STUMP » Articles » Chicago Bond Quickie: Not Wise to Scrap with Rating Agencies » 17 January 2017, 06:48

So Looking at the bond calendar, Chicago is planning on issing about $1.3 billion in General Obligation bonds.

I checked out the listing at Munios and it looks like it’s smaller: $1,162,500,000 instead of $1,275,000,000. A few details can be found here.

So what is the mayor doing ahead of this issue?

Picking a fight with Moody’s, a credit rating agency:

Chicago Mayor Pushes Moody’s to Rescind City’s Junk-Bond Rating

City is largest in U.S. company rates below investment grade
Chicago has already stopped hiring Moody’s to grade deals

Chicago is stepping up its battle with Moody’s Investors Service ahead of a $1.2 billion bond sale next week.

Mayor Rahm Emanuel, a Democrat who pushed through a record tax increase to shore up the city’s finances, asked the company to pull its junk rating on Chicago’s debt, saying it’s exaggerating the risks to bondholders and failing to recognize steps he’s taken. Chicago has already stopped hiring Moody’s to rate new bond deals, relying instead on rivals S&P Global Ratings and Fitch Ratings that continue to consider its debt investment grade.

“It has become increasingly clear that Moody’s rating methodology and agenda are far from objective and independent,” Emanuel said in a Dec. 8 letter to Moody’s Chief Executive Officer Raymond McDaniel that was released by the city. “Your current rating does not accurately reflect the city’s credit or our ability to pay debt service when due.”

Chicago became the only major U.S. city outside of Detroit with a junk rating in 2015, when Moody’s downgraded it because of the escalating pension bills triggered by years of failing to set aside enough money to cover promised benefits.

With its rating also downgraded by S&P and Fitch, Chicago has had to pay higher interest rates to bond investors, adding to its financial strain. A Chicago general-obligation bond maturing in 2026, one of the city’s most active securities, is showing a yield to worst of about 5.10 percent, nearly three percentage points more than benchmark debt, according to data compiled by Bloomberg.

Moody’s rates Chicago Ba1, one step below investment grade, with a negative outlook, indicating it could be downgraded. Fitch rates it BBB-, one step higher, while S&P’s rating is the highest at BBB+, three levels above junk.

Moody’s declined to comment on any potential changes to Chicago’s rating.

“Moody’s has a process for handling requests from issuers to withdraw their ratings and follows that process when such requests are made,” Moody’s spokesman David Jacobson said in an email. He added that the firm does not comment on “potential future ratings actions.”

…..
If Moody’s doesn’t pull the rating, the mayor asked the company to tell investors that its opinions will “solely be based on publicly available information.” Moody’s Jacobson said the company doesn’t comment on its meetings and discussions with debt issuers.

Ratings agencies don’t move quickly, for what it’s worth. Often, their moves lag information becoming known. It’s not from anything nefarious – it’s just that analysis takes time.

Here’s another thing you may not know: ratings agencies are usually given private information by the companies/entities being rated. They are explicitly excluded from certain SEC rules involving private information and securities.

But here’s a question: while I understand that even publicly-traded companies don’t have to share all their financial information to the investment world, why would there be any private numbers for a governmental entity like Chicago?

Do they have a spy force whose budget they have to keep mum?

SOME MORE ON THE RATINGS AGENCY DUST-UP

Emanuel asks credit ratings agency to back off ahead of latest round of borrowing

While the letter was dated Dec. 8, the Emanuel administration did not publicly release it until Tuesday [Jan 10]. That’s a day before city finance officials are set to start a round of meetings with potential investors, and a day after the Chicago Tribune published a story detailing the proposed borrowing, which would push hundreds of millions of dollars of debt off into the future at a higher cost to taxpayers — a practice Moody’s has criticized. Emanuel aides have said this bond issue will be the last one to push off city debt.

The letter is another in a series of steps the administration has taken to combat what it characterizes as unfair treatment by Moody’s. It last paid Moody’s to rate a bond issue in 2014, after the agency had issued several downgrades to Chicago debt but not yet placed it in junk territory. But that move had limited impact, because Moody’s has continued to rate outstanding bonds it was paid earlier to evaluate. In mid-2015 the agency issued its junk rating, which Emanuel at the time called “irresponsible.”

In a Tribune interview last August, city Chief Financial Officer Carole Brown contended the agency “backed itself into a corner” when it issued the junk rating. She noted steps Emanuel has taken to improve finances — significantly narrowing a perennial budget gap, unwinding risky variable-rate bond deals and raising taxes to lower the city’s outsized debt to government employee pension funds — and said “we’re not going to be held hostage” by Moody’s.

Brown’s critique came after a top Moody’s analyst spoke at a City Club forum, saying Chicago is not on the brink of financial ruin but needs to do far more than it has to lessen overall city debt, including what it owes to the pension funds. Moody’s pointed out that city pension debt will continue to grow for well more than a decade before it starts to decline under Emanuel’s plans.

City aims to ease investor fears ahead of $1.16B borrowing

A top mayoral aide tried Wednesday to ease lingering investor concerns about city and school finances, hoping taxpayers won’t pay the price when Chicago tries next week to sell $1.16 billion in general obligation bonds.

Chief Financial Officer Carole Brown’s pitch to investors in Chicago — and similar meetings over the next few days with investors in Boston and New York — comes two days after Gov. Bruce Rauner threw Chicago another curve ball.

The Illinois House unanimously approved Mayor Rahm Emanuel’s plan to save two of four city employee pension funds, only to have the governor declare his intention to veto the bill that locked in employee concessions and authorized a five-year ramp to actuarially required funding.

Last month, the governor’s veto of a bill giving the Chicago Public Schools $215 million in state pension help already built into the school budget created a potential crisis that could force devastating classroom cuts if that veto is not overturned.

Both of those roadblocks have heightened concerns among investors that the city is now trying to attract to the upcoming $1.16 billion general obligation bond issue.

….

So is the $1.16 billion borrowing itself. It includes $440 million in “scoop-and-toss” borrowing — $105 million more than previously planned — that extends for another generation debt that should be retired today.

It also includes $225 million to bankroll settlements and judgments against the city.

Emanuel has promised to eliminate both dubious financial practices by 2019. That’s also the deadline he’s set for eliminating a structural deficit that’s already 80 percent smaller than the one he inherited.

“They were comfortable. We’ve been telling them for a bit now that this deal was going to include scoop-and-toss. . . . But I have to tell you. I couldn’t bring another transaction included scoop-and-toss and have any amount of credibility with investors. So this has to be it for us with that — and it will be,” Brown said Wednesday.

So… you promise to be more fiscally responsible… later. Yeah, that’s very convincing.

We’ll believe you’ll stop scoop-and-tossing if you actually stop scoop-and-tossing. This is not a difficult concept.

MARKET INDICATIONS

So, let’s see how the market has been taking all of this.

Market Spreads Side with Moody’s as Chicago Picks a Fight

CHICAGO – Chicago Mayor Rahm Emanuel isn’t happy with Moody’s Investors Service, so he’s trying to make the rating agency go away.

Emanuel’s administration disclosed Tuesday that the mayor formally asked Moody’s to withdraw all of the city ratings. The disclosure came ahead of investor meetings set for this week.

Moody’s declined, according to a city official.

Moody’s downgraded the city’s GO bonds to junk-level Ba1 in May 2015. The rating remains there today, with a negative outlook.

Three other rating agencies assign Chicago ratings in the lowest investment-grade tier of triple-B.

…..
The city’s 10-year GOs have traded in recent months at the junk-level spread of 250 to 300 basis points to the Municipal Market Data’s top-rated benchmark, and its yields on tax-exempt sales over the last year and half have landed within that range. The BBB benchmark on Tuesday was at 3.17%, a 95 basis point spread to the AAA rate. The city carries ratings of BBB-minus and BBB-plus from the three other rating agencies.

The spread on its 10-year paper hitting 200 basis points in November 2014, six months before the Moody’s downgrade, dropping some and then rising to 250 basis points in April, a month before the downgrade. After the downgrade, spreads steadily climbed upward, hitting 300 basis points. That marked a doubling of the 145 basis point spread on its 10-year in a primary market outing in March 2014.

A speculative grade spread is a moving target, said one market participant. Currently, a weak investment grade name should price in the mid-to-high 100s, one market participant said. Anything at 225 basis points is considered high yield, another trader said. Another said anything over 200 falls into the high yield category.

“This shows that the market is appropriately skeptical about the other three ‘investment grade ratings,’ since much of Chicago’s near-term outlook still hinges on what happens in Springfield. It’s certainly outrageous for Mayor Emanuel to try to bully Moody’s into withdrawing its rating and kudos to Moody’s for sticking to its ‘process,’” said Triet Nguyen, head of public finance credit at NewOak Fundamental Credit. “We believe there’s no imminent risk of default at this time, just ‘spread risk’ or underperformance risk.”

Market participants have said the city could see yield penalties narrow a bit if it loses its junk status, but they may not reach investment grade levels. One participant suggested it’s more about the city shedding the taint of the label or the risk of further negative headlines from a possible downgrade.

Moody’s spokesman David Jacobson said in response to a request for comment that “Moody’s has a process for handling requests from issuers to withdraw their ratings and follows that process when such requests are made” and it does not comment on potential future rating actions.

And I have one last item that may or may not be relevant.

MOODY’S SETTLES LAWSUIT OVER OPTIMISTIC RATINGS

Moody’s pays $864 million to U.S., states over pre-crisis ratings

Moody’s Corp (MCO.N) has agreed to pay nearly $864 million to settle with U.S. federal and state authorities over its ratings of risky mortgage securities in the run-up to the 2008 financial crisis, the U.S. Department of Justice said on Friday [Jan 13].

The credit rating agency reached the deal with the Justice Department, 21 states and the District of Columbia, resolving allegations that the firm contributed to the worst financial crisis since the Great Depression, the department said in a statement.

“Moody’s failed to adhere to its own credit-rating standards and fell short on its pledge of transparency in the run-up to the Great Recession,” Principal Deputy Associate Attorney General Bill Baer said in the statement.

S&P Global’s (SPGI.N) Standard & Poor’s entered into a similar accord in 2015 paying out $1.375 billion. Standard and Poor’s is the world’s largest ratings firm, followed by Moody’s.

Moody’s said it would pay a $437.5 million penalty to the Justice Department, and the remaining $426.3 million would be split among the states and Washington, D.C.

As part of its settlement, Moody’s also agreed to measures designed to ensure the integrity of credit ratings going forward, including keeping analytic employees out of commercial-related discussions.

The rating agency’s chief executive also must certify compliance with the measures for at least five years.

Moody’s is not the only credit rating agency that has been sued, as noted in the article.

If you read this, and earlier, articles on credit rating practices, if you are not familiar with the situation: many of the ratings are paid for by the entities being rated.

BLAST FROM THE PAST: LOOKING AT THE WRECKAGE OF 2008

There is a whole history to that, but for now, I’ll point to this thread at the Actuarial Outpost I started in 2009, and something I wrote then.

I agree with Mr. Rosenkranz and the editors that regulations rely too much on the Big Three rating agencies to measure the riskiness of assets. Part of the problem is in how the agencies are compensated; once, they were paid by the buyers of debt, now they are paid by issuers. The interests there are obviously divergent. To be sure, if a rating agency was too wrong too often, it would lose its reputation and perhaps its government imprimatur — but the government moves even slower than do credit ratings.

Another obvious problem is the barrier to entry as an approved rating agency. As noted in the “Credit Default Swamp” editorial, the government does not have much incentive to recognize competitors to the current Big Three credit rating agencies. A review of what it takes to be given approval, and to lose it, as a credit rating agency may be one of the quicker regulatory fixes that could happen in the current political climate.

In light of these issues, I don’t think Mr. Rosenkranz’s proposal to measure riskiness by spreads over Treasuries really fixes the problem. While the market has virtues not held by regulators and credit rating agencies, with regards to structured financial products, there is not much proof that the market prices the risk well. The models used to price CDOs, CDSs, MBSs, CMOs, and other three-lettered horrors are complicated, and highly divergent parameter sets produce different spreads. We have seen recently that the models for mortgage-backed securities made certain assumptions about the quality of collateral, and the recovery given default, which have turned out to be greatly different from reality.

Moving from credit rating agencies as a basis for measuring risk, to market prices, may be a little improvement, but it doesn’t fix an underlying problem: individual entity responsibility for its own risk management. Just as insurance companies and banks can point to the rating agencies to cry, “But they rated those assets AAA!”, in a spread-based world the companies can cry, “But the spreads were low!”

Pushing off responsibility to third parties, whether rating agencies or the market, will not give the impetus to companies to do a hard analysis of their own positions, nor does it give incentive to fight against mispricing of risk.

This inherently is a difficult problem to solve — principal-agent problems are difficult to solve.

Buyer beware.

Compilation of Chicago posts.