5.2. Credit Rating
Local governments could improve their financial management performance by applying
for an external credit rating. A credit rating is an opinion assigned by Credit Rating
Agency on the ability and willingness of an issuer to make timely payments on a debt
instrument over the life of that instrument. By obtaining the credit rating, the local government
will better understand what the main determinants of its creditworthiness are
and can decide what changes are needed to improve its credit risk profile and thereby
reduce its borrowing costs.
Three major firms now provide this service for regional and local governments in South
East Europe: Moody's Investors Service, Standard and Poor's and Fitch. Long-term bonds
of the highest quality are rated "Aaa" by Moody's and "AAA" by Standard and Poor's and
Fitch. Issues rated below "Baa" by Moody's and below "BBB" by Standard and Poor's are
considered below investment grade. A separate set of ratings are used for short-term
notes.
Table 11: Moody's Long-term Debt Ratings (maturities of one year or greater)
Investment Grade
Aaa – "gilt edged"
Aa1, Aa2, Aa3 – high-grade
Baa1, Baa2, Baa3 – medium grade
Speculative Grade
Ba1, Ba2, Ba3 – speculative elements
B1, B2, B3 – lack of characteristics of a desirable
investments
Caa1, Caa2, Caa3 – bonds of poor standing
Ca – highly speculative
C – lowest rating, extremely poor prospects of attaining
any real investment standing
Moody's Short-term Debt Ratings (maturities of less than one year)
Prime-1 (highest quality)
Prime-2
Prime-3
Not Prime (can be thought of as speculative grade)
The rating process:
Local governments approach Credit Rating AgencyApplication with specific financial information related to the local governments'
activity is sent out to the Credit Rating Agency.
Credit Rating Agency analyses the local governments' application along with
the local and national economic conditions and assigns a credit rating to the
local government. As a rule, the credit rating of a local government cannot
exceed the country's sovereign rating.
After the initial rating, the Credit Rating Agency reviews periodically the rating
to take into account the latest financial and economic information related
to the local governments' position.
Important definitions pertaining to the rating process16:
Rating outlooks: These are opinions regarding the likely direction of an issuer's
rating over the medium term, generally 18 months. Outlooks fall into 4
categories: positive, negative, stable, developing;Rating review: A credit is placed on the watch list when it is on review for pos-
16 Moody's Investor Service – Rating Methodology
57
sible upgrade, or on review for possible downgrade, or (more rarely) on review
with direction uncertain. A formal review is normally concluded within 90
days;Confirmation of a rating: If after a formal review a rating committee decides
not to change a rating, the rating is said to be confirmed.
Access to a broad number of potential investors, thereby reducing the local
government's borrowing costs as competition will increase;
Independent opinion on the future ability and legal obligation of an issuer to
make timely payments on its financial commitments;Independent estimation of the current municipal credit condition and future
revenue and expenditure scenarios based on budget trends and budget projections;
Diagnosis of the basic risk factors that contribute to the creditworthiness condition
and identification of the critical risk areas that may threaten the ability of
the local government to make timely principal and interest payments on their
debt obligations;
Objective assessment of important municipal financial operations of critical
concern to mayors, municipal councils and citizens;
Increased transparency and accountability of municipal operations.