April 2, 2010 - Two of the three major credit rating agencies—Moody’s Investors Service and Fitch Ratings—recently announced plans to “recalibrate” their ratings on obligations issued by states and local governments. These recalibrations generally should result in an upward shift of ratings for those issuers who have outstanding obligations rated by either (or both) of the rating agencies. For those issuers with continuing disclosure undertakings made pursuant to the Securities and Exchange Commission’s Rule 15c2-12, this upward shift in ratings is likely to be a material “rating change” requiring the filing of a material event notice with the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access system (“EMMA”) at www.emma.msrb.org.
The recalibration process undertaken by each rating agency is described in their ratings reports, “Recalibration of Moody’s U.S. Municipal Ratings to its Global Rating Scale” released by Moody’s on March 16, 2010 (the “Moody’s Report”), and “Recalibration of U.S. Public Finance Ratings” released by Fitch on March 25, 2010 (the “Fitch Report”), each of which can be found on the respective rating agency’s website (www.moodys.com for Moody’s and www.fitchratings.com for Fitch).
Obligations for which a Moody’s or Fitch rating is based solely on bond insurance or another form of credit support will not be affected by the recalibrations. In other words, if an issuer does not have an underlying rating on an insured obligation, its current rating will not be recalibrated.
If an issuer has a underlying credit rating published by Moody’s, Moody’s notes that global scale ratings on insured bonds that have been recalibrated will generally be based on the highest of the financial guarantor’s insurance financial strength rating, the published underlying rating, and the enhanced rating (such as those obtained under the Oregon and Washington school bond guarantee programs), if any. We assume Fitch will use a similar protocol.
Moody’s recalibrations. According to Moody’s Report, Moody’s is recalibrating its long-term U.S. municipal ratings to a global rating scale that Moody’s uses to rate sovereign, sub-sovereign, financial institution, project finance, structured finance and corporate obligations. Moody’s cautions that market participants should view its recalibration of municipal ratings not as “upgrades,” but rather as a recalibration of the ratings to a different rating scale. “This recalibration does not reflect an improvement in credit quality or a change in our credit opinion for rated municipal debt issuers. Instead, the recalibration will align municipal ratings with their global scale equivalent.”
Moody’s indicates that, as a general matter, its ratings on general obligation debt, sales tax obligations and special tax obligations will shift upward, but that most ratings on housing, healthcare and other enterprise bonds will not change.
Moody’s has posted a tentative rating recalibration schedule on its website (www.moodys.com/gsr). According to the tentative schedule, ratings for state governments and other “select governmental ratings” will be recalibrated on April 19; ratings for local governments in Washington will be recalibrated on April 26; ratings for local governments in Alaska, Idaho, Oregon and Montana will be recalibrated on May 3; and ratings for health care, higher education, housing, state revolving funds, pooled financings and public infrastructure (e.g. airports, toll roads, and public power) will be recalibrated on May 10. Moody’s notes that some ratings may be recalibrated earlier or later than shown on the schedule as related ratings are recalibrated.
Fitch recalibrations. The Fitch Report contains similar caveats as the Moody’s Report. It explains that the intent of Fitch’s recalibration is to ensure a greater degree of comparability across Fitch’s global portfolio of credit ratings. Fitch states that: “The recalibration of certain public finance ratings should not be interpreted as an improvement in the credit quality of those securities. Rather, they are adjustments to denote a comparable level of credit risk as ratings in other sectors.”
Fitch’s recalibration will affect ratings in the state and local government tax-supported, water/sewer, public power distribution-only, and public higher education sectors. Fitch states that it will not recalibrate ratings for public power generating systems, nonprofit healthcare, private higher education, tax-exempt housing, airports, ports, toll roads, grant anticipation revenue vehicles (GARVEEs), state revolving funds (SRFs), bond banks, economic development bond funds, and other municipal enterprises.
According to the Fitch Report, all of Fitch’s state ratings will be recalibrated on April 5, and the remaining tax-supported ratings and the water/sewer, public power distribution-only, and public higher education ratings will be recalibrated on April 30.
How will issuers know their ratings have changed? Moody’s and Fitch are not likely to notify individual issuers regarding whether their ratings have been shifted upward as a result of the recalibration process. This has been our experience over the past few years with the spate of ratings downgrades triggered by the deteriorating credit quality of municipal bond insurers. Therefore, someone from each issuer with obligations rated by Moody’s or Fitch should periodically check the rating agencies’ websites around the dates indicated above to determine whether the issuer’s obligations are affected by the recalibration process.
Will a “material event” filing be necessary? For issuers that have continuing disclosure undertakings with respect to obligations that have been recalibrated, any upward shift in ratings will be a “rating change” within the meaning of Rule 15c2-12. Continuing disclosure undertakings made pursuant to that rule generally require notices to be filed regarding rating changes, if “material.” Issuers will be required to evaluate whether a change to their rating is a material change. Your bond counsel should be able to assist you in making this evaluation. If a ratings change is determined to be material, then a notice of that change should promptly be filed with EMMA. Information about filing notices with EMMA can be accessed on the EMMA website (www.emma.msrb.org) under the heading “Document Submission.”
We observe that the SEC proposed amendments to Rule 15c2-12 in July 2009 which, if promulgated in their proposed form, would require issuers to file notice with EMMA not more than 10 business days after a “rating change,” regardless of whether that change was material. Any such amendment to the rule likely would not affect continuing disclosure undertakings entered into before the amendment takes effect. However, the fact that the SEC has proposed to remove “materiality” as a condition to filing notices of rating changes suggests the SEC views all rating changes as being worthy of a continuing disclosure notice.
Please contact Jeff Nave (509.777.1601 or navej@foster.com) or any of the other lawyers in Foster Pepper’s Public Finance practice group if you have any questions about municipal bond ratings or continuing disclosure obligations.