Knowledge and Insights
Ratings agencies track the financial condition of bond issuers and update their ratings if and when necessary. Many credit ratings are upgraded or downgraded by these agencies each year. Such changes directly affect the cost of interest municipalities and taxpayers pay on their debt. Since the financial crisis of 2008, credit spreads, or the cost difference between ratings levels, have widened dramatically, significantly increasing issuers’ interest costs. In addition, recent volatility, in part stemming from anticipated cutbacks in Federal Reserve bond buying this year, is further pressuring the municipal bond market. As a result, it is more critical than ever that local governments prudently manage their finances, and do so with a view to supporting or improving their credit rating.
Your Administration Is Key
The major factors that determine municipal credit ratings are debt level, financial condition, debt security, economic and demographic profile, and management. The latter factor is the most subjective, yet it is given serious weight in ratings determinations. It is essential that municipalities demonstrate to the agencies the presence of strong leadership and planning skills, not only during their initial application for a rating, but consistently throughout all economic cycles. To help you enhance your governmental managerial skills and credit worthiness, we recommend that you incorporate into your administration the six critical components of strong municipal management, as published by Moody’s Investors Service.
Strong Management Practices
- Conservative budgeting – Understanding the many variables that affect the multi-year budgeting of your property tax revenue and municipal expenditures is essential. Reasonable and continually updated assumptions on local, state and other socio-economic data will lead to accurate projections and, hence, improved long-range planning and management. Problematic forecasting undermines your financial flexibility, which can lead to fiscal problems that will weaken your credit strength. In brief, your team should be able to demonstrate good revenue forecasting ability, tight internal controls and effective contingency planning.
- Adequate reserves – The ability to maintain sufficient and stable liquid reserves (cash), at all times—during weak or robust economic periods and to address contingencies–is viewed favorably by credit agencies and, therefore, will benefit your rating. It is also preferred and, therefore, highly recommended that you have a formal, written policy in place or adopt a resolution addressing the specifics of your fund reserve balances, such as target levels and approved uses.
- Debt planning – Ratings agencies like to see municipal debt kept at manageable levels and a policy put in place that outlines the maximum debt burden your government will undertake. The more leveraged your municipality, the more constrained its operating, financial and borrowing flexibility. It is reassuring for bondholders and ratings agencies to know that your municipality engages in multi-year planning and continual updating of capital expenditure and debt service programs.
- Contingency and succession planning – Ratings agencies consider contingency planning an essential part of all long-term municipal planning, as you must be able to competently identify and respond to unexpected changes in your revenues and expenditures. Similarly, changes in your management team and transfers of duties should be planned for and not paralyze departments that can affect your finances or jeopardize your credit strength. Above all, ratings agencies want to see foresight and proactive planning by governing officials.
- Economic development – Because economic growth drives the generation of financial resources to meet your municipal operating and debt service needs, it makes sense to employ staff to assess and oversee economic development initiatives. Well-run municipalities have guidelines in place to help them achieve targeted goals, direct the use of financial and tax incentives, and measure returns on investment. Strategic planning for economic development directly affects the future viability of your entity and, therefore, your credit rating.
- Timely disclosure – Full and timely disclosure of financial matters is of vital importance to credit ratings agencies, which often equate weak financial reporting practices to poor managerial oversight. They prefer that municipalities have audits of financial statements that comply with State of New Jersey reporting requirements prepared annually by an established and respected outside auditing firm. Primarily, you need to provide comparable information, an accurate picture of your financial condition, and quickly communicate any material events or changes that could impact your credit strength.
Strong management is a key factor in the evaluation of municipal credit ratings and the resultant cost of debt to current and future constituents. By providing strategies that ensure your financial practices are appropriate and responsive to your municipality’s needs, you can help improve your credit worthiness during good times and maintain it in weaker periods.
If you have any questions or would like further information please do not hesitate to contact us at 609-689-9700.