WhenUSPublicFinanceRatingsChangeESGFactorsAreOftenTheReasonMarch282019 - PDF document

1 WhenU.S.PublicFinanceRatingsChange,ESGFa
WhenU.S.PublicFinanceRatingsChange,ESGFactorsAreOftenTheReasonMarch28,2019 KeyTakeaways -Ourcriteriacontainkeycreditfactorsthatenableustoincorporateexistingandemergingenvironmental,social,andgovernance(ESG)risksandopportunitiesintoourratings. March 28, 2019 1 whichhighlightESGfactorsinourUSPFcriteria.MethodologyWedefineratingactionasachangeinarating(upgrade,downgrade,orwithdrawalifnotattheissuer'srequest),anoutlookrevision,orachangeinCreditWatchstatus.Likewise,wedefineESGfactorsasthosepositiveornegativecreditconsiderationsassociatedwithenvironmental;socialanddemographic;andmanagement,governance,orinstitutionalfactorsoutlinedinourcriteria.Whenweviewtheseconsiderationstobematerialandvisible,webelievetheycanaffectcreditworthinessand,ultimately,anissuer'sabilitytomeetfullandtimelydebtservice.Thiscanhappenbyinfluencingtheircapacitytoservethepublic(e.g.,providingservices,apublicgood,product,orinfrastructure);and/ortheirlong-termfiscalsustainability,physicalresilience,responsivenesstopublicdemandsandmarketchanges,ororganizationaleffectiveness.Becausepublicfinanceissuersprovideessentialservicesandinfrastructure,webelievemanyESGfactorsarefundamentaltoandembeddedintoouranalysisandareoftenkeycreditdeterminantsinourUSPFratings(seetable1).Table1 Ourmethodologyconsistedofreviewingover3,300creditratingactionspostedtoRatin

2 gsDirectfromJan.1,2017,toDec.31,2018.Wee
gsDirectfromJan.1,2017,toDec.31,2018.Weexcludedratingactionsfollowingbonddefeasancesandwithdrawalswhentheyareattheissuer'srequest.However,weincludedwithdrawalsrelatedtoinsufficientdisclosuresandlackoftimelyinformation,whichweconsiderareflectionofpoormanagementandgovernance.WethenanalyzedtheremainderusingnaturallanguageprocessingtoolstoidentifyparticularwordsorphrasesrelatingtoESGfactors,complementedbyqualitativeinterpretationoftheresults.Examplesincludehurricane(E),enrollment(S),andmanagementpolicies(G),whichassociatedirectlywiththeitemslistedintable1.Weexcludedseveralkeycreditfactors.Notableexamplesincluderatingactionsresultingfromchangesinfinancialperformance,changesinnonsocioeconomicindicators,andchangesbecause March 28, 2019 2 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason ofnewcriteriaimplementation.-Forfinancialperformance,changesinanissuer'sbudgetaryperformance,debtservicecoverage,flexibility,liquidity,anddebtstructure,wereexcludedunlesstheywerespecificallyattributedtoanESGfactor(suchasanextremeweatherevent).Thisincludesinstanceswhereissuerssustainedlong-standingfinancialchallengesorstructuralimbalance.Likewise,whenchangesinmanagementpracticesandpolicieswerecitedasfactorsinconjunctionwithfinancialperformance(forinstance,adrawdownofliquiditytolevelsnolongeralignedwithmanagem

3 entpolicytargets),theseinstanceswereexcl
entpolicytargets),theseinstanceswereexcludedfromourcount.-Fornonsocioeconomicindicators,weexcludedratingactionsdrivenbychangesinthegeneraleconomy,forexamplechangesinrealestatevaluesorsalestrends,unlesstheywerespecificallyattributabletoanESGfactor.-Finally,anyratingactionsassociatedwiththeimplementationofrevisedcriteriawereexcludedfromourcount,including"U.S.PublicFinanceCharterSchools:MethodologyAndAssumptions,"publishedJan.3,2017;"U.S.AndCanadianNot-For-ProfitTransportationInfrastructureEnterprises,"publishedMarch12,2018;the"SpecialAssessmentDebt"criteria,publishedApril2,2018;andthe"Priority-LienTaxRevenueDebt"criteriapublishedOct.22,2018.ItisimportanttonotethedifferencebetweenthenumberofESG-relatedratingactions(1,116)identifiedandthenumberofESG-relatedinstances(1,185),whichisslightlyhigher.Thisisbecause69ratingactions(6%ofthetotal)weredrivenbytwoormoreE,S,orGfactors,andthereforewerecountedmorethanonce.ResultsOverthetwo-yeartimeperiod,weidentifiedapproximatelyoneormoreESGfactorsin34%of3,315ratingactions.Ofthese,governancewasthedominantone(67%ofaratingactions),followedbysocial(28%)andenvironmental(5%)factors(seecharts1and2).Chart1 March 28, 2019 3 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason Chart2 DowngradeswereslightlymoreelevatedbecauseofESGfactors,althoughtheoverallsplitbetwe

4 enpositiveandnegativefactorswasrelativel
enpositiveandnegativefactorswasrelativelybalanced(seechart3).Chart3 MostFrequentU.S.PublicFinanceESGFactorsThe10mostfrequentlycitedcreditfactorsasthereasonforaratingactionwerelargelygovernancerelatedfactors(seetableandchart4).Ourviewofgovernanceincludestraditional March 28, 2019 4 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason considerationssuchasinstitutionalframework,oversightandboardstructure,corruption,transparencyanddisclosure.Inaddition,weconsidermanagementpracticesandpolicies,insofarastheyareclearlydefinedandwell-structured,importantgovernanceindicatorsgiventheirroleinensuringsolidinternalcontrols.ThisisafeatureweconsiderrelevantgiventheautonomousnatureoflocalgovernmentsandnonprofitentitiesintheU.S.,andthecorrespondingstronglinkbetweenmanagementandcreditquality.Whilethereareobviousbroaderimplicationsoftaxingandrate-settingdecisionsonthepublicsectorservicepopulationsandusers,forthepurposeofthisanalysis,wefocusonthemanagementframeworkasitrelatestointernalcontrolsandpolicies,ratherthantheday-to-daydecision-makingandtheimpactonfinancialperformance.Chart4 Enrollmentwastheprevalentsocialfactoracrossratingactionsduetoitscriticalroleintheratingcriteriaforeducationsectors,includingkindergarten-grade12publicschooldistricts,charterschools,andhighereducation.Enrollmentislinkedtodemogra

5 phicchangesinthearea.Serviceneedsforvari
phicchangesinthearea.Serviceneedsforvariousentitiesandpopulations,changesinincomelevelsandaffordability,andemploymentlevelsfollowcloselybehind.InUSPF,creditimpactsfromclimatechangeaffectpublicfinanceentitiesindifferentwaysandhavelargelyfocusedonthefalloutfromextremeweathereventsornaturaldisasters.S&PGlobalRatings'researchhasshownthat,withsomeexceptions,naturaldisastershavehadlimitedimpactonmunicipalratingsintheU.S.Downgradeshavebeenlesscommon,evenastheaffectedareasincreasinglyincludelargeandgrowingpopulationcenters.Notsurprisingly,issuerswhohavepreparedfornaturaldisastersbymaintainingstrongliquiditypositionsandbuildingresilientinfrastructurehaveseencreditstability.Theyhavebenefitedfromtheeconomicactivityfromrebuilding,theavailabilityoffederalandstateaid,federalpoliciessupportingcoastaldevelopment,andotherfactorsmitigatingriskstothelong-termviabilityandcompositionoftaxbases.Historically,wehaveobservedseverallocalgovernmentandmunicipalenterprisedowngradesfollowinghurricaneswhentheeconomicandfinancialdamagefromthehurricaneswaslong-lastingandsevereenoughtochangeourviewoftheirmedium-termgrowthprospectsandabilitytogeneratesufficienttaxrevenuesbeforeexhaustingexternalliquidity,aswellastheirlong-termviabilityattheirpre-disasterratinglevels. March 28, 2019 5 When U.S. Public Finance Ratings Change, ESG Factors Are O

6 ften The Reason Table2 SectorReviewIrres
ften The Reason Table2 SectorReviewIrrespectiveofregionorsector,theabsenceofacitedESGfactorinaratingactiondoesnotnecessarilyimplytheabsenceofESGconsiderationsintheratings.Forexample,environmentalfactorsplaythelargestpartinpublicpower,waterandsewerutilities,andtransportationratings,whiletheyhavenotforcharterschools.Extremeweathereventsdidhavealargeeffectontheunderlyingfinancesoreconomyofseveralissuers,butasnotedaboveothermitigatingfactorsoftencounterbalancedthenegativecreditimpactoftheextremeweatherevent,leavingmostissueratingsunaffected.Likewise,socialfactorswerethemostprevelentforhighereducationandcharterschoolratings,whiletheydidnotleadtoanyratingactionsforthestatesectorduringourtwo-yearlook-backperiod.Ultimately,thedegreeofenvironmental,social,orgovernancefactorimpacttoratingactionsvariesacrosssectors,despitebeingameaningfulcomponentofeverypublicfinanceissuer'soverallcreditworthinessandholisticallyconsideredinourcriteria(seetable2). March 28, 2019 6 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason HighereducationChart5 Enrollmentstoodoutasthelargestfactorofratingactionsforhighereducation.Thesectorexpectsissuesaroundweakeningstudentdemographicsanddecliningstudentenrollmenttocontinuein2019.Withinthissector,statefunding,managementpractices,andabilitytodiscloseinformationtous,whichwe

7 viewasabroadergovernancefactor,alsoledto
viewasabroadergovernancefactor,alsoledtoratingactions.Adversepublicityrelatedtomanagementandgovernancewasalsoprevalentin2018(formoreinformation,see"GlobalNot-For-ProfitHigherEducation2019SectorOutlook:CreditPressuresProliferate,"publishedJan.24,2019). March 28, 2019 7 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason CharterschoolsChart6 Unsurprisingly,enrollmentlevelswerealsokeyfactorsforcharterschools,duetodemographicissuesandincreasingcompetitionforstudentswithpublicschooldistricts.Governance-relatedrisksassociatedtoacharterschool'sabilitytomaintainitscharteredstatus,statefundinglevels,andacademicperformancetomeetstateandauthorizerstandardsarealsocreditfactorsinthesector(formoreinformation,see"U.S.CharterSchools2019SectorOutlook:DespiteAStableOutlook,DisruptionsCouldLeaveTheirMark,"publishedJan.16,2019). March 28, 2019 8 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason HealthcareChart7 Fromagovernanceperspective,mergersandacquisitionsdominatethesector,alongwithoverallmanagementpractices.Furthermore,thesectorisvulnerabletofederalregulatorychanges,withpoliticaltensionsrelatingtotheAffordableCareActlawsuitremaininganongoingrisktocreditquality.Whiledemandforhealthcareserviceswillalwaysexceedsupply,socialfactorsunderlineagreatmanyfactorsinoverallcreditqua

8 lity,butarelessprevalentasimmediatereaso
lity,butarelessprevalentasimmediatereasonsforratingactions.Thesefactors,whileintegraltooverallorganizationalidentityandlong-termcreditquality,tendtotakeeffectmoregradually,andthereforeareslowertoleadtoratingactionchanges.Environmentalrisks,capturedprimarilythroughnaturaldisasters,alsoaffectedthesector.Whilelargelypreparedintheeventofanemergency,hurricanes,tornadoes,floods,andothernaturaldisastershadadisproportionaltelynegativeimpactontheoperatingprofilesandinfrastructureofsomeissuersifthefacilitywasdirectlyhitorifthepatientsoremployeesthereinwereimpacteddirectly,evenifthefacilityitselfsurvivedthenaturaldisasterintact.(Formoreinformation,see"U.S.Not-For-ProfitHealthCare2019SectorOutlook:StableOverall,YetKeyRisksRemain,"publishedJan.10,2019.) March 28, 2019 9 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason HousingChart8 GovernancefactorsdominatethetopreasonsforESG-relatedratingactionswithinthehousingsector.Acrossallsubsectors,includinghousingfinanceagencies(HFA),communitydevelopmentfinancialinstitutions,andpublichousingauthorities,mostoftheidentifiedratingactionsrelatetounenhancedaffordablehousingprojects,whichweexpectedgiventheratingstressinthefield(formoreinformation,see"ForU.S.AffordableHousingIssuers,DebtServicePaymentsAreKeyToRatings,ButWhatElseMatters?,"publishedOct.2,2018).Man

9 agementandgovernance--eitherdirectlythro
agementandgovernance--eitherdirectlythroughadeteriorationorlackofoversightandstructure,orindirectlythroughdisclosureissues--wereprimaryratingactionfactors.Furthermore,somehousingsubsectors,inparticularHFAs,expectmanagementteamstohaveplansdealingwithextremeweatherevents.(Formoreinformationonthesector,see"U.S.MunicipalHousing2019SectorOutlook:StableForNow,"publishedJan.23,2019.) March 28, 2019 10 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason LocalgovernmentsChart9 Governancefactorswerefrequentlycitedinlocalgovernmentratingactions--upwardsof70%ofcasesinboth2017and2018.Weincludekindergarten-grade12schooldistricts,citiesandcounties,andspecialdistrictssuchasmunicipalutilityandlibrarydistricts.Governanceincludespoliciesandpracticiesaswellasdelaysinfinancialdocumentationanddisclosure,andwasgenerallythemostinfluentialESGfactor.Weconsidertheimpactofstatefundingonschoolsasagovernancefactoraswell.Managingpensioncostsandtheassumptionsbehindthosepensionplans,canalsofallunderthisumbrellaofanalysis.Therefore,ourviewofgovernancecapturesissuesthataffectlocalgovernments,bothpositivelyandnegatively.Socialissues,representingasmallerproportion(about20%inbothyears),includefactorssuchasenrollmentandchangesinincome.Althoughtheyareratingactionfactorslessfrequently,webelievesocialissuesarestillhighlyreleva

10 ntforouroverallcreditanalysis.Environmen
ntforouroverallcreditanalysis.Environmentalissues,capturedmostlythroughnaturaldisasters,affectedonlyasmallpercentofratingactions,reflectingthesmall-but-concentratedimpactnaturaldisastersandenvironmentalriskhavehadtodate.(Formoreinformationonthesector,see"U.S.LocalGovernment2019SectorOutlook:ShowersForSome,DownpoursForOthers,"publishedJan.9,2019.) March 28, 2019 11 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason PublicpowerChart10 Becausefossilfuelsareaprincipalinputforelectricutilities,environmentalfactorsplayakeyroleinouranalysisofpublicpowerutilities.Thefocusoflegislators,regulatorsandthepubliconclimatechangecontributestoinitiativesforcontrollingpowerplantgreenhousegasemissions,utilities'useofbodiesofwatertocoolpowerplants,andtheirdisposalofthebyproductsofproducingelectricitywithcoalandnucleurfuel.Similarly,liabilityissuesarisingfromtheintersectionofdroughtconditionsinCalifornia,sparkingutilitypowerlinesandCalifornia'sexpansiveinterpretationofresponsiblepartiesarealsoimportanttoS&PGlobalRatings'analysisofenvironmentalissues.(Formoreinformation,see"CaliforniaPublicPowerUtilitiesAreBetterAbleToTemperWildfireRelatedLiabilityExposuresThanIOUCounterparts,"publishedFeb.28,2019.)Governanceconsiderationsarealsoimportantfactorsinourassessmentsofelectricutilities.Theevolvingregulatoryandle

11 gislativeenvironmentalframeworksforelect
gislativeenvironmentalframeworksforelectricutilitiestaskmanagementteamswiththeneedtodevelopstrategicsolutionsthatenableutilitiestoconformtoregulatorymandateswhileservingcustomerswitheconomicalandreliablepower.Cybersecurityrisksalsorepresentimportantgovernanceissuesforutilitymanagement.NuclearconstructionprojectsinGeorgiaandSouthCarolinaprovideasalientexampleoftheinfluenceofgovernanceonelectricutilityratings.Theprojects'significantdelaysandcostoverrunsunderscoreprojectstewardshipissues.Theresultingpoliticalfalloutandlitigationamongtheprojectparticipantsthatchallengecostresponsibilityandtheowners'righttocostrecoveryarealsoimportantgovernanceconsiderations.Inaddition,costrecoveryissuespointtothesocialelementofourESGanalyses,asdotheeffectsoftheprojects'costsontheaffordabilityofconsumers'retailelectricrates.(Formoreinformation,see"U.S.PublicPowerAndElectricCooperativeUtilities2019SectorOutlook:RatingsStabilityPersistsInADifficultEra,"publishedJan.22,2019.) March 28, 2019 12 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason StatesChart11 GovernancefactorsdominatedESG-relatedratingactionsacrossstateswithpensionsbeingthemostfrequentfactorofthereviewedratingactions.Ouroutlookforstatesshowsthat,despiteexpectednear-termstability,pensionswillcontinuetobeacontributingfactorinweakercreditqualityfo

12 rsomestates.Othergovernancefactorsthatar
rsomestates.Othergovernancefactorsthataroselessfrequentlyrelatetodefaultofscheduledinterestpaymentsaswellaspoliticalandregulatoryrisks.Whileweviewsocialfactorsasmajorratingconsiderationsforthesector,thesearelessfrequentandnottheprimaryissueinthereviewedratingactions,giventheirmoregradualimpact.Similarly,extremeweathereventsandnaturaldisasterscanaffectanystatebutnotnecessarilybemajorcontributingfactorstoratingactions.Statestypicallyhaveconsiderableflexibilitytoabsorbshort-termeffectsofclimate-relatedeventsgiventhesizeoftheirbudgetsandhaveinstitutedstrongresponseplans,whichlimitstheimpactonratings.Theongoingfiscalrelationshipthatprovidesemergencyfederalaiddirectlytostateshasalsohasbeensignificantinaddressingnaturaldisasterseffectively.Weexpecttheseriskstocontinue,althoughtherelativedistributionoftheirimpactonratingactionscouldchange.(Formoreinformation,see"U.S.StateSector2019Outlook:Caution-SlowerSpeedsAhead,"publishedJan.8,2019.) March 28, 2019 13 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason TransportationChart12 Aspublicownersandoperatorsofmasstransitagenciesandtransportationassets(suchasairports,tollroads,ports,andparkingfacilities),thissectorisindirectlyexposedtoregulationaffectinggreenhousegasemissionsanddirectlyexposedtoclimatechangebecauseofitsimpactoncurrentandfutureinfras

13 tructure(forinstance,buildingmoreresilie
tructure(forinstance,buildingmoreresilientroadwaysandbridges).Theyarehighlyexposedtoextremeweatherevents,thatcandisruptoperationsandaffectfinancialperformance,albeittypicallyforshortdurationsoftenwell-mitigatedthroughinsurance.Wecapturedinstanceswhereweviewextremeweathereventstoresultindiminishedcreditqualityoverthemedium-to-longterminourlook-backanalysis.Weanticipatethisriskwillrisetotheextentextremeweathereventsincreaseinseverityandfrequency.Exposuretodemographictrendsandknownsocialrisksreflectedinchangesindemand-customerpreferencesaremoregradualandallowformanagementtoadjust,althoughtherisksfromdisruptionfromterrorism,pandemics,andothershocksarealwayspresent.Mostoftheratingactionsinthesectorduringthissampletwo-yearperiod(whichcoincidedwithimplementationofnewcriteria)wereassociatedwiththehurricanesthathittheU.S.VirginIslandsconstitutedthemainenvironmentalfactorinouranalysis.(Formoreinformation,see"U.S.TransportationInfrastructure2019SectorOutlook:MostlyStable,DespiteExpectedSlowerGrowthAndUnlikelyInvestmentPackage,"publishedJan.17,2019.) March 28, 2019 14 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason WaterandsewerChart13 Inourview,ESGalignsperfectlywiththecoremissionofwaterandsewerutilities,andmostoftenmanifestsinmanagement'seffectivenessofitsriskandfinancialmanagement,typically

14 associatedwithlong-termplannningandactio
associatedwithlong-termplannningandactions(formoreinformation,see"ForWaterUtilities,ESGIsJustBusinessAsUsual").Governanceisalsoreflectedthroughrisksandopportuntiesassociatedtoorganizationalstructure.Utiliestakeactiontogaineconomiesofscalethroughconsolidationofregionalwaterservicesystemsandmergersbetweenwaterdistrict'sandneighbouringcities.ESGwillremainastandardofthepracticein2019,becausetheroleofwaterutilitiesistobalancetheprovisionofessentialserviceswithenvironmentalstewardship,affordability,andmaintainingfinancialintegrity.Furthermore,withtheproliferationofgreenbondsandinvestment,weexpectsomeoftheenvironmentalriskstobemitigated,helpingissuersadapttoclimatechange.(Formoreinformation,see"U.S.MunicipalWaterAndSewerUtilities2019SectorOutlook:Stable,AlthoughPotentialDisruptionsAreNotMakingPlanningEasy,"publishedJan.15,2019.) March 28, 2019 15 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason March 28, 2019 16 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason RelatedResearch-HowEnvironmental,Social,AndGovernanceFactorsHelpShapeTheRatingsOnGovernments,Insurers,AndFinancialInstitutions,Oct.23,2018-HowSocialRisksAndOpportunitiesFactorIntoGlobalCorporateRatings,April11,2018-HowEnvironmentalAndClimateRisksAndOpportunitiesFactorIntoGlobalCorporateRatings-AnUpdate,

15 Nov.9,2017-CreditFAQ:UnderstandingClimat
Nov.9,2017-CreditFAQ:UnderstandingClimateChangeRiskAndU.S.MunicipalRatingsOct.17,2017 Thisreportdoesnotconstitutearatingaction. March 28, 2019 17 When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason ContactListPRIMARYCREDITANALYSTPRIMARYCREDITANALYSTPRIMARYCREDITANALYSTKaitiVartholomaiosNewYork+1(212)4380866kaiti.vartholomaios@spglobal.comLisaRSchroeerCharlottesville(434)529-2862lisa.schroeer@spglobal.comTheodoreAChapmanDallas(1)214-871-1401theodore.chapman@spglobal.comPRIMARYCREDITANALYSTPRIMARYCREDITANALYSTSECONDARYCONTACTLadunniMOkoloNewYork(1)212-438-1208ladunni.okolo@spglobal.comKurtEForsgrenBoston(1)617-530-8308kurt.forsgren@spglobal.comDavidNBodekNewYork(1)212-438-7969david.bodek@spglobal.comSECONDARYCONTACTSECONDARYCONTACTSECONDARYCONTACTRahulJainNewYork+1(212)4381202rahul.jain@spglobal.comRandyTLaymanCentennial+1(303)7214109randy.layman@spglobal.comEvaJaniNewYork+1(212)4380114eva.jani@spglobal.comSECONDARYCONTACTSECONDARYCONTACTSECONDARYCONTACTAlexLouieCentennial303-721-4559alex.louie@spglobal.comJamieLSemanSanFrancisco(1)415-371-5020Jamie.Seman@spglobal.comKaitiWang,CFANewYork212-438-0566kaiti.wang@spglobal.comSECONDARYCONTACTSECONDARYCONTACTSECONDARYCONTACTYingHuangSanFrancisco(1)415-371-5008ying.huang@spglobal.comTimothyPMeernikCentennial+1(303)7214786timothy.meernik@spgloba

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