California moves toward open source ratings for city bonds

December 6, 2012

In the past year, three California cities have filed for bankruptcy. This casts a pall on the bonds of other California cities, because investors wonder if they also contain buried fiscal issues. In an effort to create more transparency, a new open source ratings project was recently launched:

Responding to market concerns about municipal credit quality, the California State Treasurer’s Office has commissioned a San Jose State University economist and a government-bond research group, Public Sector Credit Solutions, to develop a default probability model for city bonds.

The “default probability model” (which is what most credit rating agencies use as a model) was created by former Moody’s executive Marc Joffe of Public Sector Credit Solutions. Here is what the California State Treasurer is hoping that it will do:

“The new model will provide the State an approach to identify troubled cities, and increase the amount of information available to investors and the public,” said State Treasurer Bill Lockyer. As Treasurer, Lockyer serves as chairman of the California Debt and Investment Advisory Commission, which issued the RFP for the work and reviewed proposals.

Lockyer’s support for more scrutiny on California cities follows his call in October for underwriters involved with capital appreciation bonds to help out issuers. It’s an effort that I called Bill Lockyer’s “big stick.” The issue, as I wrote in October, is that municipal bond offerings are not scrutinized by anyone prior to them being offered. One of the best approaches to monitoring cities is to evaluate their capability to service more debt:

The biggest problem with muniland is that bond offerings are not reviewed before they are brought to market. Neither state securities regulators, the Municipal Securities Rulemaking Board or the SEC do any preview of municipal bond offerings.

Credit rating agencies that monitor cities often have less surveillance when cities are not issuing debt or are not in fiscal distress. So an open source model that can be run on a consistent basis by multiple parties could have great value to market participants. Joffe said that data for the model comes from city comprehensive annual financial reports (CAFRs), budgets and the State Controller’s Cities annual report. These are all publicly available reports that anyone can access.

Next May, muniland will have access to the Lockyer open source model:

The model, which is scheduled for publication in May 2013, will be fully transparent, so that anyone can use it free of charge. The model will be available via a web page and in an Excel workbook.

This idea could go viral and a create a massive new transparency push for muniland.

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