed in its current methodology on Nov. 4.
Comments from market participants can have a larger impact, Richman said.
"In a lot of cases, our initial methodology differed from the final result," she said. "And that is how we want it to work."
