Treasurer Lemoine Denounces S&P State Rating Methodology
June 9, 2010
Chief Credit Officer, Corporates and Governments
Standard & Poor’s Financial Services, LLC
55 Water Street
New York, NY 10041
Re: Methodology for U.S. State Ratings
Thank you for reconsidering the methodology and assumptions used by Standard & Poor’s for rating United States state governments, and for accepting comments on your newly proposed approach. I greatly appreciate the opportunity to speak to this effort.
The proposed methodology appears to set out five prime factors, five override (other)factors, twenty metrics, and a multitude of indicators that are intended in combination to provide greater clarity and detail to support a state’s rating. Unfortunately, this extensive structure disguises an alarming failure to address the key purpose for which ratings are purchased, and seems to circumvent Standard & Poor’s own statement that “[t]he likelihood of default is the single most important factor in our assessment of creditworthiness.” see http://www.standardandpoors.com/ratings/definitions-and-faqs/en/us/#def_2
I agree that the central question that a rating must address is this: “What is the likelihood that debt service on the state’s bonds will be paid in full on time every time?”
In failing to focus on this question, the new methodology offers little improvement over existing rules and, if adopted, would do a continuing disservice to states.
As you know, the people of Maine have a one hundred and ninety year history of issuing state general obligation bonds without default, a constitutional mandate to pay bond holders in full before any other state expenditure can occur and a state government with current revenue expectations at twenty-five times general obligation debt service. Under the proposed methodology, the critical security strengths that Maine offers are deeply buried and dramatically diluted.
Look, for example, at how debt-payment security provided by Maine’s constitutionallyimposed debt service payment promise would be obscured in the analysis and given almost no weight when determining Maine’s ultimate rating.
Using the language of the proposed new methodology, Maine’s constitutionally established “priority of payment for debt service” would be treated as one of several “specific security features relating to GO debt” and evaluated in parallel with other debt features such as “the nature of the repayment pledge,” “amortization features that are imbedded in constitution or statute” and “legal restrictions related to debt issuance.” Decisions on “security features” evaluations then would be averaged with the scores from the various other debt features, such as “the legal flexibility to issue debt for a range of purposes.” Only then would we receive a composite score for a “Legal Framework” indicator.
After that, the score for the Legal Framework indicator would be averaged further with dozens of other indicator scores for “Balanced Budget Requirements,” “Tax Structure,” “Disbursement Autonomy” and “Voter Initiatives.” This second averaging would in turn provide the score for the “Fiscal Policy Framework” metric.
The Fiscal Policy Framework metric results yet again would be averaged with the scores from the “System Support” and “Intergovernmental Funding” metrics to create a third averaged score, this time for the “Governmental Framework” factor.
The score from the “Government Framework” factor would go through a fourth step of averaging with the scores from the remaining four factors, “Financial Management,” “Economy,” “Budgetary Performance and Flexibility,” and “Debt and Liability Profile.” The scores for each of these other factors would have been achieved through a similar three-step indicators-metrics-factors averaging process.
In the end, the critical debt-service fail-safe that the people of Maine have embedded into their Constitution would become nearly irrelevant to your rating opinion. A similar diminution of importance occurs for our perfect 190 year history of general obligation debt service payments.
If Standard & Poor's fully intends to recognize the unique general obligation credit strengths of U.S. states, the proposed methodology greatly misses the mark. I strongly urge you to rewrite your proposal so that future state ratings will provide fair guidance for investors who want your valued opinion on this overriding question: “What is the likelihood that debt service on the state’s bonds will be paid in full on time every time?”
Again, thank you for reopening your methodology for rating U.S. states. I appreciate the opportunity to be heard on this critical development.
David G. Lemoine
For more information on the proposed S&P State Ratings Methodology, see: http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245211884743