Municipal Bond Ratings Research Articles

Do Credit Rating Agencies Influence Elections?

Abstract We show that credit rating agencies can influence political elections. We find that incumbent political parties experience an increase in their vote shares following municipal bond upgrades. The evidence is consistent with rating agencies affecting elections indirectly by expanding local governments’ debt capacity and directly through an impact on voters’ perceptions of the quality of incumbent politicians. To identify these effects, we examine election outcomes within neighboring counties by exploiting exogenous variation in municipal bond ratings due to Moody’s recalibration of its scale in 2010.

Signaling climate resilience to municipal bond markets: does membership in adaptation-focused voluntary clubs affect bond rating?

This paper examines whether US cities’ membership in voluntary climate clubs improves the municipal bond ratings issued by S&P, Moody’s, and Fitch. We suggest that only clubs focused on climate adaptation could help cities signal their resilience to climate risks and their ability to service their municipal bonds. Yet, club membership is only a signal of intent. By itself, it does not offer concrete evidence that cities have adopted adaptation policies or enhanced their resilience to climate risks. We examine three climate clubs: ICLEI, whose membership obligations cover climate and other environmental issues; C40, whose scope covers both climate mitigation and adaptation; and 100 Resilient Cities (100RC), which focuses on adaptation only. Employing a two-way fixed effects model for a panel of 80 US cities from 1995 to 2018, we find that 100RC membership leads to a small improvement in bond ratings. This has important policy implications: Assurances about implementing adaptation policy, as opposed to evidence about how adaptation reduces climate risks, could have spillover effects on municipal finance. In such cases, climate adaptation could have tangible implications for city-level finances.

The interest cost of split-rated municipal bonds before and after Moody's recalibration in 2010

PurposeIn April and May of 2010 Moody's recalibrated its municipal bond ratings to a global scale, the system they use for other asset classes and the same scale used by Standard and Poor's (S&P). The authors investigate the impact of Moody's recalibration on true interest cost (TIC) of competitively-sold, uninsured, new bond issues with split bond ratings, by looking at a sample of bond issues before recalibration (1997–2010) and after recalibration (2010–2017).Design/methodology/approachTwo different hypotheses are tested for each period to estimate whether TIC remains the same when the S&P rating is higher (H1) than Moody's rating or lower (H2) compared to bond issues for which the S&P and Moody's rating are the same. Further, two additional hypotheses are tested. H3 tests whether the impact of having a higher rating from S&P is the same as having a lower rating from S&P. H4 tests whether the impact of having a split rating is the same in the pre- and post-recalibration period.FindingsTests suggest that before recalibration a higher S&P rating leads to significantly lower interest costs, but a lower S&P rating does not lead to significantly higher costs. After recalibration, a higher S&P rating leads to significantly lower interest costs; however, a lower S&P rating leads to significantly higher interest costs for the bonds in the sample. The findings also suggest that the rating systems of Moody's and S&P became more similar to each other after recalibration and that the impact on interest cost of a higher S&P rating is reduced after the recalibration.Originality/valueIt appears that a given Moody's rating (which used higher credit standards in the period before recalibration) was more influential than the S&P rating prior to recalibration because investors “ignored” a lower S&P rating during this period. After recalibration, the lower S&P rating was no longer ignored by investors. Therefore, Moody's recalibration seems to have had the intended effect of moving the credit standards of the two rating agencies more into parity. This provides value to investors since they may now assume, unlike the situation in the pre-recalibration period, that similar ratings from the two companies provide similar information about the probability of default and loss that would occur following a default. From the standpoint of regulators, the municipal credit information is easier to understand and is more transparent for investors.

Inscriptions of resilience: Bond ratings and the government of climate risk in Greater Miami, Florida

In recent years, credit rating agencies have begun to incorporate a municipality's resilience and vulnerability to climate change into their US municipal bond rating methods. Drawing on the case of Greater Miami resilience planning and Science and Technology Studies-inspired work on inscriptive devices, I investigate how this incorporation practically happens, and how it shapes the ways that Greater Miami governments attempt to govern climate risk through resilience investments. What “counts” as resilience there, I suggest, is increasingly an effect of the observational practices of rating agencies. However, the still-emergent status of resilience as an object of knowledge among rating agencies and Greater Miami governments means that resilience retains a degree of plasticity, allowing government officials and residents alike to mobilize the term for different purposes and toward different ends. In tracing the emergent relations between rating agency practice on climate risk and local government resilience investments, the paper makes two contributions to scholarship in economic and urban geography. First, it illuminates the ways that extra-local practices of expert valuation shape the local construction of environmental fixes. Second, it offers insights into how one of the key actors of the 2007–2008 financial crisis is beginning to lay the epistemic groundwork for future economic crises and inequalities in and between cities, this time as they relate to climate change impacts and a city's supposed resilience and vulnerability to them.

Forms of government and municipal financial performance

IMPACT This paper finds that the political influence of a local mayor on the appointment of the chief administrative officer (CAO) has a negative influence on the financial outcomes of local governments, as evidenced by lower municipal bond ratings. This finding suggests that excessive political authority delegated to mayors may restrict managers from using long-term and apolitical financial strategies. The authors urge local governments to have a mechanism that insulates their CAOs from political pressures to increase government efficiency and decrease the risk of corruption.

The effects of high-quality financial reporting on municipal bond ratings: evidence from US local governments

ABSTRACT While credit rating agencies mention that a government factor is one criterion for assessing municipal bond ratings, current studies on credit ratings offer relatively little evidence as to how the government factor affects municipal bond ratings, compared to socioeconomic and financial factors. By utilising the award of the Certificate of Achievement for Excellence in Financial Reporting Programme of the Government Finance Officers Association as an indicator for high-quality financial reporting, we find that the quality of financial reporting is one important factor that determines municipal bond ratings. We also demonstrate that the repeated actions of providing high-quality financial reporting are valuable for municipalities by enhancing market credibility and thus improving ratings. The positive impact of high-quality financial reporting is greater for municipalities which have just begun to give a signal of providing transparent financial information to the market than municipalities which have already built market credibility for a long time.

Can Credit Rating Agencies Affect Election Outcomes?

We show that credit rating agencies can have a significant effect on election outcomes. Specifically, we find that incumbent politicians in upgraded municipalities experience an increase in their vote shares and likelihood of winning. This incumbent effect is due to an expansion of local governments’ debt capacity that allows them to increase spending. The effects are stronger among Democratic incumbents. We identify these effects by exploiting the exogenous variation in municipal bond ratings due to Moody’s recalibration of its scale in 2010. The effects are consistent with good economic conditions and increases in wealth making voters more lenient toward the incumbent due to attribution errors and reduction in information asymmetry.

Unexpected Bond Ratings and the Cost of Municipal Debt

We investigate whether credit rating agencies (CRAs) and investors price the extent to which municipal bond ratings are explainable using public information. We use an ordinal logistic regression to estimate the expected and unexpected portions of bond ratings, and find that both CRA fees and yield premiums are higher for negative unexplained (i.e., pessimistic) ratings. CRA fees are not generally associated with positive unexplained (i.e., optimistic) ratings, although we document a positive association when financial reporting quality or investor sophistication is low. While creditors price both pessimistic and optimistic unexplained ratings, yield premiums for pessimistic ratings are significantly greater than yield discounts for optimistic ratings. These findings manifest after the passage of the Dodd-Frank Act, among sophisticated investors, and among municipalities with high financial reporting quality. We contribute to research that examines the determinants of municipal debt costs, CRA fees, and the information content of bond ratings.

Reading risk: The practices, limits and politics of municipal bond rating

This article contributes to the growing literature on the relationship between local governments and financial markets by demystifying the municipal bond rating process. Since the Great Recession, the dynamics of municipal debt have moved to the forefront of American urban politics and the pursuit of high bond ratings has become a key mechanism constraining local policy autonomy. However, we know little about the actual practices of the rating agencies. Drawing on interviews conducted within these organizations, the article examines the criteria, processes and organizational practices that produce ratings. In conversation with calls for bridging the divide between political economy and techno-cultural approaches to markets, the paper shows how bond rating is structured by an ever-present tension between the need to understand localized investment risk in all its place-specific complexity while striving to fit that risk within the standardized grid of the rating scale. Further, the analysis highlights the imperative of budget flexibility through which indebted local governments are pushed into self-disciplining of their finances. As such, the article unpacks a particularly opaque area of local politics and furthers ongoing conversations between financial geography and urban political economy.

Do Rating Agencies Benefit from Providing Higher Ratings? Evidence from the Consequences of Municipal Bond Ratings Recalibration

ABSTRACTWe ask whether credit rating agencies receive higher fees and gain greater market share when they provide more favorable ratings. To investigate this question, we use the 2010 rating scale recalibration by Moody's and Fitch, which increased ratings absent any underlying change in issuer credit quality. Consistent with prior research, we find that the recalibration allowed the clients of Moody's and Fitch to receive better ratings and lower yields. We add to this evidence by showing that the recalibration also led to larger fees and to increases in the market shares of Moody's and Fitch. These results are consistent with critics’ concerns about the effects of the issuer‐pay model on the credit ratings market.

The Economic Effects of Public Financing: Evidence from Municipal Bond Ratings Recalibration

We show that municipalities’ financial constraints can have a significant impact on local employment and growth. We identify these effects by exploiting exogenous upgrades in U.S. municipal bond ratings caused by Moody’s recalibration of its ratings scale in 2010. We find that local governments increase expenditures because their debt capacity expands following a rating upgrade. These expenditures have an estimated local income multiplier of 1.9 and a cost per job of $20,000 per year. Our findings suggest that debt-financed increases in government spending can improve economic conditions during recessions. Received December 14, 2015; editorial decision February 28, 2017 by Editor Andrew Karolyi.

Information Ambiguity and the Cost of Debt: Evidence from Municipal Bond Ratings

Information Ambiguity and the Cost of Debt: Evidence from Municipal Bond Ratings

Costs of the Municipal Bond Rating System

I estimate that the contemporary system of municipal bond ratings costs issuers over $2 billion annually. Fees paid to rating agencies directly account for about $500 million of this total. The greater burden on issuers arises from the relatively harsh ratings that agencies assign municipal bonds viz.-a-viz. other instruments. These costs take the form of additional interest paid to investors and purchases of municipal bond insurance intended to reduce this interest burden. Since defaults by rated municipal bond issuers are so rare, and since defaulting issuers can usually be identified ahead of time by accounting ratios and economic indicators, I conclude that significant cost savings are possible by replacing the current rating system with model-based assessments that yield higher ratings overall while still differentiating at-risk issuers.

Local government type and municipal bond ratings: what’s the relationship?

ABSTRACTThere is an extensive literature analysing the executive branch within local U.S. government jurisdictions. This has largely revolved around the differences between elected mayors and appointed city managers. Much of the academic work has considered the potential efficiency gains that may be associated with either form of government and comparative analyses between the two. However, the empirical literature has been divided regarding the relative efficiency of either form. This article attempts to add to that literature by considering how bond markets may perceive potential efficiencies that emerge from one executive type over the other by evaluating bond ratings for a sample of large municipal governments in the United States. Overall, the results suggest that municipalities headed by a city manager are associated with increased bond ratings (and thus lower borrowing costs), which may lend support that this form of administration is, on some margin, relatively more efficient than others. These results are robust to a number of specifications.

Local Government Type and Municipal Bond Ratings: What's the Relationship?

There is an extensive literature analyzing the executive branch within local U.S. government jurisdictions. This has largely revolved around the differences between elected mayors and appointed city managers. Much of the academic work has considered the potential efficiency gains that may be associated with either form of government and comparative analyses between the two. However, the empirical literature has been divided regarding the relative efficiency of either form. This paper attempts to add to that literature by considering how bond markets may perceive potential efficiencies that emerge from one executive type over the other by evaluating bond ratings for a sample of large municipal governments in the U.S. Overall, the results suggest that municipalities headed by a city manager are associated with increased bond ratings (and thus lower borrowing costs), which may lend support that this form of administration is, on some margin, relatively more efficient than others. These results are robust to a number of specifications.

Asymptotic Properties of the Markov Chain Model method of finding Markov chains Generators of Empirical Transition Matrices in Credit Ratings Applications

Credit quality changes need to be analysed from time to time. A good model for analysis needs to determine the Capital and reserves needed to support Credit Instruments portfolios as well as individual Credits. Conditions under which the Series method of finding Markov chains generators of Empirical Transition Matrices in Credit Ratings applications are identified in this article. Searching for valid Generators especially when a true generator does not exist and the properties of the series method is shown. Credit exposures Transition from one rating to another as well as Historical information are used to model estimation that pro- vide a description of Credit quality evolution probability. Time Homogeneous Markov Model specification is popularly used but it is only good in providing a description of portfolio risk changes in the short run hence restrictive in long run Credit processes. I propose a test which is simple and is of time homogeneity null hypothesis performed on all types of data reported often. The data used in the test is Sovereign debt, Municipal Bonds and Commercial paper. I find that transitions on municipal Bond ratings are described adequately for a period of up to five years. The Commercial paper assumes Markovian characteristics for a period of up to Six Months on a scale of 30 days transitions and the Sovereign debt transitions are described adequately by the Markov model using small data sample sizes.

The Economic Effects of Public Financing: Evidence from Municipal Bond Ratings Recalibration

We show that municipalities’ financial constraints can have important effects on local economies through a ratings channel. We identify these effects by exploiting exogenous variation in U.S. municipal bond ratings caused by Moody’s recalibration of its ratings scale in 2010. We find that local governments increase expenditures because their debt capacity expands following a rating upgrade. These expenditures have an estimated local income multiplier of 2.4 and a cost per job of $21,000 per year. Our findings suggest that debt-financed increases in local government spending can improve economic conditions during recessions.

The GASB No. 34 Impact of Budget-to-Actual Variances on Bond Ratings: Evidence from U.S. Cities

ABSTRACTWe investigate the managerial incentives and debt cost effects associated with budget-to-actual variance disclosures required by the GASB No. 34 reporting model. Empirically, we document associations between variances and municipal bond ratings in a sample of large U.S. cities over the period 2003–2006. We find a disproportionate share of favorable variances for revenues, expenditures, and the net (i.e., surplus/deficit). Further, we show that revenue variances in either direction are associated with lower bond ratings, i.e., precision is important in predicting revenues. In contrast, favorable expenditure variances are associated with higher bond ratings, i.e., imprecision may be tolerated if the variance is favorable. These associations exist despite indirect evidence of managerial incentives to create budgetary slack for both revenues and expenditures. The findings suggest that these disclosures required in the GASB No. 34 financial reporting model indicate factors that influence municipal debt costs.

Home Bias: Evidence from Municipal Bond Ratings

We examine credit ratings to shed new light on competing hypotheses in the home bias literature. We find that credit analysts who grew up in the state of the issuer award more favorable ratings than analysts who grew up outside the state. This effect is increasing in credit risk, reduces new issue credit spreads, and expands affected issuers’ debt capacity. Because this effect is driven by where analysts grew up, not by where they reside while producing ratings, we conclude that our results reflect home bias rather than superior information. Tests of timeliness and symmetry in rating updates by home and outside analysts further support this conclusion. We also find that analysts’ early life experiences influence the magnitude of the home bias. Overall, this paper shows that home bias exists among information producers, not just investors, and has real economic effects.

Determinants of Municipal Bond Ratings for General‐Purpose Governments: An Empirical Analysis

In the wake of the destabilization of the tax‐exempt bond insurance industry, this paper presents an ordered probit model of the determinants of the credit ratings of 965 county and city governments from throughout the nation. The underlying Moody's rating of these governments is posited as a function of a vector of publicly available economic, demographic, governmental, fiscal, and financial variables. The empirical results demonstrate the relative importance of economic base diversity, the growth rates of earnings, and population as well as existing full faith and credit debt on credit ratings. Additionally, our findings support the proposition that the existence of tax limits reduce the perception of credit quality, while expenditure limits raise credit ratings.