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9.1. SR 01-21-2014
City of Elk Request for Action River To Item Number Mayor and City Council 9.1 Agenda Section Meeting Date Prepared by Worksession January 21, 2014 Tim Simon, Finance Director Item Description Reviewed by Standard and Poor's Rating Methodology and Cal Portner, City Administrator Assumptions Update Reviewed by Action Requested No action requested, just information on new Standard and Poor's (S&P) rating methodology and assumptions. Background/Discussion In October of 2013, S&P updated its methodology and assumptions for assigning credit ratings to general obligation bonds in the United States. Based on these new criteria and assuming unchanged credit characteristics, S&P expects 60% of the ratings will not change, 30% of the ratings would increase and 10%would decrease. Since the city has not issued any new general obligation bonds we have not received an updated rating based on the new criteria. Our financial advisor,Terri Heaton from Springsted,will present information on the new criteria and offer insight on some recent ratings. Springsted works with several cities that have recently been reviewed under the new criteria and are helping us prepare for when we issue the wastewater bonds later this year. Financial Impact None Attachments • Standard and Poor's: U.S. Local Government General Obligation Ratings: Methodology And Assumptions. September 12, 2013 • Springsted's newsletter. November 2013 P a w E A E U s r NaA f RE] STANDARD & P00R'S RATINGS SERVICES RatingsDirect° ............................................................................................................. Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings: Methodology And Assumptions Primary Credit Analysts: Jeffrey J Previdi,New York(1)212-438-1796;jeff.previdi @standardandpoors.com Christopher M Krahe,Chicago(1)312-233-7063;christopher.krahe @standardandpoors.com Lisa Schroeer,Charlottesville(1)434-220-0892;lisa.schroeer @standardandpoors.com Horacio G Aldrete-Sanchez,Dallas(1)214-871-1426;horacio.aldrete @standardandpoors.com Karl Jacob,Boston(1)617-530-8134;karl.jacob @standardandpoors.com Matthew T Reining,San Francisco(1)415-371-5044;matthew.reining @standardandpoors.com Jane H Ridley,Chicago(1)312-233-7012;jane.ridley @standardandpoors.com Criteria Officer,U.S. Public Finance: Cathy L Daicoff,New York(1)212-438-6766;cathy.daicoff@standardandpoors.com Chief Credit Officer-Americas: Lucy A Collett,New York(1)212-438-6627;lucy.collett @standardandpoors.com Table Of Contents ............................................................................................................. I. SCOPE OF THE CRITERIA II. SUMMARY OF CRITERIA UPDATE III. SUMMARY OF CHANGES FROM THE REQUEST FOR COMMENT IV. IMPACT ON OUTSTANDING RATINGS V. EFFECTIVE DATE AND TRANSITION VI. METHODOLOGY A. Local Government Rating Calibrations WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 1 1190266 1300881696 Table Of Contents (cont.) ............................................................................................................. B. Framework For Determining A U.S. Local Government Rating C. The Institutional Framework Score D. Economic Score E. Management Score F. Budgetary Flexibility Score G. Budgetary Performance Score H. Liquidity Score I. Debt And Contingent Liabilities Score VII. APPENDIX I: Selected Historical Statistics VIII. APPENDIX II: Relationship To The State Rating IX. APPENDIX III: Changes Since The Request For Comment X. GLOSSARY XI. RELATED CRITERIA AND RESEARCH Related Criteria Related Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 2 1190266 130088t696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings: Methodology And Assumptions 1. Standard&Poor's Ratings Services is updating its methodology and assumptions for assigning issuer credit ratings (ICRs) and issue credit ratings based on general obligation(GO)pledges of local governments in the United States. This update follows our request for comment(RFC), "Request For Comment:U.S. Local Governments: Methodology And Assumptions,"published on March 6, 2012. This update provides additional transparency and comparability to help market participants better understand our approach to assigning local government ratings,to enhance the forward-looking nature of these ratings, and to enable better comparisons between U.S.local government ratings,local government ratings in other countries, and all other ratings. The"Principles of Credit Ratings",published on Feb. 16, 2011,form the basis of this criteria. 2. For the ratings in scope,this criteria supersede the following articles: • GO Debt, Oct. 12, 2006 • Key General Obligation Ratio Credit Ranges—Analysis Vs. Reality,April 2, 2008 • Does Bigger Always Mean Better?Sizing Up The Impact Of Size On Municipal Ratings,April 22, 2008 • Location, Location, Location:What Does It Mean For My Community's Rating?April 22, 2008 3. All capitalized terms are defined in the glossary,section X,paragraphs 90-97. I. SCOPE OF THE CRITERIA 4. The criteria apply to all U.S.local government issuer credit ratings and issue ratings on GO bonds issued by municipal governments that are not special purpose districts. Examples of local government entities in the scope include cities, counties,towns,villages,townships, and boroughs, called municipalities in the criteria. Examples of special purpose districts excluded from the scope include school districts,library districts,park districts, and forest preserve districts, among others. The criteria also do not apply to U.S. states or territories but do apply to the District of Columbia. II. SUMMARY OF CRITERIA UPDATE 5. The criteria use the same major elements as our criteria for rating local and regional governments outside the U.S. (see "Methodology For Rating International Local And Regional Governments",published Sept. 20, 2010). Specifically,the criteria assign ratings based on the assessment and scoring of seven key factors: • Institutional framework; • Economy; • Management; • Budgetary flexibility; • Budgetary performance; WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 3 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions • Liquidity;and • Debt and contingent liabilities. Although the criteria assess the same factors,the measures used to assess these factors are detailed in a manner consistent with the characteristics and reporting conventions of U.S.public finance obligors. 6. The initial indicative rating results from a weighted average of the factors detailed above.The economy score receives a 30%weight, and the management score receives 20%.The financial-related scores,liquidity,budgetary performance and budget flexibility,each account for 10%of the total score.The institutional framework score also receives a 10% weight,as does the debt and contingent liabilities score. Certain score levels result in ratings different from those suggested by the weighted average. Chart 1 outlines a summary of the analytical framework for assigning a local government's GO rating. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 4 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Chart I Analytical Framework For Local GO Ratings Financial Measures Debt R Institutional Economy Management Contingent Framework 8 liquidity �"���� �u�et�� Liabilities 10% 30% 0% uidi Performance Flexibility 10% 10 10% Indicative Rating Positive Overriding Factors Negative Overriding Factors Love market value per capita (one-notch High income levels (cane- or tiro-notch adjustment) adjustment) Low nominal fund balance (one-notch adjustment) Sustained high fund balances {one-notch adjustment) 4 Weak liquidity(caps rating at 'BBB+'or BB+') Weak management(caps rating at W or'BBB-') Lack of willingness to pay obligations 4 (caps rating at`BBB-`for leases and `B' for debt) Large or chronic negative fund balances (caps rating at`A+'N `A-`, or`BBB') Budgetary flexibility score of'S' (caps rating at ',A.+') 4 Structural imbalance (caps rating at Potential one-notch adjustment (but not higher than cap) Final Rating P�Standard&PDors 2413. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 5 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions III. SUMMARY OF CHANGES FROM THE REQUEST FOR COMMENT See Appendix III in Section IX. IV. IMPACT ON OUTSTANDING RATINGS 7. Standard&Poor's maintains issuer credit ratings or ratings on GO debt(or debt equivalent to or based on the GO rating)for more than 4,000 governments included in the scope of the criteria.Assuming that governments maintain their current credit characteristics,testing suggests that about 60%of the ratings would remain unchanged under the criteria while about 30%of the ratings would increase and about 10%would decrease,generally by one notch. V. EFFECTIVE DATE AND TRANSITION 8. The criteria described in this article are effective immediately and apply to all new and outstanding ratings within scope.We intend to complete our review of issuers affected within the next 12 months. VI. METHODOLOGY A. Local Government Rating Calibrations 1. Local Governments Globally 9. Local governments exist to provide services to the population. Services may be mandated by a higher-level government,but often the levels and choice of services to be provided are at the local government's discretion. Governments may rely on locally levied and collected taxes or user charges, or on taxes,grants, or aid distributed from higher levels of government to fund services. Local governments often have little direct control over funds distributed from higher levels of government, and higher-level governments may place restrictions on local taxing levels--if local taxes may be levied at all. 10. A local government's ability and willingness to make fiscal adjustments and its legal and political relationships with higher levels of government can be more important to its ability to meet debt service than its economic trends or financial position.An overall economic decline can threaten the ongoing paying ability of a company more directly than a government because the company may find it difficult to raise prices or reduce costs due to demand elasticity. Although unpopular,governments with sufficient autonomy may raise taxes or cut services without seeing mass outmigration from the jurisdiction relative to the demand volume reduction faced by a company. For governments without such autonomy,relationships with higher-level governments are key for restoring balance. 11. Variables such as economic conditions, debt levels,and financial performance can suggest when difficult decisions to restore fiscal balance might become necessary,but do little to suggest whether prudent decisions will be made. Different government responses can therefore produce different default outcomes for periods with the same level of WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 6 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions stress.Accordingly,predictions of precise default amounts and probabilities become more suspect.This complicates the calibration of criteria to economically-based stress scenarios but does not prohibit it. The long-term and repeating trend of higher local-government defaults following periods of significant economic stress is well-established and dates back to ancient Greece. 2. The Specific Case Of U.S. Local Governments 12. From a global perspective,U.S. local governments have a fairly high degree of autonomy.Virtually all U.S. local governments levy some sort of tax and levy various other fines,fees, and charges. U.S. census data show that own-source revenues account for 63%of local general government revenues. However,this total includes school districts which typically receive a large amount of state funding. For municipalities and counties specifically, data for credits rated by Standard& Poor's suggest this percentage is 79%. Direct funding from the federal government represents only about 4%of total local government revenues,much of which represents funds designated for capital spending. 13. Due to the federalist structure of the U.S. government,individual states,rather than the U.S. government,make most of the laws regarding what taxes local governments may raise,how much debt they can issue, and other matters of local government finance.A local government rating is not automatically constrained by the U.S. sovereign rating or its respective state rating. The economic and fiscal relationships, dependencies, and/or interdependencies between levels of governments will determine the credit linkages along with our framework to rate entities above a sovereign rating(see"Methodology And Assumptions: Request For Comment: Ratings Above The Sovereign—Corporate And Government Ratings"published April 12, 2013). 14. Although states do have significant power over their local governments,their use of this power pales in comparison to the use of such powers by sovereign or regional governments in other countries.Although states have at times tinkered with the mix of local government revenues and imposed various limits or regulations around the use of debt and taxes,the basic tenets of U.S.local government finance have remained largely in place since colonial times. Neither American independence,the American civil war,nor severe economic downturns, such as those witnessed in the late 1830s,late 1870s, and early 1930s,have changed the basic premise of local governments relying largely on own-source revenues to fund different service levels of their own choosing. Some studies suggest to us that this self-reliance drives the low debt levels and fiscal stability observed in U.S. local governments and similar jurisdictions (see Jonathan Rodden in Related Research). 15. Property taxes remain a cornerstone of U.S. local government finance and often provide stability to finances. This stability results from laws in many states that delink tax base growth from overall market volatility. In addition,the lag between market cycles and their effect on revenues allows public officials to adjust rates to offset market effects. The recent downturn illustrates this. Property tax revenues actually grew in 2009,while income tax revenues declined 17% and sales taxes declined 7.5%. Owing to the aforementioned lag, analysis done by the Pew Charitable Trusts using U.S. Census data shows that property tax revenue did decline in 2010,but only by 1.05%.Although conditions vary, data from local governments rated by Standard&Poor's show no decline in property tax revenues for the average government in fiscal 2010. For more information, see Lutz, Molloy,and Shan in Related Research. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 7 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions 3. The Strength Of The General Obligation Pledge And State Level Incentives For Debt Payment 16. A general obligation pledge usually obligates a local government to use all legally available funds to pay debt service and--if such current funds are not sufficient--to take actions necessary to increase those funds. This includes an obligation to levy additional property taxes specifically for debt service, although state tax caps may limit this pledge. A limited tax pledge may affect the rating(see"Standard&Poor's Refines Its Limited-Tax GO Debt Criteria", published Jan. 10, 2002). 17. In addition, some states have laws that empower state governments to take over local governments when their financial position deteriorates significantly or to direct state-appropriated monies for debt repayment. Even temporary relief from debt payments may elude local governments if GO debt enjoys the additional benefits of dedicated taxes or other"special revenues".About one-half of states' statutes either fail to provide specific authorization for municipalities to file for bankruptcy, as currently required for a bankruptcy filing under the U.S. Bankruptcy Code, or prohibit such a filing. Of the remaining 28 whose statutes authorize bankruptcy, 15 states only authorize municipal bankruptcy subject to approval or other conditions,and many states have used this approval power to intervene before a bankruptcy can occur. 18. While the nature of the GO pledge may best explain the miniscule net losses experienced on municipal debt during the Great Depression(net losses amounted to 0.4%of debt outstanding),in our view the limitations associated with Chapter 9 bankruptcy, and states'use of their additional oversight powers also contribute to the sector's extraordinarily low default rate by reducing political risk. Faced with the potential for longer-term costs of reduced market access and reputational damage for state and local officials,nonpayment of debt,in our view,makes little sense for most governments experiencing fiscal stress. 4. U.S. Local Government Payment Performance 19. Some proponents of current local government stability criticize references to local government defaults in periods such as the Great Depression or earlier. They cite changes such as lower government debt levels,improved revenue diversification, stronger state oversight, and fundamental changes to the economic and banking sectors as reasons why such previous default performance is less relevant.While the criteria recognize and incorporate many of these changes, such statements,in our view, overlook important reasons to consider past payment performance. First,given the experience of the recent recession and current economic challenges,the idea that the municipal performance seen only since World War II will continue regardless of future conditions is itself suspect. Rather than blind speculation, past performance provides observable data with which to compare and contrast different scenarios. Second,the period since World War II generally does not provide sufficient stressful periods with which to calibrate general obligation criteria(see "Understanding Standard&Poor's Rating Definitions",published June 3, 2009).Although the recent recession may demonstrate that municipal credits in general are investment grade,it provides little insight as to whether the current criteria appropriately differentiate'A', 'AA', and'AAA' credits as suggested by the article above. That evaluation requires more stressful periods. 20. Several studies provide what we consider to be good summaries of past municipal credit performance. The work most often quoted is George Hempel's"The Postwar Quality of State and Local Debt",published by the National Bureau of Economic Research(NBER)in 1971. The criteria also take Hempel's 1964 University of Michigan dissertation, "The Postwar Quality of Municipal Bonds", on which the NBER publication is based as a resource because it provides a bit WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 8 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions more detail.A major source for Hempel's work that focuses specifically on local government debt is Albert M. Hillhouse's"Municipal Bonds:A Century of Experience". Both works provide summaries and discussion,but do not present the underlying data. Hillhouse's"Defaulted Municipal Bonds(1830-1930)",lists every recorded default over the 100-year period referenced.When considering relationships between state and local governments,William A. Scott's "Repudiation of State Indebtedness"provides details on the actions of states under stress. 21. Hillhouse and Hempel come to similar conclusions on municipal defaults. On the one hand,local government defaults occur across all types of governments (see Appendix I in Section VII),in both good and bad economic times. On the other hand,the number of local government defaults becomes worrisome only during very stressful periods, and even then a majority of governments continue to pay their debts (see chart 2 and Appendix I). Both agree that the ultimate repayment record for local governments when they default is very strong. Chart 2 Gove rn me nt Defa u Its As i Pe rce ntage Of Tota Governmental By F' Of Governmerif •Ccuntws and pm ishrss ■1-=Tcrated municipal •._7i=perated municipals ■9 chm I diatricts ■uthae d&t iCt fafot 1t'. 1z. 12 10 S t 0 "9'?9 "qsv "9 "9"9' "q f 'gog 79 '9 19-9 1191V9 %9 1% See table 16 Standard&PDDrs 2013. 22. The criteria consider the overall strong payment performance even after adjusting for differences in economic stress. The criteria are calibrated to provide rating results consistent with the extraordinarily historically low levels of local government defaults. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 9 1190266 l30088t696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions 23. We do not expect a change in the historically extraordinarily low default rates in this sector.When there is a rapid deterioration,we do expect to continue to see multiple-notch downgrades. Please see"The Time Dimension Of Standard&Poor's Credit Ratings",published Sept.22, 2010,for a description of potential ratings migration. B. Framework For Determining A U.S. Local Government Rating 24. The criteria assess seven factors: • Institutional framework(see paragraphs 36-40); • Economy(see paragraphs 41-47); • Management(see paragraphs 48-58); • Budgetary flexibility(see paragraphs 59-64); • Budgetary performance(see paragraphs 65-68); • Liquidity(see paragraphs 69-77); and • Debt and contingent liabilities(see paragraphs 78-84). Scores for each factor range from'1' (the strongest)to'5' (the weakest).The economy score receives a 30%weight and management receives 20%.These scores receive the highest weight because of management's ability to tap the local economic base for additional revenues if it chooses to do so in a timely manner. The financial scores combined receive 30%,with liquidity,budgetary performance, and budgetary flexibility each accounting for one third of the 30%.The institutional framework score and debt and contingent liabilities score each receive 10%(see chart 1).Table 1 shows the indicative rating outcomes that result from the weighted average of these scores.Absent the overriding factors detailed in table 2,the final rating assigned to the GO issue or the ICR will be within one notch of the indicative rating shown in table 1,with one-notch differentials determined based on trends and comparisons with similarly rated peers. When the overriding factors detailed in table 2 notch the rating(rather than cap the rating),the one-notch differentials of the prior sentence can still be applied. Importantly,certain data are adjusted to facilitate comparability and consistency. Please refer to paragraphs 94 to 102 for a list of defined terms and related adjustments. In addition,please refer to the article, "Standard& Poor's U.S. Public Finance Local GO Criteria: How We Adjust Data For Analytic Consistency",published Sept. 12, 2013,for a more extensive summary of data adjustments. Table 1 Indicative Rating Outcomes Resulting From The Weighted Average Of Factor Score Weighted Average Indicative Rating 1.00-1.64 AAA 1.65-1.94 AA+ 1.95-2.34 AA 2.35-2.84 AA- 2.85-3.24 A+ 3.25-3.64 A 3.65-3.94 A- 3.95-4.24 BBB+ 4.25-4.54 BBB 4.55-4.74 BBB- WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 10 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Table 1 Indicative Outcomes Resulting From • Average Of • • 4.75-4.94 BB 4.95-5.0 B The indicative rating results from the weighted average outcomes as shown above.The final rating may differ from the indicative rating above by one notch based on trends and comparisons with peers in that range.The final rating may also differ from the indicative rating due to the presence of overriding factors described in paragraphs 25-35.For ratings below`B-'please see"Criteria For Assigning`CCC+',`CCC',`CCC-',And `CC'Ratings"published Oct. 1,2012,and"Standard&Poor's Ratings Definitions",published June 17,2013. Overriding Factors 25. The criteria employ a series of overriding factors that can result in the final rating assigned to the local government being different from the indicative rating outcome suggested by table 1. Table 2 summarizes these factors. Certain conditions result in the final rating moving a specified number of notches above or below the indicative rating. If multiple notch overrides exist,the final rating is based on the net effect of those overrides. 26. Certain other conditions result in the final rating being capped at a certain level.When such conditions exist,the final rating could be lower than the cap depending on the severity of the condition present, and the final rating could be lower than the indicative rating even if the indicative rating is lower than the ratings cap in table 2. Rating caps are absolute,meaning that the positive relative adjustments described below do not allow ratings to exceed the cap. If multiple cap overrides exist,the rating cap used is the lowest cap of all the individual overrides that apply. 27. If multiple overrides involving both caps and notches exist,the final rating will be based on the lower of the lowest rating cap or the indicative rating as adjusted by the notch overrides. For example, a local government could have an indicative rating of'A', a negative one-notch override,and a condition that results in a capped rating of'A+'. In such a case,the indicative rating as adjusted by the notch override would equal'A-'. Since'A-'is lower than the rating cap,the final rating could be at most'A' (if the one-notch adjustment described in paragraph 24 were applied) or any lower rating given that a cap override applies. If,instead,the indicative rating were'AA'in this example,then the indicative rating as adjusted by the notch override would be greater than the rating cap of'A+'.Therefore,the rating outcome could be no higher than'A+'(the one-notch adjustment cannot increase a rating above a rating cap),but could be any lower rating given that a cap override applies.We acknowledge that the assignment and removal of caps may cause an increase in ratings volatility and potentially steeper rating transitions. Table 2 Summary Of Overriding Factors paragraphs Overriding Factor Result Notch Overrides Projected per capita EBI*>225%of U.S.projected per capita EBI Final rating one notch higher than that suggested by table 1 Projected per capita EBI*>300%of U.S.projected per capita EBI Final rating two notches higher than that suggested by table 1 Total Market Value per capita<$30,000 Final rating one notch lower than that suggested by table 1 Available Fund Balance>75%of general fund expenditures for the most recently reported Final rating one notch higher than that suggested year,the current year and next year and is expected to continue by table 1 WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 11 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Table 2 Overriding Summary Of • paragraphs 25-35) (cont.) Available Fund Balance<$500,000 Final rating one notch lower than that suggested by table 1 Cap Overrides(rating capped) Liquidity score equals'4' Final rating capped at'BBB+' Liquidity score equals'5' Final rating capped at'BB+' Management score equals'4' Final rating capped at the lower of'A'and one notch lower than that suggested by table 1 Management score equals'5' Final rating capped at the lower of'BBB'and two notches lower than that suggested by table 1 Management score equals'5'due to a lack of willingness to support unconditional debt Final GO rating on debt not in default capped at'B' obligations Available Fund Balance<-10%of general fund expenditures for the most recently reported Final rating capped at'A+' year or budget flexibility score equals'5' Available Fund Balance<-5%of general fund expenditures for the two most recently Final rating capped at'A-' reported years Available Fund Balance<-5%of general fund expenditures for the three most recently Final rating capped at'BBB' reported years Budget performance:For local governments that exhibit characteristics of structural Final rating capped at`BBB+' imbalance expected to continue and the government does not have a credible plan to restore balance *EBI--Effective Buying Income(see glossary) Factors That Notch From The Indicative Rating a) Rating adjustments for certain economic measures 28. When variables measured as part of the overall economic score take on extreme values, adjustments from the indicative rating occur.When projected per capita Effective Buying Income (EBI) as a percentage of the U.S. projected per capita EBI exceeds 225%(50%higher than the top income threshold in table 8),the final rating is raised by one notch to account for the extreme income levels in the tax base.When projected per capita EBI exceeds 300%of the U.S. level,the final rating is raised by two notches. No similar adjustment applies to Total Market Value(TMV)per capita because high scores often result from concentrated tax bases.When TMV per capita is less than$30,000, however,the final rating is lowered by one notch to reflect the limited tax base supporting debt. b) Sustained large positive fund balances 29. An abnormally large sustained Available Fund Balance signifies heightened flexibility if projections suggest that it will endure.Accordingly,the maintenance of an Available General Fund Balance exceeding 75%of general fund expenditures for the most recently reported year,the current and next year, and that is projected to continue at that level raises the final rating by one notch. c) Low nominal fund balances 30. The Available Fund Balance as a percentage of expenditures measure,used in the budgetary flexibility score, can mask vulnerability when absolute nominal levels of reserves are low.Accordingly,when the Available General Fund Balance for the most recently reported year is below$500,000(but above a level that causes a rating cap to occur--see paragraph 34),the final rating is lowered by one notch to reflect this vulnerability. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 12 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Factors That Cap The Final Rating d) Liquidity 31. Although liquidity receives limited weight in determining the indicative rating because of a local government's ability to make fiscal adjustments,its importance grows as the liquidity score weakens.A liquidity score of'4' caps the final rating on a local government at'BBB+'regardless of other strengths.An overall liquidity score of'5'limits the final rating to no higher than'BB+'. e) Management 32. The decentralized and autonomous nature of U.S. local governments creates a stronger link between management and credit quality,particularly when limited or weak management exists.Accordingly, an overall management score of'4' results in a final rating at least one notch below the indicative rating outcome and limits the rating to no higher than W.A score of'T results in a final rating at least two notches below the indicative rating outcome and limits the rating to no higher than'BBB-'. 33. When a management score of'5'results from a current lack of willingness to pay a debt,capital lease obligation, or a moral obligation pledge(see paragraph 53),the rating cap depends on the nature of the obligation.A current lack of willingness to pay an unconditional debt obligation of the government would cap the final rating on other GO debt of the government at no higher than'B' and would likely be lower.While the ICR of a local government would fall to 'D' or'SD'following a default on an actual debt obligation,the payment prospects for other GO debt may remain stronger (such as when the default results from insufficient funds for limited-tax GO debt and other GO debt enjoys an unlimited-tax pledge). Consistent with our criteria for appropriation-backed obligations,a failure to pay a capital lease obligation also caps the GO rating(see"Appropriation-Backed Obligations",published June 13, 2007).A current lack of willingness to pay a capital lease or other obligation subject to annual appropriation by the government,including a moral obligation pledge,would limit the GO rating to no higher than'BBB-'even though the government was not legally obligated to make payment on the appropriation obligation without the appropriation. 0 Large or chronic negative fund balances 34. A government's Available Fund Balance forms the initial score for budgetary flexibility. Even when other forms of flexibility exist,however,a nontrivial fund balance deficit signifies heightened pressure,especially when the deficit endures. The presence of such pressure is consistent with the capped ratings suggested by table 2,even though the government may retain a significant capacity to repay debt.Accordingly,an Available Fund Balance of less than negative 10%of general fund expenditures in the most recently reported year caps the final rating at'A+'. Ratings above'A-' are typically for cases where we believe the Available Fund Balance will not be less than negative 5% beyond the most recently reported year.A budget flexibility score of'5' signifies limited flexibility and also caps the final rating at'A+'.An Available Fund Balance of less than negative 5%for the two most recently reported years caps the final rating at'A-'. Ratings above'BBB' are typically for cases where we believe the Available Fund Balance will not be less than negative 5%beyond the most recently reported year. The existence of such Available Fund Balance for the three or more of the most recently reported years signifies to us a chronic problem and caps the final rating at 'BBB'. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 13 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions g) Structural imbalance 35. The final rating is capped at'BBB+'when the entity has structural imbalance. For this purpose structural imbalance is determined over a four-year horizon(past two years, current year, and next fiscal year).Additionally,management does not have a credible plan to adequately correct the imbalance. Characteristics of structural imbalance include: • Significant use of one-time revenue, • Borrowing for ongoing operations, • Unplanned fund balance drawdowns, • Recurring unbudgeted expenditure and revenue mismatch, and • Significant dependence on volatile revenue. C. The Institutional Framework Score 36. The institutional framework score assesses the legal and practical environment in which the local government operates.Accordingly, all governments of the same type within the same state receive the same score. Since state constitutions and state laws generally dictate the terms under which local governments may operate,the score reflects these state-specific elements. To enhance comparability with local governments outside the U.S.,the criteria assess the same areas as detailed in paragraph 39 of our criteria, "Methodology For Rating International,Local,And Regional Governments",published Sept. 20, 2010. Specifically,these areas include predictability,revenue and expenditure balance,transparency and accountability, and system support. Scores for each area,however,use slightly different measures that are more specific and more relevant to the U.S. and range from'1'(the best)to'5'(the worst). The criteria then average each of the scores equally to determine the overall institutional framework score as detailed in table 3. Table 3 Institutional •rk Score Outcomes Score Range Institutional Framework Score 1(very strong) 1.75-2.75 2(strong) 3.0-3.75 3(adequate) 4-4.5 4(weak) 4.75-5 5(very weak) The institutional framework score results from the average of the scores for predictability,revenue and expenditure balance,transparency and accountability,and system support(see paragraphs 37-40).Each score receives equal weight in the average. 1. Predictability 37. Predictability assesses the extent to which a local government can forecast its revenues and expenditures on an ongoing basis.The ability and frequency of changes to municipal responsibilities or revenue raising capabilities resulting from state or statewide voter actions can complicate local government decision making.An inability to sufficiently plan and implement strategies to accommodate these changes can affect a government's fiscal position. Table 4 details the scoring for predictability. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 14 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Table 4 Predictability Assessing Score Description 1(very strong) None of the following elements are true:voter initiative or referenda rights exist to automatically alter revenues or expenditure responsibilities;the state has significantly changed its statutes governing local government revenues or expenditure responsibilities in the past eight years(to the detriment of this type of municipality);the state has changed the disbursement pattern of state-shared revenues in the past eight years(to the detriment of this type of municipality)and these revenues are a major portion of local government revenues. 2(strong) One of the elements in 1 is true,but such events are not frequent from a long-term perspective.The nature of deliberation and implementation of change allow sufficient time for local government planning and adjustment. 3(adequate) More than one of the elements in 1 is true,or at least one of the elements is recurring.The nature of deliberation and implementation of change allow sufficient time for local government planning and adjustment. 4(weak) At least one of the elements in 1 is true,but the pace of change does not allow for planning and adjustment. 5(very weak) The system is volatile,with ongoing and ill-prepared large-scale transformations that do not allow for planning and adjustment.Legal rights and obligations between the state and local level are unclear,adding to the lack of clarity. 2. Revenue and expenditure balance 38. Revenue and expenditure balance assesses the extent to which local governments have the ability to finance the services they provide.The focus is on revenue raising capability in scores one,two and three under the presumption that most municipalities have significant control over their expenditures. Only when revenue raising capacity is limited, and there are significant unfunded or partially unfunded expenditure mandates, are scores of four or five likely. Additionally,the criteria treat state provisions that require minimum balances as enhancing flexibility,while those that limit balances diminish it.Table 5 details the scoring for this measure. Table 5 Assessing Revenue • Expenditure Score Description 1(very strong) Local governments within the state have statutory flexibility to raise local source revenues for operating purposes without voter approval.Where limits on the ability to raise revenues exist,they are such that most governments within the state still retain significant capacity to raise revenues. 2(strong) Local governments within the state have some flexibility to raise local source revenues for operating purposes without voter approval.Limitations(such as property tax caps)restrict flexibility,but still allow for most local governments to raise such revenues. 3(adequate) Virtually no ability exists to raise local source revenues for operating purposes without voter approval.Additional flexibility may come from state revenue sharing. 4(weak) No ability exists to raise local source revenues even with voter approval,or there are significant unfunded or partially unfunded expenditure mandates that overwhelm the average entity's budget. 5(very weak) No ability exists to raise local source revenues even with voter approval,and there are significant unfunded or partially unfunded expenditure mandates that overwhelm the average entity's budget. A statutory minimum fund balance improves the score by one point and a statutory maximum fund balance worsens the score by one point. 3. Transparency and accountability 39. Transparency and accountability assess the overall institutional framework's role in encouraging the transparency and comparability of relevant financial information.When states require annual audits,this increases the likelihood that audits will be done and that late audits will be noted. States'regulations requiring audits and strong accounting standards such as generally accepted accounting principles(GAAP)usually enhance reporting detail and consistency across municipal credits,making it easier to have a sufficient uniform method of interpretation. States that allow cash WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 15 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions accounting tolerate a lesser degree of completeness and consistency.Table 6 details the scoring for this measure. Table 6 Transparency Assessing . Accountability Score Description 1(very strong) State statutes or other provisions require annual financial statements that comply with GAAP. 2(strong) State statutes or other provisions require audited annual financial statements,but no GAAP requirement exists.Most audits utilize accrual and/or modified accrual accounting. 3(adequate) State statutes or other provisions require annual financial statements,but no GAAP requirement exists.Most audits utilize cash or modified cash accounting. 4(weak) No requirement for annual financial statements exists or there is no requirement for an audit.Interim reports provide the only source of financial information for most local governments in some years. 5(very weak) No requirement for financial statements exists.Cash-basis reports provide the sole source of financial information for most local governments in most years. 4. System support 40. System support addresses the extent to which local governments receive extraordinary support from a state government when the local government is under extreme stress.Forms of extraordinary support range from state government control and oversight to emergency loans or other liquidity assistance.Table 7 details the scoring for this measure. Table 7 Support Assessing System Score Description 1(very strong) A tested,formal mechanism for providing extraordinary support for local governments exists,which has restored fiscal stability.Such mechanisms may help with liquidity,capital market access,government management,or capital funding. 2(strong) Mechanisms for providing extraordinary support are less formalized,untested,or have not consistently restored fiscal stability but ongoing mechanisms to help with liquidity,capital market access,government management,or capital funding do exist. 3(adequate) No mechanisms for providing extraordinary support exist,but state statutes do not authorize local governments to file for bankruptcy or require further state approval. 4(weak) No mechanisms for providing extraordinary support exist and state statutes specifically authorize local governments to file for bankruptcy without state approval. 5(very weak) No mechanisms for providing extraordinary support exist,and the state has recently passed legislation that threatens the solvency of local governments without providing adjustment capabilities. D. Economic Score 41. The economic score assesses both the health of the asset base relied upon to provide both current and future locally derived revenues as well as the likelihood of additional service demands resulting from economic deterioration. Projected per capita EBI as a percentage of the U.S.level, and TMV per capita combine to form the initial economic score due to the data availability of these statistics at the local level and their correlation with overall economic activity and local government revenues.Table 8 details the manner in which different values of these two statistics combine to form the initial economic score. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 16 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Table 8 Assessing The Economic Score (see paragraphs Total Mrlwt Value PerCspils Projected per capita effective buying i mconne >5195 5100,000 to 380,000 to 555.000 to asa*A of U.S.projected per capita EBI ,000 51 ,000 3100,000 S80.CCC <5EE,000 X150 1 1. 2 2.F 3 110 to 1EA 1.` 2 2.5 ?•.E• 85 to 110 2 .: 3 3.5 4 70 to 85 2.5 v 15 4.5 s70 3 3.E 4 4. E Ascoreof 1°.'2', '3','4'. and .E' m ea n s very stro n g, strong, adequate, veak, and very%%eak. respectively. Qualitative facto-rs With a positive irrpact on the ini0al QualitativefactDrs with a negative irrpact on the initial score score Participation in a largerbroad and diversified economy fsee N egati ve bu d get i m pa ct fre m d em og ra ph ic pro file: population paragraphs 4E-47). decrease and+or high share of dependent population (�55%) have a material negative impact on future revenue growth and expenditure needs, Astabilizing institutional influence Wth a longstanding role as High county unemploym ent rate(>10%). a major employer, such as higher education, health care, military, a large and stable corporate presence. If employment concentration where an in d i vid u a I secto r (excluding education1health, government, and transportation, trade and utilities)represents more than 30°6 ofthe nonfarm wrk base, or tax base concentration Wiere the top 10 taxpayers represent more than 2,5%ofthe tax base exists,the score%worsens byone paint(1). Ifthetop 10 taxpayersexceed 45%ofthe tax base,the score worsens bytvo points(20). The adjustment impact of each qualitative factor countsfor one point(1.0), except for employment and taxbase concentration, wherethe scare maydiffer bytm points(20)asdescribed above.The final economic scare equalsthe initial score adjusted up or down based an thenet effect of the qualitative factors. rletricsthat equal a cut-off point between t%%o initial scores%Mll equate to the mrse scare.To calculatethe market value percapita,the criteria usethe most recent estimate available.To calculate projected percapita EBI,the criteria usethe most recent local level EBI available, adjusted forger capita personal income growth expectations forthe next fiveyears IHS Inc.(kno%v1 as Global Insight)oranother similar source is used forcounty-level data and U.S. income projections, while Nielsen (Claritas�f or another similar source isused for local legal data.To measure unemployment,the criteria use county4evel data from the Bureau of Labor Statistics and take the annual rate forthe last calendar year. For local governments located with multiple counties, county-level data is weight-averaged based on the percentage of the population ofthe local governm ent in each county. 42. The final economic score will vary from that suggested by the initial score depending on the presence of one or more conditions, as shown in the table 8. 43. Local income and TMV statistics may underestimate fundamental economic strength. For example,local TMV statistics will not accurately reflect the economic activity and stability brought by a university,nor will student income WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 17 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions levels reflect their additional spending power coming from parent financing or student loans. Participation in a broader metropolitan area may bring nonresident spending into a community or provide additional job opportunities for residents beyond its borders--especially when the metropolitan area is economically strong. 44. By contrast,income and TMV per capita may fail to account for additional risks. The impact on income and economic activity from job losses may not immediately show up in income levels and market prices, and such losses are more likely to occur in more cyclical and concentrated tax bases. Because they do not exhibit strong cyclicality, concentration in the education/health,government, and transportation,trade and utilities sectors are not considered for this adjustment. County-level unemployment rates are used to reflect the wider view of the local economy. Population declines may also dampen the impact on per capita measures, and high Dependent Population levels can mean additional service requirements or different levels of willingness to support tax increases. 45. We assess participation in a larger broad and diversified economy at the Metropolitan Statistical Area(MSA)level. When the MSA is deemed to be broad and diverse, a positive adjustment of one point is applied to the initial economic score. The determination is based on an evaluation of three components--employment diversity, employment growth, and the employment base. Each of the three components is scored as strong,moderate, or weak and is equally weighted. Strong and weak scores offset each other,while a moderate score remains neutral. MSAs are considered to be broad and diverse when the net score of the three components is strong, and are not considered broad and diverse when the net score is weak. If the net score is moderate, applying the broad and diverse adjustment to the initial economic score may be warranted if we determine the local government benefits significantly from participation within its respective MSA. 46. Employment diversity within an MSA is primarily assessed using a Herfindahl Index that includes the share of total employment distributed across 12 general employment sectors. For this index,we consider less than 0.15 to be strong, between 0.15 and 0.18 to be moderate, and greater than 0.18 to be weak. Employment growth is primarily measured by the percentage change in total employment within an MSA for the prior five-year period. For this measure,we consider an MSA with a rate better than the sum of all MSAs as strong;if the MSA's rate is worse but within three percentage points of the sum of all MSAs it is considered moderate, and a rate more than three percentage points worse is considered weak. The employment base measures total employment within the MSAs across all sectors. For this measure,we consider population greater than 250,000 to be strong,between 100,000 and 250,000 to be moderate, and less than 100,000 to be weak. 47. Additional considerations include employment concentration within specific sectors if. 1)the Herfindahl index is greater than 0.067, excluding the education/health,government, and transportation,trade, and utilities sectors, or 2) any volatile sector is more than double the level found in the sum of all MSAs and a large 10-year percentage decline in total employment(greater than 10%). If any of these considerations exist,they may reduce the overall score from strong to moderate or moderate to weak. E. Management Score 48. The rigor of a government's financial management practices is an important factor in Standard&Poor's analysis of WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 18 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions that government's creditworthiness. Managerial decisions,policies, and practices apply directly to the government's financial position and operations, debt burden,and other key credit factors.A government's ability to implement timely and sound financial and operational decisions in response to economic and fiscal demands is a primary determinant of near-term changes in credit quality. The management score assesses the impact of management conditions on the likelihood of repayment. The score does not measure individual managerial quality, organizational efficiency, or any other performance indicator associated with management. Table 9 summarizes the scoring for the management score. 49. The Financial Management Assessment(FMA)methodology(see "Financial Management Assessment",published June 27, 2006)used in U.S.public finance forms the starting point for the management score.The FMA assesses only the policies and practices of a local government. Our criteria recognize the mere development of such practices as a principal method for preventing default as early as the 1930s evidenced in Hillhouse. Table 9 Assessing The Management paragraphs Sere Characteristics 1 (verystrong) FhlAscore of'Strong` and none ofthe factors in scores'4'or '5'are present. 2(strong) FNIAscore of'Good'and none ofthe factors in scores'4'or '5'are present. 5(adequate) FNIA score of'Standard' and none ofthe factors in scares'4' or'5'are present. 4(veak) FtlAscore of'Vulnerable'or any ofthe fc %%ing is present: there is a financial reporting restatement that has a material negative impact; arry ofthe conditions in score's'existed within the pastthreeyears;the structural imbalance override condition exists orexisted vithin the past three years; or a vary high debt, pension, and OPEB burden. 5(very vreak) Regard!essof the FtlAscore, any of thefollo%ling is present: a management team that lacks relevant skills resulting in a weak capacity for planning, monitoring, and management; an auditor has delivered a going concern opinion,the government is exhibiting an un%illingness to support a debt or capital lease obligation; or the governmeflt is actively considering bankru t rinthenearterm. Qualitative factors with a positive impact on the Qualitative factors vith a negative impact on the initial initial score score Consistent abilityto maintain balanced operations. Frequent management tumover inhibiting a current understanding ofthe government's financial position and its abilityto adjust, or political gridlock, or instabilitythat brings th a sa m e resu Its. Govemment service levels are limited. Consistent inabilityto execute approved structural reforms for t%%o con secutive yes rs. Foreach relevant qualitative factor,the scare changes byone point.The final management scareequalsthe initial scare adjusted up ordowi based on the net effect ofthe qualitative adjustments. ❑ualitative adjustments cannot improve an initial management scare of'5'or, in certain cases, a scareof'4 (see paragraph 557 . WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 19 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions 50. Regardless of the initial management score resulting from the FMA and any adjustment factors, certain conditions automatically cap the score at'4' or'T.A capped score of'4' can occur if the financial reporting of the municipality is subject to material restatements to an extent that the uncertainty created is consistent with ratings no higher than W. This does not include required accounting adjustments such as required changes by the Governmental Accounting Standards Board(GASB).Another instance when a capped score of'4'may occur is within three years after a condition that would cause or caused a management score of'T. In such cases,the uncertainty surrounding management's ability to rebound from the condition(s)is also consistent with ratings no higher than'A'. The same result can exist while the local government's finances are structurally imbalanced(see paragraph 35) or during the three-year period thereafter when management is rebounding from the structural imbalance condition. Finally, a capped score of'4'may result from having a debt,pension, and other postemployment benefits (OPEB)burden that is considered very high and management's lack of a credible plan to address the situation. Characteristics of a very high burden include: • Total governmental funds debt service plus required annual pension payment plus annual OPEB payment as a percentage of total governmental funds expenditures above or expected to exceed 50%; • A growing recent and near-term expected trend of these fixed-cost charges; and • Fiscal flexibility unable to compensate for these elevated fixed-cost charges; 51. The first instance in which a municipality can receive a capped score of'T occurs when a management team lacks the relevant skills to adequately plan,monitor, and manage the government's finances.Although rare,these conditions usually occur when the management organization concentrates nearly all management functions with one individual who then leaves.To receive a score of'T, a lack of qualified subordinates and delays in replacing the departed individual usually exist.As this period lengthens,the government's true financial position becomes less clear, and an auditor may have difficulty rendering an opinion on the government's financial statements. 52. The second instance occurs when an auditor has delivered a going concern opinion with the most recent review of the government's financial position. Other forms of qualified audit opinions do not result in a score of'T. 53. The third instance occurs when a government shows an unwillingness to support a debt,capital lease obligation, or moral obligation pledge.A current lack of willingness to pay vendors,vendor leases, or other commercial obligations would not automatically result in a score of'5',although it could indicate increased financial pressure that could bring lower ratings through the other elements considered by the criteria.A current lack of willingness may or may not be clearly established before the actual payment date of the obligation concerned. Even before a government has formally chosen not to pay an obligation,downward rating adjustments could result from the expectation of such events. 54. The fourth instance occurs when representatives of the government take actions that indicate active consideration of bankruptcy filing in the near-term. 55. Various qualitative factors may raise or lower the final management score relative to the initial score,as shown in table 9. 56. Even when limited policies exist,the risk management poses to credit quality may still be limited. First,management may excel in consistently balancing operations despite the absence of formal policies. Second,when the government provides limited services, operational risk declines.The management score improves by one point when either of WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 20 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions these conditions exists. The criteria measure government operational risk by distinguishing between the following two categories: • Typical services: the municipal government provides public safety,roads,basic planning and permitting, and some utility services. Governments providing significantly higher levels of complex or resource-intensive services also receive a score of'typical'. • Limited services: the municipal government maintains roads and provides only limited additional services that are mostly administrative or non-labor-intensive. It either does not provide public safety services or contracts them out to other governments.Any other services are limited and could be scaled back or discontinued if they became a burden. 57. No qualitative adjustment may raise the score if the initial score equals'5'. In some instances a score of'4' cannot be adjusted in a positive direction. No improvement in the final score occurs when a capped score of'4'is assigned because of the conditions described in paragraph 50. 58. Negative adjustments to the initial management score address circumstances or obstacles that prohibit management from planning and executing. Such conditions could include rapid management turnover or political gridlock or instability.The criteria also recognize that not all obstacles can be foreseen and use two consecutive years of failure to implement planned structural reforms as evidence that such an obstacle exists even if it has not been precisely identified. F. Budgetary Flexibility Score 59. The budgetary flexibility score measures the degree to which the government can look to additional financial flexibility in times of stress. Table 10 details the scoring for budgetary flexibility. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 21 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Tableill Assessing The Budgetary f paragraphs Available Fund Balance As A Of Expenditures "-15 X15 4-8 1-4 <1 Sere 1 2 3 d 5 Ascore of°1',`2,-T,*, and m eons very stmng,strong, adequate, kveak. anti very%wak, respectively. {qualitative factors with a positive impact an the inrt ar Qualitative fa torswth a negative impact on the initial SOON_- SCOW. If projedionsfurthe current yearand the follobMngiyear If projections for the currentyearand the following year suggest a better initial scare. suggest a vdorse initial scare. !{bi14,to avoid financial imbalances Mhdemonstrated High levels afquestionable receivabl es a r amounts due from capacity and vAll in g n ess to cut operational spending(by more other funds vith deficit balances. than 2%), resulting from a flexible cast structure, flexible legislation, andW%%idespread political support. Existing state taxesps do not apply to thegovernment, orthe Limited capacityto cut expenditures due to infrastructure or government retains substantial flexibilityunderthe caps. operational needs or political resistance. Demonstrated ability and WIlingnessto raise taxes Men Limited capac4,to raise revenuesdueto consistent and needed (and voter support is usually obtained when such ongoing political resistances°hick can in dud eselfamposed approval is required). restrictionsthreugh charter or local initiative processes. Timing of fiscal year and tax billing dates result in high cash ', here cash accounting is used,the criteria use cash %vith abnormalhf Io,,v fund balance levels. balances instead of fund balances and the score is worsened by one point. 1,1 aintenance of an available fund balance exceeding aO% of general fund expenditures.fDr the most recently reported year, the current year and next year. For each relevant qualitative factor,the score changes by ane pDir>t. The final budgetary texdbilityscnre equals the initial scare adjusted up or down based on the net effect of the qualitative factors. Arnetricthat equalsa cutoffpo-int between two initial scares vv 11 equate to the worse scare. 60. Various qualitative factors may raise or lower the final budget flexibility score relative to the initial score, as shown in table 10. 61. The existing Available Fund Balances reflect the most obvious and measurable form of flexibility. However,we recognize that municipalities may have ongoing balances legally available for operations outside the general fund. Therefore,the Available Fund Balance in the initial score reflects all available funds legally available for operations. The initial score is the Available Fund Balance as a percentage of general fund expenditures.The measure uses data from the most recent reported year. 62. Qualitative adjustments to the budgetary flexibility score generally compensate for shortcomings in the fund balance measure or assess other forms of flexibility. GASB Interpretation No. 5 specifies how much of taxes already levied and possibly even collected must be deferred from a recognition perspective based on the timing of these elements relative WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 22 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions to the fiscal year. In some jurisdictions,this results in the accounting creation of low fund balances in a small number of credits that in reality have substantial resources. On the other hand,high fund balances as a percentage of expenditures may overestimate flexibility if the quality of receivables recognized is suspect.The Available Fund Balance measure will be net of any Available Fund Balance that includes questionable receivables that we do not expect to be collected,but if receivables are unable to be projected with confidence,the negative"questionable receivables"score adjustment is used instead of making an adjustment to the data(see table 10). For entities that report on a cash basis,the criteria use cash balances instead of fund balances.The score is worsened by one,however, to compensate for the lack of clarity on what funds are truly available.The maintenance of a consistently high fund balance--exceeding twice the level associated with the top score--that we expect to continue represents a positive adjustment that may offset a negative adjustment when both conditions exist. 63. Other forms of flexibility primarily include the ability to raise additional revenues or reduce expenditures.These tools are at least equal in power to the use of existing balances,but qualitative adjustments better suit their complexity due to the various forms they can take.With regard to tax caps,the institutional framework score incorporates the extent to which statewide tax caps exist,but the budgetary flexibility score differentiates those credits that retain flexibility despite the tax caps.The criteria separately assess local political support for increases,including cases where there are self-imposed limitations as a result of local charter initiatives or referenda. 64. The option to use fund balance in the near term can provide fiscal flexibility although fund balance drawdowns may impair future fiscal flexibility.Likewise,increasing fund balances can enhance fiscal flexibility. Our forward-looking analysis evaluates the budget performance for the current and next fiscal year. If our projections result in a score change, either up or down,the score is adjusted by one point in the relevant direction. G. Budgetary Performance Score 65. The budgetary performance score measures the current fiscal balance of the government,both from a general fund and total governmental funds perspective.Table 11 details the scoring for this measure. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 23 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Budgetary Tabli-11 Assessing The _ . ; Taial Govern nwnial Funds Net Result ) General Fund Net Result (%) >-1 -1to5 5to-10 -10 to-1E fAE (>5) 1 2 3 3 4 (-1 to 5) 2 3 3 4 5 L*-1) 1 3 4 4 5 5 A score of`1',°2',`3',`4' and E means wery strong. strong, adequate, weak, and very weak, respectively. Qualitative factors Wth a positive impact on the initial Qualitative factors with a negative irrpact on the initial score, score, Expected strudural improvement: if projecti a n s fo r th e Expeded struduraI deteroration: ifprojedions forthe current current}ear and follo vii ng year suggested a better initial year and fallowing year suggested a worse initial sere,the scare sere,the scare%wuId improve by ane paint.The score would wmrsen by one or too points.To worsen bytm points, vwould improve bytvo pointsonlyifrequired a dj ustm ents to expected performance must fall to the commensurate level within revenues or expend itu res t o pro ducethe result were already the current yea r. approved. Deferred payments on a cash basis: in cases where g a a d ratios hide significant underspending due to deferred payments,the deferral produces a better scare. Significant h isto ri c vo I atil ity i n performance because afvery cyclical revenues (e.g. ail& gas a &alestaxes on luxury goads andlor dependence an volatile state transfers)or exposure to event{elated ri sks, and the sources afvalatilfty remain. For each relevant qualitative factor,the sere changes by a n e point, except fior expected struduraI impro vement a deterioration which could result in a difference oftvo paints relative to the initial scare. The Ina I budget performance scare equals the initial scare adjusted up ardown besed on the net effect ofthequaIitative fa dors. tletri csthat equal a cut-o ffpoint betweentwa initial sco res will equate to th a woo rse scare. 66. Various qualitative factors may raise or lower the final budget performance score relative to the initial score, as shown in table 11. 67. The budgetary performance score begins with a measure based on the most recent year reported because it is observable and verifiable. The criteria will usually smooth planned capital expenditures to arrive at a more sustainable view of ongoing performance by eliminating the spending of borrowed funds for capital expenditures.Adjustments are also made for net transfers to identify the structural result. 68. However,future credit quality is dependent on current and future performance.Accordingly,the score can be adjusted by one or at most two points if actions or events subsequent to the date of the measure suggest different results in the coming years. Examples of actions warranting such adjustments include updated current-year estimates,new budgets, or budget amendments featuring approved revenue or expenditure adjustments. The criteria also compensate for artificially positive outcomes resulting from deferred expenditures, such as underfunding required pension WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 24 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions contributions,with a negative adjustment of one point.A negative adjustment of one point also exists for the uncertainty associated with governments facing increased volatility in revenues with a more-than 10%year-to-year decline, such as those highly dependent on oil and gas-related revenues or sales taxes on luxury goods or subject to event-related risk. The criteria include financial reporting restatements that are not material enough to warrant a management score(see paragraph 50) of'4'but inject a degree of uncertainty to the performance score,as a one-point negative adjustment. Event-related risk can also include sudden and material negative financial performance from enterprises owned by the entity. H. Liquidity Score 69. The liquidity score measures the availability of cash and cash equivalents to service both debt and other expenditures. Table 12 details the calculation of the initial score, as well as the manner in which other factors affect the liquidity score. The measure uses data from the most recently reported year. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 25 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Table 12 Assessing The Liquidity Score (see paragraphs Tit G�v�m rr�nt#vaitabt+e iastt#s Of Tali t �rr�r�Furrka 11�t Total Gowernment Availatle Cash As% >124 100 to 120 80 to 100 .10 to 30 <40 Of Total G oxemmental Funds E),penditures 9 to 15 3 4 4 to 8 = 3 3 4 1 to - 4 4 4 4 <1 E_ 5 5 5 _ A score cf 1. 2. ?, 4 and 5 are verystrong,strong, adequate, vreak and very weak, respectively. Qualitative factors Wth a positive impact on the initial Qualitative facto with a negative impact on the initial :sere, score; If projections forthe current year(andthe fellcvingyear) If projections fbrthe current year(and the follovingyea.r) suggest a better initial snare,the score improves by one suggest a Ywrse initial score,the score morsens by one point. point. If access to external liquidityis'exceptionar asdefined in Ifaccessto external IiquicIity is uncertain'as defined in table table 12,the score improves byt%w paints; if-strong',the 13,the score mrsensbyt%%u points; if-limited',the score scare improves by one paint. mrsens by one paint. Very robust and stable internal cash fio%vgeneration capacity High refinancing risk overthe next 24 month& cam pared ttith peers i n th is categ cry. Aggressive use of investments. Exposureto non-remote contingent Iiatrility riskthat could come due within 12 months. See paragraph 77 far ci rcumstances resulting in an a uta m atic sea re a f* or `. E Ara or in a ry p rc cc ed s(su ch as unusedshort- term borrovAng)that span fisca I years a r th at are oth ervAse d edi cated will be adjusted cut of—etaI GovemmentA:ailable Cash. For each relevantgualitative factor,the wore changes by one point, except for accessta external Iigaidity41ich could change the final score bytvia poi ntsand contingent Iisbility expo sure 4ich could cap the score at Dr'5.The fi nal Iiquiditysccre equals theinitial sea re adjusted up or da%%n based on the net effect afthequalitative fsdors. M etricsthat equal a out-off paint between two initial scares will equate to the worse score. 70. Various qualitative factors may raise or lower the final liquidity score relative to the initial score, as shown in table 12. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 26 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions 71. Because governments hold monies in various funds that may be accessed for short-term liquidity,the measure uses Total Government Available Cash held by the government and recognizes most governments' ability to engage in interfund borrowing. Undrawn amounts under committed bank lines and other facilities are included as cash, and drawn amounts are included with both debt service and total expenditures if due within the next 12 months. 72. Through adjustment factors,the criteria also recognize the role that capital markets and bank financing can play in local government liquidity, as well as the strengths and weaknesses associated with other conditions. 73. The access to external liquidity score detailed in table 13 measures a local government's access to capital market and bank financing. 74. Availability of liquidity varies and in part is a function of the current and near term financial condition. Our forward-looking analysis evaluates the cash,expenditures and debt service for the current and next fiscal year. If our projections result in a score change, either up or down,the score is adjusted one point in the relevant direction. Table 13 Assessment Of Access To External Liquidity paragraph Access To External Liquidity Typical Characteristics Exceptional There is well-tested access to capital markets through different capital financing programs as well as a history of tapping these markets for over 15 years through different economic cycles. Strong There is a record of sufficient access to capital markets,and no reason to believe access has diminished. Satisfactory There is no record of access to the capital markets in the last 20 years,but there is also no reason to believe that external financing could not be obtained at a price acceptable to the government. Limited Legal or market obstacles to the use of debt instruments for liquidity management exist;the availability of bank loans is limited. Uncertain Access to external liquidity is highly questionable,considering both capital market and bank sources. 75. Although local governments in general have enjoyed good market access even through the last economic downturn and credit tightening,the score assesses access relative to the specific local government rather than to the sector as a whole.Absent a market-based or issuer-specific reason to question future market access,the score will use the government's own record of market access in addition to any state-specific sources. 76. The criteria also recognize that future cash balances may be understated for credits with strong cash flow generation capabilities. Often,this results from conservative budgeting procedures that consistently produce positive budget variances. 77. By contrast,projected cash balances may be more at risk under certain conditions,including aggressive use of investments,high refinancing risk over the next 24 months, or exposure to other contingent liability risk that could come due within the next 12 months.Aggressive use of investments includes the use of derivatives for investment rather than hedging purposes, a focus on return over preservation of principal and liquidity, and the use of nontraditional instruments without an ability to articulate their risks and how they will be mitigated. High refinancing risk includes instances where the issuer could be forced to access outside financing due to a lack of internal liquidity, but the issuer will have limited warning when the need arises and has no credible plan to do so on a timely basis. Other contingent liquidity risks include payments resulting from rating triggers,legal judgments,deficits of other enterprises, WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 27 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions or other events that are foreseeable within our current-year estimate.When such events are likely,the coming year's cost of these obligations exceeds 25%of general fund revenues, and the government lacks a commitment to implement a credible plan to finance the obligation,the final liquidity score is capped at'5'.When such events are likely,the coming year's cost of these obligations exceeds 10%of general fund revenues, and the government lacks a commitment to implement a credible plan to finance the obligation,the final liquidity score is capped at'4'. Otherwise, the presence of such obligations worsens the liquidity score by one point.Any such element deemed certain is included as an expenditure in total cash as a percentage of total governmental funds expenditures. If the event would result in a higher debt obligation,the criteria also include the item as debt service in the total government cash as a percentage of total governmental funds debt service measure. For more information on contingent liquidity risks, see "Contingent Liquidity Risks In U.S. Public Finance Instruments: Methodology And Assumptions",published March 5, 2012. I. Debt And Contingent Liabilities Score 78. The criteria form the initial debt and contingent liabilities score from the combination of two measures:total governmental funds debt service as a percentage of total governmental funds expenditures and net direct debt as a percentage of total governmental funds revenue.Debt service as a percentage of expenditures measures the annual fixed-cost burden that debt places on the government.Debt to revenues measures the total debt burden on the government's revenue position rather than the annual cost of the debt,which can be manipulated by amortization structures. Net direct debt is calculated as of the date of our analysis,including any debt issuance we are currently rating. Debt to expenditures is measured similarly,recognizing any near-term changes due to the government's debt structure.Table 14 details the scoring for the debt and contingent liabilities score. For more information on debt measurement,see"Debt Statement Analysis",published Aug. 22, 2006. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 28 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Table 14 Assessing The Debt And Contingent Liabilities Score (see paragraphs Net Direct Debt As% Of Total Governmental Funds Revenue —otaI GavernmentaI Funds C,ebt Service As A%of Total Governmental Funds <y 0 50 to 6G = 'c 12M 120 to 180 x180 Expenditures 8 to 15 2 15 to 2E 5 25 to 35 4 = v 5 +35 4 5 5 5 5 A score of 1. 2. 3,4 and 5 are very strong,strong adequate, meak and veryvveak, respectively. Q ual itative factors with a po sitive i rrp a ct o n the i n it a I Q ual"iive factm vAh a rmgative Wpactanthe scare: inrlisl wore Overall net debt as a percentage of market value belokV3%. Significant medium-term debt 0ansproducea higher initial scare when included. Overall rapid annualdebt amortization, Wth morethan 65% Exposureto interest-rate risk or instrument provisions coming due in10 years. that could increase annual payment requirements by at I east 20%. Overall net debt as a percentage of market value exceeding 10%. Unaddressed exposure to large unfunded pension or OPEB obligations leading to accelerating payment abligations over the medium term that represent significant budget pressure[see paragraph 82}. Ifthere is plan to address the abligations,the fin aIscore vaarsens by one point; other4tisethescare%,jxsens by twYD points. Speculative contingent liabilities orthose othervise likely to be funded on an ongoing basis bythe government representing more than 10% oftotal governmental revenue. For each relevant qualitative factor.the scare changes by one point, except for unaddressed expcsureto unfunded pen sian or 0 P E B abligations-,-hich can %%orsen the final scare by two points.-he final debt anti contingent liabilities scare equals the initial scare adjusted up ordo,,An based an the net effect afthequalitatiwe factors. lletrics equaI a cute ffpoint betvveen two initial sea res WlI equate to the vxrse scare. 79. Qualitative adjustments may raise or lower the final debt and contingent liabilities score relative to the initial score, as shown in table 14.The criteria consider pending debt issuance through an upward score adjustment when including WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 29 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions the planned or recently issued debt results in a worse score. 80. The criteria improve the final score by one point when above-average annual debt amortization(based on total direct debt)inflates the debt service as a percentage of expenditures score and masks the future flexibility stemming from an early deleveraging. The criteria do not apply this adjustment when the early amortization results from a near-to-medium term bullet maturity that will not be retired with funds on hand. Exposure to interest-rate risk or instrument provisions that cause amortization or interest-rate changes beyond the issuer's control increase the score by one point,reflecting additional uncertainty as to whether current debt service levels are representative of those going forward. Examples include unhedged variable-rate debt or higher interest rates resulting from failed remarketings in instruments such as auction-rate securities,variable-rate demand bonds, and certain direct purchase obligations. 81. An overall net debt to TMV level of above 10%worsens the score by one point,while a low level,below 3%,improves the score by one point. This statistic captures the burden of the local government's debt in addition to that of overlapping jurisdictions on the overall tax base.An atypical debt burden can present extra challenges or flexibility over and above that suggested by the individual government's debt burden alone. 82. The impact of pension and OPEB obligations depends on the degree to which such costs will likely escalate and whether the government has plans to address them. Relative to debt,governments have a higher level of flexibility to address these costs,both from a temporal payment perspective and from an obligation level perspective. Many governments have the flexibility to alter benefit levels, and some governments already have availed themselves of this ability. Most governments also can pay less than the annual required contribution without leaving the fund unable to meet actual payments in the current and following year. On the other hand, such delays accelerate the growth rate of future payments.When the potential for such accelerations exists and the increased payments increase budget stress, the final debt and contingent liabilities score worsens by one point when a specific and credible plan to address this burden is in place. Otherwise,the score worsens by two points relative to the initial score.Among the areas of analytic focus when assessing the pension and OPEB burden will be: • The required annual pension payment plus annual OPEB payment as a percentage of total governmental funds expenditures.A combined carrying charge of 10%or more will be considered elevated,however,we will consider whether we expect the elevated payments to result in lower future obligations. • The actuarial funded ratio(s) of the pension plan(s) a local government participates in or sponsors. If the ratio(s)are less than 80%,they will receive further review especially when the carrying charge is elevated.We also consider the magnitude of the unfunded obligation in tandem with the funded ratio(s)when assessing the potential for stress. • The contributions actually made to all pension plans a local government participates in or sponsors. The degree to which a local government contributes less than its full required contribution(s)could be an indication of either short-term cash flow issues or a willingness of management to defer difficult decisions. • The OPEB costs exceed 5%of total governmental funds expenditures and the local government has limited flexibility to change or amend these benefits. 83. Finally, another adjustment considers additional future contingent liabilities not yet requiring government support. While our debt burden calculation already considers other nondirect debt requiring government support and our liquidity score considers the near-term impact of any contingent liabilities,the adjustment to the debt score results WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 30 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions from a likelihood of ongoing payment obligations not yet occurring that represent more than 10%of total governmental funds revenues. Once the payment obligations become reality,they are included in the debt measure. Examples of contingent liabilities include potential legal judgments, currently self-supporting government enterprise debt that is likely to require support in the near future,guaranteed debt likely to need support in the near future,and additional costs resulting from pending changes in law. 84. As discussed in paragraph 50,a very high debt,pension, and OPEB burden can lead to a management score of'4', which caps the final rating at the lower of'A'and one notch lower than that suggested by table 1. In cases where these liabilities are not determined to be excessive,the one-notch flexibility described in paragraph 24 may be used to account for the impact that elevated levels of these liabilities can have on credit quality. VII. APPENDIX I: Selected Historical Statistics 85. Selected historical statistics on local government defaults taken or derived from George Hempel's"The Postwar Quality of State and Local Debt" are shown in tables 15 and 16. Table 15 Number Of Recorded Defaults From 1839-1965 By Type Of Governmental Unit Counties and Incorporated Unincorporated School Other Year States parishes municipals municipals districts districts 1839-1849 9 4 1850-1859 2 7 4 4 1860-1869 1 15 13 9 1870-1879 9 57 50 46 4 2 1880-1889 30 30 31 5 1 1890-1899 94 93 50 9 12 1900-1909 43 51 33 11 11 1910-1919 7 17 5 7 1920-1929 1 15 39 10 14 107 1930-1939 417 1,434 88 1,241 1,590 1940-1949 6 31 7 5 30 1950-1959 12 31 4 23 42 1960-1965 17 70 20 41 44 Total defaults 22 720 1,867 307 1,353 1,846 Total state and local 50 3,043 17,997 17,144 34,678 18,323 governmental units in 1963 Table 16 Government Of •tal Governmental Units By Type Of • Counties and Incorporated Unincorporated municipals School districts Other districts Year parishes(%) municipals(%) (%) (%) (%) 1839-1849 0 0 0 0 0 1850-1859 0.2 0 0 0 0 1860-1869 0.5 0.1 0.1 0 0 WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 31 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions Table 16 Government Of •tal Governmental Units By Type Of • • 1870-1879 1.9 0.3 0.3 0 0 1880-1889 1 0.2 0.2 0 0 1890-1899 3.1 0.5 0.3 0 0.1 1900-1909 1.4 0.3 0.2 0 0.1 1910-1919 0.2 0.1 0 0 0 1920-1929 0.5 0.2 0.1 0 0.6 1930-1939 13.7 8 0.5 3.6 8.7 1940-1949 0.2 0.2 0 0 0.2 1950-1959 0.4 0.2 0 0.1 0.2 1960-1965 0.6 0.4 0.1 0.1 0.2 To derive the percentages,the table uses the study's total number of governments in 1963 for the total number of governments in all periods because this statistic is not available for all periods and the number of governments did not vary dramatically over these periods.The percentages above will overestimate annual default rates in many cases due to the multiyear nature of the periods. VIII. APPENDIX II: Relationship To The State Rating 86. Local governments have a number of connections to their state governments. State governments may change the levels of funding provided to local governments. State legislatures may also change laws on local government funding, debt issuance, or even expenditure responsibilities. In smaller or more concentrated states,the nature of the economic bases may also be similar. 87. Given the historical record and ongoing localized nature of local government finance,the criteria measure the impact of additional stress by state governments through the standard scores.Were a state to alter local government funding statutes or mechanisms for its own fiscal purposes, such decisions could result in changes to the predictability,revenue and expenditure balance, and system support scores for all related local governments(see paragraphs 37-40).As the direct impact on a local government's fiscal balance becomes clear, changes to the budgetary flexibility and budgetary stress scores could occur. 88. Probably due to the historical trends of ongoing local control described in subsection A,there is limited data to show that state credit stress directly brings local government stress.Where correlation does exist,there is little evidence to suggest causation. Hempel notes that following the panic of 1837,nine states defaulted,namely Arkansas, Florida, Illinois, Indiana, Louisiana, Maryland, Michigan, Mississippi, and Pennsylvania. He cites only two municipal defaults following the panic, only one of which was in these states(Mobile,Ala. and Detroit, Mich.). The low level of municipal debt outstanding at the time,however, also likely limited defaults. 89. By the time of the depression of 1873 through 1879,local government debt had also significantly increased,in part because of prior restrictions on state debt issuance following the 1837 experience. Based on statements from Hempel and Scott, 12 states appear to have defaulted on or repudiated their debt during this period. Exact numbers of local government defaults by state during this period are elusive. Hillhouse's "Defaulted Municipal Bonds(1830-1930)" provides perhaps the best source. The author does not provide dates for the more-than 860 defaults cited,but instead provides citations for pieces that provide further information on these defaults. Using these citations as a proxy for the WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 32 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions period in which these defaults occurred allows for an analysis of whether credits presumably defaulting in this period were also in states that defaulted. Table 17 provides this detail. Table 17 Reported Local Government Defaults In Defaulting And Nondefaulting States Over Various Periods(see paragraphs 19-23) Local defaults 1837-1843 Local defaults 1873-1880 Local defaults 1936 In states that defaulted 0 56 290 In states that did not default 2 85 2,869 Source:"Defaulted Municipal Bonds and Municipal Bonds,A Century of Experience" 90. Finally, Hillhouse's primary work, "Municipal Bonds,A Century of Experience", also lists municipal defaults by state during the Great Depression. Of the 3,159 credits in default as of January 1936, 290 were in Arkansas,the one state experiencing payment difficulties. Of this total however, 279 were school districts or other special districts.With regard to cities with populations of 10,000 or more in default,Arkansas had one out of nine such cities in default. In comparison, Ohio had 24 of 61 such cities in default, Michigan had 21 of 41,and New Jersey had 18 of 54. 91. Of course many other municipal defaults occurred between the periods referenced in table 17,and others have followed since, despite the lack of periods generating additional state payment defaults. Common reasons for these defaults include periods of overleveraging followed by a decline in local revenues,real estate or other development speculation, and fraud or mismanagement. Sometimes these defaults occurred in a regional pattern,while other times they were idiosyncratic. 92. Although no additional state defaults have occurred recently, several were significantly tested during the last recession. Despite budget gaps too large for one-item solutions, state cutbacks have posed no serious credit threat to municipal governments. The reduction of aid in some states has resulted in the need for local government adjustment,but,in our view,the size of these cutbacks in no way threatened the outright solvency of municipalities or their ability to service debt. IX. APPENDIX III: Changes Since The Request For Comment 93. On March 6, 2012 Standard&Poor's published"Request For Comment: U.S. Local Governments: Methodology And Assumptions". Market participants who responded were generally positive about the increased transparency and clarity of the criteria. Some of them provided specific comments about certain metrics, data sources. and weighting of analytical factors(see"What's Happening With The Proposed U.S. Local Government Criteria?An Update On Feedback And Implementation",published Sept. 19, 2012). These comments and further analysis led to the following main changes between the criteria and the proposal presented in the RFC: • Several overriding factors have been added(see table 2).Among them are:Available Fund Balance of less than $500,000, a budgetary flexibility score of'5', and exhibiting characteristics of structural imbalance. • The positive qualitative adjustment for participation in a broad and diversified economy in the economic score has been modified to reflect a more-robust analysis of MSAs to help determine if the adjustment will be made. • To further augment the forward-looking nature of our analysis,positive and negative qualitative adjustments have WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 33 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions been added to the budgetary flexibility and liquidity scores to account for situations when projections suggest better or worse scores. These adjustments had previously existed only in the budgetary performance score in the RFC. • The liquidity score can be capped at'4' or'5'if certain levels of non-remote contingent liability risks exist to capture the significant stress these obligations can pose. • Chiefly due to the changes listed above,the ranges for the indicative rating outcomes in table 1 were changed slightly to keep consistent our view of credit quality for the sector. • Finally, additional characteristics were added to the description of the management score of'4'to capture situations where management is enduring or has recently endured conditions that pose credit stress. X. GLOSSARY 94. Available Fund Balance:the sum of the Available General Fund Balance + any other fund balances of the government legally available for operations. For entities that report on a cash basis,the criteria use cash balances instead of fund balances. 95. Available General Fund Balance: the portion of the general fund balance that is legally available for operations. Based on GASB 54 designations,this generally includes assigned and unassigned balances but may include committed if committed for emergencies or other uses intended to support operations if necessary. 96. Dependent Population: the total population of an area that is younger than 15 years plus the total population of an area older than 65. 97. Effective Buying Income(EBI): personal income(wages, salaries,interest, dividends,profits,rental income, and pension income)-federal, state, and local taxes and nontax payments(such as personal contributions for social security insurance). 98. General Fund Net Result(%) (total general fund revenues-total general fund expenditures + transfers in from other funds-transfers out to other funds)divided by general fund expenditures. 99. Metropolitan Statistical Area: geographic entities delineated by the federal government that contain a core urban area of 50,000 or more population. MSAs consist of one or more counties that include the core urban area as well as any adjacent counties that are highly integrated. 100. Total Government Available Cash:total cash(cash, and cash equivalents + investments(when grouped with cash in the audit))—proceeds of borrowings that are otherwise dedicated—other encumbered cash+ liquidation of certain highly liquid securities. 101. Total Governmental Funds Net Result(%): (total governmental revenues-total governmental expenditures)divided by total governmental fund expenditures. 102. Total Market Value:the estimated market value of all real and personal property within the jurisdiction,typically determined as part of a government or other independent appraisal to determine taxable or assessed value. WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 34 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions XI. RELATED CRITERIA AND RESEARCH Related Criteria Articles complementing the criteria • Appropriation-Backed Obligations,June 13, 2007 • Contingent Liquidity Risks In U.S. Public Finance Instruments: Methodology And Assumptions, March 5, 2012. • Debt Statement Analysis,Aug. 22, 2006 • Financial Management Assessment,June 27, 2006 • Methodology For Rating International Local And Regional Governments, Sept. 20, 2010 • The Time Dimension Of Standard&Poor's Credit Ratings,Sept. 22, 2010 • Criteria For Assigning'CCC+', 'CCC', 'CCC-',And'CC'Ratings, Oct. 1, 2012 Related Research • What's Happening With The Proposed U.S. Local Government Criteria?An Update On Feedback And Implementation, Sept. 19, 2012) • Municipal Bankruptcy: Standard&Poor's Approach And Viewpoint, Oct. 4, 2012 • Hempel, George Henry, "The Postwar Quality of Municipal Bonds",University of Michigan doctoral dissertation, 1964 • Hempel, George Henry, "The Postwar Quality of State and Local Debt", National Bureau of Economic Research, 1971 • Hillhouse,A.M., "Defaulted Municipal Bonds (1830-1930)", Municipal Finance Officer's Association of the United States and Canada, December 1935 • Hillhouse,A.M., Municipal Bonds, "A Century of Experience", Prentice-Hall, New York, 1936 • Hoene, Christopher W. and Pagano,Michael A., "City Fiscal Conditions in 2010", National League of Cities Research Brief on America's Cities, October 2010 • Lutz, Byron, Molloy, Raven, and Shan,Hui, "The Housing Crisis and State and Local Government Tax Revenue: Five Channels", Finance and Economics Discussion Series, Divisions of Research and Statistics and Monetary Affairs, Federal Reserve Board,Washington D.C.,August 2010 • Rodden,Jonathan, "The Dilemma of Fiscal Federalism: Grants and Fiscal Performance around the World",MIT Draft Working Paper, Sept. 28, 2001 • Standard&Poor's Refines Its Limited-Tax GO Debt Criteria,Jan. 10, 2002 • Understanding Standard&Poor's Rating Definitions,June 3, 2009 • Standard&Poor's U.S. Public Finance Local GO Criteria: How We Adjust Data For Analytic Consistency,Sept. 12, 2013 • Methodology And Assumptions: Request For Comment: Ratings Above The Sovereign—Corporate And Government Ratings,April 12, 2013 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer-or issue-specific attributes as well as Standard& Poor's Ratings Services'assessment of the credit and,if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions,issuer- or issue-specific factors, or new WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 35 1190266 1300881696 Criteria I Governments I U.S. Public Finance: U.S. Local Governments General Obligation Ratings:Methodology And Assumptions empirical evidence that would affect our credit judgment. Additional Contact: Steven J Murphy,New York(1)212-438-2066;steve.murphy @standardandpoors.com WWW.STANDARDANDPOORS.COM/RATINGSDIRECT SEPTEMBER 12,2013 36 1190266 1300881696 Copyright©2013 by Standard&Poor's Financial Services LLC.All rights reserved. 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Credit Rating Agencies Revise Criteria for Operational Finance Group General Obligation Bonds Ways to Get to Know the After months of review,Standard&Poor's(S&P)implemented their new criteria for Financial Health of Your general obligation(GO)debt last month. Moody's has released their proposed GO Communit PAG F criteria. Both agencies emphasize that the main reason for their new criteria is to y provide transparency regarding the factors,scoring and weighting used to determine the rating. However,the respective scoring systems are modified through this process Executive View and may result in rating changes when employed. Building and Giving Back S&P indicates that,based on preliminary research,they expect 60%of GO ratings to to Communities. . .. . . . . . . . . . stay the same;30%to be upgraded and 10%to be downgraded. S&P uses a scale of 1 to 5 to score seven categories,(shown below),and can further adjust each score by qualitative assessments. The new methodology focuses more acutely on operations, Mid-Atlantic and Organizational debt and liquidity for all governmental funds. Management/Human Resources Groups Weighting of S&P Credit Factors The Growing Need for Succession Planning. . .. . .. . .PAGE Institutional Framework Organizational Management/ Economy Human Resources Group Management Turning Uncertainty and Obstacles into Confidence Budget Performance and Opportunities . .. . . .. . . ..PAGE Budget Flexibility Springsted Investment Advisors Liquidity The Changing Role of the U.S.Federal Reserve. . .. .°r Debt/Pensions 0% 10% 20% 30% Public Education Group What are the key considerations? Strategies to Delight and Cash is king. Liquidity is measured against expenses for all governmental funds Exceed Expectations: 30-Day and also compared to total governmental debt service. In the past,unassigned Callback Strategy . . . .. . . .. . .PAGE 5 balance in the general fund was compared to general fund budgets. • Debt compared to total governmental revenues and also debt service compared to Housing&Economic total governmental expenditures is scored. Net debt below 3%of full market value Development Group /o and retirement of 65 of principal in less than 10 years improves the score. Managing Increased Economic The Institutional Framework and Management are S&P's two management assessments. In addition to financial practices,they now score predictability, Development Activity . . . .. . .PAGE 6 structural balance,transparency,accountability and system support for Management scores. • Budgetary Flexibility and By Terri Y.Heaton Performance measure fund balance across governmental funds and annual Senior Vice President performance of the general fund. and Client Representative-9 (Expenditures in special purpose theaton @springsted.com Article continues on Page 2 NOVEMBER 2013 Expertise. Insight. Accomplishment. Credit Rating Agencies Revise Criteria Continuedfrorn the cover funds and capital funds,including bond or grant proceeds that result in intentional deficit spending,should be noted in your credit reviews.) We've assisted multiple issuers with new issue ratings using the new methodology. As of this writing, all those issuers have had their ratings affirmed or upgraded. S&P offers a free U.S. Local Governments Credit Scenario Builder application for the Apple iPad. S&P maintains the results provided by the free app will be within one notch of their assessment. Moody's methodology is still"proposed"and will not be used until formally adopted. (NOTE: the deadline for Moody's Request for Comments("RFC")was November 4.) They predict a limited number of ratings will change using their new methodology.The scoring system is not as explicit as S&P's. Moody's categories and the weighting assigned are in the chart below: Weighting of Moody's Credit Factors 1 � Moody's expressed reason for reducing the economy/tax base weighting is their conclusion Economy/tax base that some communities are"unwilling or unable to convert... their local economies into revenues." The debt/pensions weighting Finances increases because"pension liabilities and debt each represent enforceable claims on the 1 -Current resources of local government." Management ■Proposed There are also key differences within the finances and debt/pensions categories: • Fund balances are measured as a percentage Debt/Pensions of revenues both currently and using a 5-year trend. 0% 10% 20% 30% 40% 50% • Cash balances are also measured as a%of revenues currently and using a 5-year trend. • A grid is used to compare revenue raising ability,expenditure reduction ability and predictability of each to arrive at an institutional framework score. • Shared pension"debt"scores a 3-year average of Moody's derived adjusted net pension liability divided by full value and by operating revenues. • Direct debt is also compared to full value and operating revenues. Fitch hasn't proposed new criteria and believes they have always been transparent in their reports and analysis. We will keep you informed should they join the trend. For more information regarding credit rating methodologies,go to www.springsted.com—there you will find links to S&P's new criteria and free credit scenario builder application,Moody's proposed new criteria and Fitch's credit rating methodologies. Need something more specific to your credit rating? Contact your Springsted representative. If you are new to Springsted,call 651-223-3000 and ask for credit rating assistance. OPERATIONAL FINANCE GROUP Ways to Get to Know the Financial Health of Your Community Whether you are new to your community • State Department of Management for evidence that diversification was or have been there for many years,it . U.S. Census Bureau pursued. Another indicator Springsted may be a good idea for you to scrutinize uses is expenditure growth trends over your organization's financial health U.S.Bureau of Labor Statistics time compared with revenues on a per This allows you to get a new perspective When we review clients'finances,we capita basis. Are the basic needs of a of your operations and balances in the use different resources to focus on key growing population being covered through way your citizens,financial markets and indicators of the community's financial an annually balanced budget,or does the potential developers see them. Here are health If the community does a CAFR, entity have years of deficits? The annual the first resources Springsted consults we are able to locate many of the indicators fund balance level and trend over time is when getting up to speed with a new through the statistical section. Without a key financial health indicator and most jurisdiction. a CAFR,however,we can still use the often measured as the fund balance as • Comprehensive Annual Report information provided in the financial a percent of annual expenditures and/or (CAFR)and City Budget section of their annual audit,along with revenues. In addition to the General Fund, • Electronic Municipal Market Access the U.S. Census Bureau,to locate the Article cowinues on Page 5 (EMMA)site established by the demographic characteristics needed. Municipal Securities Rulemaking Since the General Fund is the primary By Bryan R.Kidney Board(MSRB) means of providing basic governmental services, Springsted examines the diversity Vice President • Rating agency reports (or diversification)of the revenues. If the and Client Representative • State League reports entity is in a state that limits the ability to bkidney @springsted.com significantly diversify revenues,we look it PAGE 2 ® Springsted EXECUTIVE VIEW Building and Giving Back to Communities Springsted's Mission Statement officials find themselves in. Having The purposeful structure of the concludes with the words: "building met the challenges of the last few years, Symposium reflects the reality that to communities on a fiscally-sound and to what point should we now steer our build communities,the talents well-managed basis." Over the last communities in the years ahead? Most and expertise of all local government few years,most communities have doubt the next few years will return to resources must be brought together dealt with historic fiscal challenges the pre-Great Recession financial and and focused on solutions. We which have tested their management development times. What will be the are entering a new chapter in our and governance. Now,in many new equilibrium point? What decisions communities'lives. Bring your communities, signs are improving; should we be making now to effectively ideas and participate in this year's pressures are easing and local shape our communities? Symposium,Thursday,November officials are discussing their future The Symposium is unique in that 21st in Saint Paul,Minnesota. More position. it brings together a multitude of information is on the back page of On its 17th anniversary,the perspectives from across jurisdictional this newsletter. Springsted Symposium strives to lines. The agenda's scope draws give back to our client communities interest from elected officials, by providing practical and valuable managers,and finance and development By David N.MacGillivray information that is useful for both professionals. The officials come from the immediate and long terms. The all types of governments. The agenda theme for 2013 is `Rebalancing Local blends insights and perspectives from Chairman Governments.' This goes to the the far horizon to those immediately dmacgillivray @springsted.com core of the framework many local before us. MID-ATLANTIC AND ORGANIZATIONAL MANAGEMENT/HUMAN RESOURCES GROUPS 17 out of 18. 28 out of 43. Who's future. However,the problem still needs are in the organization, going to step up to fill Larry's position? exists and may be greater than providing the necessary time to What does all this mean? originally thought,as indicated in the adjust programs,create training 17 out of 18 represents the number numbers presented above from the two opportunities and to strategically of department heads eligible for communities noted. Complicating the recruit candidates in a planned immediate retirement in a Virginia city. situation is the recent change in belief fashion to meet these needs. Such 28 out of 43 represents the number of among many mid-level managers that an effort indicates the community management team members eligible a career in local government was a is serious about an efficient use of for retirement within three years in a lifetime of employment. While no resources in an era of slow growth prime Philadelphia suburb. And the definitive data supports this thought, in revenues and demonstrates to question,"Who's going to step up to anecdotal evidence indicates recent citizens the community is planning for fill Larry's position?"is one asked by reductions eats schn force, la reforms continuation of efficient and effective many localities when the community's and reduced benefits have created a City Manager(or substitute the title desire among some younger talent to Finally,research indicates for any department head position) seek employment e higher rates t communities with a dedicated announces retirement. At a growing a in the private sector,higher rates the succession planning program often rate,local government professionals pay p g experience increased employee are retiring and the search for new pool of potential candidates for upper morale,higher retention rates and talent often becomes a major challenge. level management positions. a work environment encouraging While the Great Recession has slowed The need to have an available pool innovation and organizational change. retirement rates in the public sector of new talent ready to step up to a Springsted's Management Services temporarily,the ultimate surprise for a manager role and the practical desire Division often serves as a resource in local governing body can be avoided. for succession planning,regardless this area. Please contact us to learn of the size of the organization are Recent studies indicate only 13 highly important to maintaining more about how your community can percent of today's local government community service levels for local initiate a program to meet your needs. managers are under 40,while nearly 1 percent were under 40 in the early government. Succession planning 7 71 per With the Recession (which took creates opportunities for the local By John A.Anzivino hold in 2007),many governments set government to proactively identify and Senior Vice President aside discussions and thoughts about plan for staffing and training needs. and Client Representative succession planning as they dealt with Doing so allows an organization declining revenues and an uncertain to predict where critical personnel janzivino @springsted.com Jk PAGE 3 ® Springsted ORGANIZATIONAL MANAGEMENT/HUMAN RESOURCES GROUP Turning Uncertainty and Obstacles into Confidence and Opportunities The role of elected officials and with an understanding that the talking about long-held beliefs administrators in the public sector change journey is neither a is now an essential priority and is evolving and changing, and the management fad nor a one-time prerequisite as opposed to an opportunity to be catalysts for project. option. organizational improvement is more Understanding traditional Over the past 12 months,public prominent than ever before. barriers(and there are many) officials have moved from a In my experience working with cities to organizational improvement recessionary mindset to one of and counties of all shapes and sizes,I are viewed as opportunities to opportunities and optimism. have witnessed firsthand a variety of overcome and not inhibitors of Leaders and their organizations principles and practices defining and action. are not the same as they were in shaping organizations today. Whether Recognition of a level of 2008;understanding this fact and the rationale for action is in response to capitalizing on the opportunities the impacts of the Great Recession or uncertainty following the change before you will define how successful simply to capitalize on opportunity-or process. Sometimes the answers you will be 5, 10 and even 15 years even citizen expectations -these five simply are not evident or obvious. from now. ideas have been noted in the work of Engaging staff early and often is public sector leaders: a means to minimize uncertainty and obtain essential buy-in and • Traditional roles and positional support for actions. responsibilities are less defined Realizing risk is high and there than ever before. Organizations are is no clear script to follow. seeking multi-talented employees Organizational improvement By David J.Unmacht who bring flexibility and adaptability may take many forms,including Senior Vice President to the workplace. updating structures, systems, and Consultant • Importance of leading organizations business processes and historical through a continuous change process practices. Openly discussing and dunmacht @springsted.com SPRINGSTED INVESTMENT ADVISORS The Changing Role UN Lilt U.S. FtUUlcil irwbdfve History rose to more than $3.5 trillion in Unfortunately,a psychology has The U.S.Federal Reserve("the Fed") August 2013 from $869 billion in developed in the markets of the Fed was created to ensure our monetary August 2007. Conventional tools as all-powerful and capable of single- and financial systems were safe, used to stimulate the economy, such handedly saving the economy. The as controlling interest rates and actual power of the Fed is surpassed flexible and stable. It was to act as changing the discount rate and reserve by the market's belief in its power and, lender of last resort to banks during requirements,were not working. The thus,its capability to move markets. times of financial crisis until prices/ market was looking to the Fed to This was vividly demonstrated when markets could be stabilized. The implement QE to pump money into the Fed announced it would begin Fed operates independently from the financial system and for banks, tapering its bond buying as soon as the U. S.Treasury and is responsible in turn,to lend money to the public. September 2013. The markets reacted for Monetary Policy(controlling the The Fed had hoped that QE2 and vehemently,driving the benchmark supply of money)while Congress QE3 would lower long-term interest 10-year U.S.Treasury yield up and controls Fiscal Policy (i.e. government rates,increase investment and boost the stock market down, as they tried to the past,it was seen as a low profile spending/revenue collection). I job growth. Although it kept long- figure out what the Fed was thinking. it has been only institution charged with keeping its term rates down, r inall successful with the two The Fed's strategy seems to be ma policy in support of the Government's. matte objectives. keeping us afloat so far. Only time will tell whether they were successful What happened? Score card for the Fed? or whether their actions will create The Fed's role expanded following the The Fed has been both praised and inflation in the future. global financial crisis. In recent years, it has used extraordinary measures criticized for its role in carrying out monetary policy in this fragile °y "'c'c'a "`a'er to maintain the economy,the most economy. Many economists believe visible being its intervention in the t Vice President our nation would have entered into bond markets with large scale asset and Consultant purchases(referred to as"quantitative a depression had it not taken an tkraser @springsted.com easing"or"QE"). The Fed's assets aggressive approach. di PAGE 4 ® springsted PUBLIC EDUCATION GROUP Strategies to Delight and Exceed Expectations: 30-Day Callback Strategy Whether you are a superintendent, Day Callback." This practice is spoke about a month ago about... At city administrator or county executive, consistent with a well-known Nelson that time you told me that... I wanted fielding concerns and complaints Boswell quote,"Always give people to get back to you to make sure from residents is an important part more than what they expect to that..." Of your job. Sometimes you are the get." So how can Boswell's charge Based on my personal experience problem-solver in terms of listening, translate into a working strategy for using the 30-Day Callback approach, investigating,and resolving the issue. busy executives? I can assure you the vast majority of At other times,the case is delegated to When a complaint or concern hits constituents will be delighted and a subordinate. When complaints and your desk-whether in the form of a surprised you cared enough about requests are handled well,problems call,letter or email-the protocol is them and their concerns to check are solved,misunderstandings are straightforward and well understood: back, see if the problem was resolved, resolved and constituents are usually listen; ask clarifying questions; and confirm things had been handled satisfied with how they were treated- collect details; seek additional data; appropriately. all of which builds good will in your collect contact information; and community. When things are not give the individual an estimate on A secondary benefit of this approach processed quickly and effectively,the when you or someone else will get is equally powerful,which can be head administrator is often saddled with back to them. Step two is also more framed as second chances. If an individual or group who are more than likely consistent with your the problem was not solved,or a frustrated and angry now than when the current modus operandi: decide subordinate had not handled the issue original problem evolved. whether you are going to own on a timely and quality basis,the callback provides another chance to Business journals are replete with and process the problem or if the get it right(and another chance to hold articles extolling best practices to issue is going to be delegated to a accountable if they had achieve high levels of quality, service subordinate. It is at this point the subordinates acnot performed tc your expectations and customer loyalty. Consultants are 30-Day Callback strategy builds on also busy training management staff to and enhances what you have done Consider adding the 30-Day Callback implement the latest model to "surprise in the past. Simply click on your methodology to your administrative and delight"your constituents. While `Tasks' function in Outlook,record toolkit—a no cost,minimal time building and maintaining systems some brief notes about the issue commitment, and high impact strategy to achieve high levels of quality and at hand and set a reminder for one to improve quality control and surprise customer service are challenging, month later. and delight your community. some strategies can be employed by When the reminder flag pops up management staff that are both simple in 30 days,it's time to delight and By Don E. Lifto,Ph.D. and highly effective. Early in my career exceed expectations. as a public school superintendent,one p Senior Vice President of my mentors taught me a simple "Hi,this is Superintendent(City/ and Client Representative but powerful strategy: the"30- County Administrator)Joe Doe. We I dlifto @springsted.com p Tod Rgzl@)d OfltrodRJ D��-alzoo - • • ._ - . 1 Financial Health of Your Community Continredfrom Page 2 enterprise funds are reviewed to ensure with the historic trends. Any debt rated A community's financial health is they generate revenues from fees charged to by one of the major rating agencies is vitally linked with its demographic and those receiving services. important for you to review from the economic condition. The income,age, If there is outstanding debt,a good resource latest report. You should also contact employment and other factors all influence to turn to is the entity's presence on the your auditor and ask for a list of the the environment within which services EMMA site established by the MSRB. An recommended journal entries they are demanded,infrastructure is constructed Official Statement issued publicly for a have proposed. Be sure to ask for and ability to pay is determined. A good recent debt issue provides the latest snapshot clarification of the journal entry and understanding of these indicators will assist of all of your major financial indices along why they were or were not made in your in gauging your financial capacities. financial system. PAGE 5 ® springsted ® Springsted Springsted Incorporated Springsted's mission is to provide high quality, 380 Jackson Street,Suite 300 independent financial and management advisory Saint Paul,MN 55101-2887 services to public and non-profit organizations, and work with them in the long-term process of building their communities on a fiscally sound Address Service Requested and well-managed basis. Springsted Incorporated-Corporate Headquarters 380 Jackson Street,Suite 300 Saint Paul,Minnesota 55101-2887 651-223-3000 Or call an office nearest you: California 818-456-4861 Colorado. 303-893-5800 Iowa. 515-244-1358 Kansas/Missouri. 816-333-7200 Virginia. 804-726-9748 Wisconsin. 414-220-4250 For more information about articles,to request additional copies or to view previous issues,please visit our website at www.springsted.com The Springsted Letter is edited by: Rick E.Yount,Director of Communications David W.Webber,Executive Assistant ' � � • " � � � . • • C_ o E � MA o O9E O@YWOUMWE eaturing ex erts from the fields of public�finance,+ e�onomi o erational ►nance, organ►iational man y1ment/huma esou e HOUSING & ECONOMIC DEVELOPMENT GROUP The economy has been growing and quite the `refresh button'with policy-making Cities are in a stronger position when a bit of permit activity has been building boards and be sure sufficient time and they define the parameters they wish to up over the past few years. As part of resources are budgeted to satisfy the evaluate,and then require the applicant to that overall real estate activity,cities are required project due diligence. follow their procedures. experiencing an increase in requests for It is helpful when the developer applicant The sooner cities are able to revisit those economic development assistance. seeking financial assistance provides application procedures and enforce them, These requests are demanding staff time and at least some details in a preliminary the more efficient the use of staff time attention. They also require policy-making financing plan so valuable time is spent will be. boards to revisit some of their economic only on projects that are real and meet the development policies and procedures. With city's policy objectives. Arriving at the By Anthony L.Schertler staff layoffs occurring during the Recession, appropriate level of financial assistance for many cities need to tighten the process by economic development projects involves Senior Vice President which they evaluate economic development understanding and challenging various and Consultant proposals. Now may be a good time to hit development financing assumptions. tchertler@springsted.com PAGE 6 ® Springsted Public Sector Advisors T, v pp II it : Springsted � STANDARD 8 PaOR'S Elks � � RATINGS SERVICES River McGHAW HILLFIMANCIAI � City of Elk River, MN Credit Rating Considerations Standard & Poop 's New Methodology January 21 , 2014 Public Sector Advisors Spring5t @d Factors Affecting Credit • Economy • Management • Budget Performance • Budget Flexibility • Liquidity • Debt/Pensions • Institutional Framework Public Sector Advisors Springsted Ratin g Scale Moody's S & p Fitch Highest Aaa AAA AAA Aa 1 AA+ AA+ Aa2 AA AA Aa 3 AA- AA- A1 A+ A+ A2 A A A3 A- A- Baa1 BBB+ BBB+ Baa2 BBB BBB Lowest (Investment Grade) Baa3 BBB- BBB- Public Sector Advisors s Springsted Standard & Poor' s New Methodology • October 2013 Implementation • Transparency • Weighting of Factors • Blending of current financial and economic position with management factors • Scale of 1 to 5 to score categories — 1 is the highest; 5 is the lowest Public Sector Advisors Springsted Expected Results • 60% no change • 30% upgrade • 10% downgrade Public Sector Advisors s Springsted Weighting of S&P Credit Factors Institutional Framework Economy Management Budget Performance Budget Flexibility Liquidity Debt/Pensions 0% 10% 20% 30% 40% Public Sector Advisors Springsted Economy • Total Market Value Per Capita — Score of 1 for EIVIV in excess of $195,000; 5 for less than $55,000 • Projected Per Capita Effective Buying Income as a % of US Projected EBI — Score of 1 for 150 ( 150% of US Buying Income); Score of 5 for less than 70%. — From Claritas, Inc. Public Sector Advisors Springsted Economy- Ells River \ STANDARD&POOR"S Not Topics Credit Tools Infographics Understanding Ratings 0 to RATINGS SERVICES S&P's U.S.Local Governments Ratings Criteria/ US LOCAL GOVERNMENTS Create Scenario Scenario Comparison ' Elk River Overrides e Indicative Rating' ••• •••••-•1 Illustrative Issuer Credit Rating Range" Adjust the Score:Economy ♦ positive Impact O Negative Impact V Total Market Value Per Capita + Participation in a larger broad and diversified economy. Projected Per•Capita $100 000 to $80,000 to $55,000 to Infcome asaY1nof >$195,000 5$55,000 U.S.Projected[?BI $195,000 $100,000 $80,000 No r` Yea > 150 1 I i,�j 2_J Q,�j 3 + A stabilizing institutional influence with a —J J longstanding role as a major employer such as 110 to 150 and st education,health care,military,or large 1.5 Z 2.5 3 3.5 and stable corporate presence. 85 to 110 2 2,5 4 No Yes 70 to 85 2.5 g � 3.5 i 4 J-4.5� —�� Negative budget impact from a demographic 70 3 3.5 4 4.5 5 profile Population decrease and/or high share of Dependent Populati on(>55%)have a material SCORE AFTER ADJUSTMENT 'These are not Standard&Poor's Ratings Services credit ratings.Read our full disclaimer Public Sector Advisors 8 Springsted Management • "Strong" rating from last credit report • Management Policies are strong, well embedded, and likely sustainable • Highlights — Monthly reports to Council — Ability to amend the budget — Long-term financial and capital plans — Debt management policies — Reserves policy at 40-45% maintained Public Sector Advisors 9 Springsted Management- Ells River 7 STANDAR08ROOR'S Hot Topics Credit Tools Infographics Understanding Ratings to RATINGS SERVICES Sll U.S.Local Governments Ratings criteria 1 US LOCAL GOVERNMENTS Scenario Comparison My Scenarios Elk River Overrides 'Indicative Rating' . .: •••---••••-•••---••••, Q Illustrative Issuer r t� Credit Rating Range` Adjust the Score:Management + Positivelmpact a — Negativehnpact a Assessing The Management Score + Consistent ability to maintain balanced operations. Score Characteristics FMA score of"Strong"and none of the factors in scores W or'S'are present. NO j j Yes r FMA score of"Good"and none of the factors in scores'V or'S'are present. + Government service levels are limited. STRONG No Yes FMA score of"Standard"and none of the factors In scores'4°or'S'are present. 3 ADEQUATE FMA score of"Vulnerable"or any of the following Is present:there is a financial Frequent dersta management turnover inhibiting a 4 WEAK reporting restatement that has a material negative impact;any of the conditions in current understanding of the government's or score's'existed within the past three years;the structural imbalance override I financial position and its ability tt a adjust,th J political gridlock or instability that bangs the same results. 5 VERY Regardless of the FMA score,any of the following Is present:A management team WEAK that lacks relevant skills resulting in a weak capacity for planning,monitoring,and r ,^ management;an auditor has delivered a going concern opinion;the government is ` No Yes SCORE AFTER ADJUSTMENT "These are not Standard&Poor's Ratings Services credit ratings.Read car full disclaimer Public Sector Advisors 10 Springsted Budgetary Flexibility • Available Fund Balance as a % of Expenditures* — 1 if greater than 15% — 5 if 1 % or less *higher % required for MN cities due to semi-annual collections of tax revenues Public Sector Advisors Springsted Budgetary Flexibility STANDARD&POOR'S Hot Topics Credit Tools Infagraphics Understanding Ratings RATINGS SERVICES I S&P's U.S.Local Governments Ratings Criteria► US LOCAL GOVERNMENTS Create Scenario Scenario Comparison Elk River Overrides Indicative Baling' , . .....................ti Illustrative Issuer • - Credit Rating Range' Request an S&P Rating Adjust the Score:Budgetary Flexibility + Positive Impact O Negative Impact l?/ Available Fund Balance As A%Of Expenditures + If projections for the current year and the following year suggest a better initial score the score improves by one point. i >15 8to15 4to8 1 to4 51 .. No Yea Secure + Ability to avoid financial imbalances with demonstrated capacity and willingness to cut operational spending Iby more than 2°/a}, resulting from a flexible cost structure,flexible legislation,and/or widespread political support. No * Yes SCORE AFTER ADJUSTMENT 'These are not Standard&Poor's Ratings Services credit ratings.Read our full id sclairner Public Sector Advisors 12 Springsted Budgetary Performance • Total Government Funds Net Result (%) — Revenues over expenditures and other sources and uses as a percentage of expenditures — -1 % or greater = 1 — -15% or less = 5 • General Fund Net Result (%) — 5% or more = 1 — -1 % or less = 3 (lowest) Public Sector Advisors Springsted Budgetary Performance - Elk River q STANDARDBPOOR'S Hot Topics Credit Tools Infographics Understanding Ratings RATINGS SERVICES S&P's U.S.Local Governments Ratings Criteria► US LOCAL GOVERNMENTS Create Scenario Elk River Overrides Indicative Rating' •••••••••.••••••••••••. Illustrative Issuer Credit Rating Range' Request an S&P Rating Adjust the Score:Budgetary Performance + Positive Impact ?) — Negative Impact Total Governmental Funds Net Result(%) Expected structural improvement:If projections for the current year and following year suggested a better initial score,the score would improve by General fund net �-1 -1 to-5 -5 to-10 -10 to-15 5-15 one point.The score would improve by two result I%) points only if required adjustments to revenues or expenditures to produce the result were 3 I g I Q I already approved. No Yes(1 pt) Yes(2 pts) -1 to 5 1 Expected structural deterioration:If projections for the current year and following year suggested a worse initial score,the score would worsen by one or two points.To worsen by two points, expected performance must fall to the commensurate level within the current year. SCORE AFTER ADJUSTMENT These are not Standard&Poor's Ratings Services credit ratings.Read our full diwlairne Public Sector Advisors 14 Springsted Liquidity • Total Government Available Cash as a % of Total Governmental Funds Debt Service — 120% or more = 1 — 40% or less = 5 • Total Government Available Cash as a % of Governmental Funds Expenditures — 15% or more = 1 — -1 % or less = 5 Public Sector Advisors Springsted Liquidity- Ells River S&P's U.S.Local Governments Ratings Criteria/ US LOCAL GOVERNMENTS Create Scenario Scenario Comparison My Scenarios Elk River Overrides Indicati . . .ve Rating' .................••ti Illustrative Issuer Credit Rating Range' Request an S&P Rating Adjust the Score:Liquidity + Positive Impact ? Negative Impact Total Government Available Cash As%Of + If projections for the current year(and the following year)suggest a better initial score,the Total Govemment score improves by one point. Available Cash As n tal >120 100 to 120 80 to 100 40 to 80 540 of Total Govemme Funds Expenditures No Yes >15 . �� � If access to external liquidity i 2 s'exceptional' $to 15 2 � 4 sJ defined in the criteria,the score improves by two points;if'strong',the score improves by one 4to$ 3 point. lto4 4 No Strong Exceptional I d 4 I� 51 r� I r� I + Very robust and stable internal cash flow generation capacity compared with peers in this SCORE AFTER ADJUSTMENT Public Sector Advisors 16 Springsted Debt and Contingent Liability • Net Direct Debt as a % of Governmental Funds Revenue — 30% or less = 1 — 180% or more = 5 • Total Governmental Funds Debt Service as a % of Total Governmental Funds Expenditures — 8% or less = 1 — 35% or more = 5 Public Sector Advisors Springsted Debt and Contingent Liability- Elk River A STANDARD&POOR'S Hot Topics Credit Tools Infographics f Understanding Ratings RATINGS SERVICES S&P's U.S.Local Governments Ratings Criteria/ US LOCAL GOVERNMENTS Create Scenario Scenario Comparison Elk River Overrides Indicative Rating* •••-••-••-•••-••-•1 Illustrative Issuer 8 O Credit Rating Range' Request an S&P Rating Adjust the Score:(Debt&Contingent Liability + positive Impact — Negative Impact 0 Net Direct r + Overall net debt as a percentage of market value below 3%. Total Gov.Funds Debt Service of Total Gov.As Fu c8 <30 30 to 60 60 to 120 120 to 180 ?180 No 'j' Yes Expenditures <$ 1 �,��� + Overall rapid annual debt amortization,with more than 65%coming due in10 years. 8to15 _ i No Yes 15 to 25 3 25 to 35 4 4 1 g I�J J Overall net debt as a percentage of market value y exceeding 10%. X35 4 5 J No " Yes SCORE AFTER ADJUSTMENT 'These are not Standard&Poor's Ratings Services credit ratings.Read our full di5claimcr Public Sector Advisors 18 Springsted Institutional Framework • Assesses the legal and practical environment in which the local government operates • All entities in MN are scored the same • Mn cities with populations over 2500 are considered "Strong" Public Sector Advisors Springsted Institutional Framework- Ells River STANDARD&POOR'S Mot Topics Credit Tools Infographics Understanding Ratings RATINGS SERVICES S&P's U.S.Local Governments Ratings Criteria US LOCAL GOVERNMENTS Create Scenario Scenario Comparison Elk River Overrides Indicative Rating' . . . Illustrative Issuer Credit Rating Range' Request an S&P Rating Adjust the Score:Institutional Framework (2)Predictability A Revenue and Transparency and A System Support Expenditure Balance Accountability 1 VERY STRONG 2 STRONG 41 • 3 ADEQUATE 4 WEAK 5 VERY ^ ^ WEAK III Q SCORE These are not Standard&Poor's Ratings Services credit ratings.Read our full disclaimer Public Sector Advisors 20 Springsted Interest Rates BB! 25-bond (Revenue) and 20-bond (G.O.) Rates for 5 Years Ending 11912014 6.5% ----BBI 25 Bond BBI 20 Bond 1/912014 6.0% 25 bond: 5.34% .,� 20 bond: 4.68% G ■, y 1 ■~, J■% I 5.5% - , � 1 1 J r .. �.� r +�+ 1` ^��■� J J ■% N ■ j 41.1 ,�■ J ■■�� Jly�,I to 4.0% to 3.5/0 y V V VVAVI WTV 3.0% Cb �1,P � ,yti �y41 4 41 \)rl y41 4 gy`b y�y'1. �y�,r,) 4&C, P KV �y�y`L ",l y- 4\rp 4P 4 CP Dates Prepared by Springsted Incorporated Public Sector Advisors 21 Springsted Next Steps • Review of Policies and Procedures • Review Financial Position-Statements • Prepare for Credit Rating Call —first time with new methodology-28 questions • Update on Pavement Management Program • Tour of City in May in conjunction with call • Bond Sale in May/June • Rating estimated between AA+ and AAA Public Sector Advisors Springsted