The state of Rhode Island currently holds an S&P credit rating of AA with a negative outlook. The negative outlook reflects continued significant pressure on state finances, despite substantial ongoing actions to balance the budget and the availability of federal stimulus funding.
We believe that additional economic deterioration beyond the state’s current projections could further reduce economically sensitive revenue and make the achievement of a balanced budget more difficult. The way that eventual budget-gap solutions are constructed will be an important component of our view of Rhode Island’s creditworthiness.
The rating could be lowered if the state is not able to adopt long-term budget solutions that make significant movement toward the elimination of a structural budget deficit. But, you may be asking, how did S&P arrive at this rating and outlook?
One factor that sets Standard & Poor’s apart from many of its competitors is that our ratings are the product of fundamental analysis. That means that in our analysis, we drill down into all sorts of market, business and financial data, as well as a review of economic trends. We combine that research with the insight gained from years of analytical experience. At that point, we may supplement this research with quantitative analysis through the use of models.
Even though two companies may be largely alike – existing in the same industry and manufacturing similar products – no two companies are identical. The same holds true for states, municipalities and municipal enterprises. Each has its own financials, and is guided by a management team and strategy that may be markedly different than others’. It is the mission of the analyst to understand both the similarities and differences, and make an assessment of how each might have an effect on a given administration’s ability and willingness to pay its financial obligations – the definition of creditworthiness.
Our work begins when an entity approaches S&P for a rating. In some cases, the group wants a rating as a first step in tapping the global credit markets by issuing a bond to fund capital expenditures or finance an obligation. Or, the group may simply want the credibility that comes from a credit rating, which can be a sign that they are a substantial and a suitable business partner.
Our first step is to assign the analytical team that has the experience and industry knowledge to perform the analysis. At the same time, a business-development team comes to a contractual agreement with the administration. These teams are wholly separate – analysts are never part of the business discussions.
The management meeting is followed by some two to three weeks of analysis. Sometimes, the information conveyed in this meeting is enough for the analytical team to form a rating opinion, but in other cases, more research is necessary. For example, in the water or sewer industry, proceeds from bond issues may be used for construction of elaborate facilities that must generate significant, ongoing cash flow in order for the issuer to make timely principal and interest payments.
In that instance, part of the analytical process involves determining that the enterprise has a history of satisfying customers who return time and time again.
A site visit can be enlightening. Once analysts return from such a visit, they report what they have observed. No amount of number crunching can reveal the telling indicators that analysts report back concerning the state, local government or enterprise.
Once the lead analyst is satisfied that the team has examined all the necessary data to develop a rating opinion, he or she must then subject that opinion to the scrutiny of a rating committee and explain the analysis. The rating committee generally comprises several senior analysts – some with knowledge of the state, municipality or enterprise and others with other expertise.
The reason for including the latter is to ensure that the analyst can make a compelling case for his or her opinion, even to someone without knowledge of this specific state of affairs. That helps achieve another goal: that a rating from one analytical group is comparable to a similar rating issued by a different analytical team.
The process does not end there, however. Once we issue a rating, we perform ongoing surveillance of the issuer and any events in the marketplace or economy that could have an effect on the issuer’s ability to make timely debt payments. If we feel that there is enough negative pressure on the issuer to potentially affect its creditworthiness, we may place the issuer on “Negative Outlook” or “CreditWatch Negative,” signaling a potential downgrade of the issuer’s rating.
Conversely, if the fortunes of the issuer improve markedly from the point we published our rating, we may opt to upgrade the rating.
For example, Standard & Poor’s Ratings Services assigned an initial rating of BBB- to Central Falls’ general obligation debt in 1995. Periodically, we published rating rationales which included our concerns and the city’s challenges. In the middle of 2010, S&P downgraded the city. The rating action reflects our view of the city’s filing of a petition with the state of Rhode Island Superior Court requesting the appointment of a receiver to oversee the affairs of the city to assist in balancing the city’s budget. The city was downgraded to C, one notch above default.
Ratings have been and will remain an important, independent benchmark of credit quality, and we continually look for ways to improve our processes and independence. We recognize that trust is something we must earn every day, with every rating opinion we publish. •
Henry Henderson is a ratings services credit analyst for U.S. public finance ratings for Standard & Poor’s.
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