- General Information About Rating
- Corporate Credit Rating Methodology
- Bank and Financial Institutions Credit Rating Methodology
- Corporate Governance Rating Methodology
- Structured Finance
- The Methodology of Country Rating
- Project Finance Rating Methodology
- Rating Methodology of Local Authorities and Their Issuances
- Multilateral Development Banks, Financial Institutions, Other Supranational Institutions Rating Methodology
- Sovereign Rating Methodology
- Public Enterprises Rating Methodology
- General Principles for Issue Rating
- JCR-ER Rating Update Policies
- Case of Default and Probability of Default Definitions
The local administrations in case of insufficient funds from taxes or from their central administration and in line with the increasing urbanization to provide civil or infrastructure services, finance the existing or the planned projects or create cash flow for their other needs can issue bonds at different types and maturities or obtain funding from the money markets or international institutions. The local administrations are rated according the factors and heading sated below.
- The socio-economic structure,
- The legal factors,
- The corporate governance structure and quality,
- The indebtedness structure,
- The financial structure and the budget performance.
For the issuance of financing bonds of the local administrations the below stated factors are added to those stated above
- The adaptability of the mentioned project.
In terms of descriptive criteria;
- The service and quality of the local administrations,
- The risk position and the corporate management,
- The historic debt payment information,
- The current assets,
- The situation of the subsidiaries and affiliates
are being examined.
The Socio-Economic Structure
The financial health of a community is closely linked to the revenues impacted by it’s economy. The revenues of the local administrations are mainly the real estate taxes, the value of the services rendered and arising from sovereignty rights and other similar tax revenues. For this reason, in the first step, to determine the debt repayment capacity of the issuer by JCR ER;
- The location,
- The infrastructure,
- The natural resources,
- The Debt and liabilities,
- The tax base and tax composition,
- The employment base
are analyzed. In the measurement of the debt repayment capacity, the level of the capability to generate revenue and liquidity of the local administration without high dependence on budget and subsidy is an important factor. For this reason, from the rating perspective, the differentiated and entensive tax base are among the most positive factors. All those analysis are being evaluated according to the factors stated below.
- The natural structure of local economy,
- The specifics of the local revenue,
- The indicators of development and the existing urbanization services,
- Local population and employment.
The Legal Factors
The tax payers predispositions and resistances, the local administrations mechanisms enabling to collect the service revenues on time, the real and legal control power, the comprehensiveness of the regulation are analyzed in detail. All those analysis are being evaluated according to the factors stated below.
- The funding levels and limits,
- The ongoing legal suits and disputes,
- The taxation authorities,
- The service charges and the contribution margins,
- The real control power on the revenue resources,
- The revenue collecting mechanisms and the assessment from legal perspective.
The Corporate Governance Structure
Organizational structure is analyzed in terms of the management, management information systems, control and planning processes to provide depth of the governance and the delegation of the power. For a better assessment of the current planning and projections, whether there has been an excess in the previous projects in terms of cost and duration and their realization levels should be analyzed. In order to determine the level of management skill, analysis of budget applications from a duration perspective should be examined separately. Adoption of the budget in time reflects the integrity of the political and social processes. Besides the delayed budget plannings are a sign of political difficulty or obstruction. Management is expected to be skillful and willing in revenues and expenses adjustments to produce a realistic budget. All those analysis are being evaluated according to the factors stated below.
- Organizational Structure,
- From the perspective of split between politics and service justice in fulfilling its liabilities,
- The depth and continuity of management,
- The documentation of taxes, collection and application mechanisms,
- The assessment of past projects,
- The autonomy level of the local authorities,
- The management information systems,
- The internal control and audit mechanisms,
- The relations with the industry,
- The accounting systems,
- The mechanisms of audit of nature and quality,
- The international relations.
The Indebtedness Structure
Under this heading JCR ER’s analysis focus on the indebtedness structure, the weight of the debt, the financing needs in the future and the possible scenarios of the cash flows. In case of the arise of the default condition laws of the local administrations are being examined from the creditor’s or the investor’s point of view. All those analysis are being evaluated according to the factors stated below.
- The current composition of debt,
- The interest rate and debt coverage ratio,
- The historic debt service performance,
- The easy access to credit resources,
- The off balance sheet commitments,
- The liquidity gaps,
- The legal situation in default.
The Financial Structure and the Budget Performance
Under this heading, for the financial analysis of the local administrations the past and current balance sheets are evaluated. Assets and liabilities, revenue and expenses composition, the inclinations, the stability structure analysis are among most important issues. Efficiency of local authorities are evaluated quantitatively in terms of financial flexibility, operational efficiency and wasteful expenses.
Past trends of general budget support, the grants etc. are examined. Besides, under this heading the economic strength is also a criterion being examined. Because, the state’s economic situation, the revenue resources, expenditure policies etc, are important issues for the debt repayment capability of local administrations. All those analyses are being evaluated according to the factors stated below.
- The budgeting and planning processes,
- The tax assessments and past trends,
- The revenues and expenses, the timing, composition and the historic information,
- The fees paid by the service users and the tax ratios, inclinations,
- The state subsidy,
- The state structure of the state.
Rating of Debt Instruments
The rating of a bond gives an opinion about the probability of paying the principal and interest on time and in full, in other words, the probability of default. In the methodological infrastructure of JCR ER, bond rating, is based on the rating of the local administration.
Depending on the specifics of the issue its rating can be above or below the rating of local administration. The bonds guaranteed by an institution having a higher rating or asset backed bonds can obtain a higher rating than the local administration’s rating.
Collateral of the debt instrument is among the most important factors to determine probability of default and the recovery rate (from the creditors point of view how much risk does the investment carry). Collaterals can be provided in different ways such as;
- The assets on and off the balance sheet of the institution issuing the bond,
The other assets on the balance sheet of the local administration, the off balance sheet assets and treasury bonds can be collateral. The quality and liquidity of the collateral are important factor on the credit risk of the bond. Because a strong and liquid collateralization means a strong recovery in case of a default, it increases the rating of the bond. The asset backed bonds issued are considered fully collateralized.
if administrations are going to issue in foreign markets and want to avoid transfer and convertibilty risk they can insure the bonds. As rating of the insured bonds are free of country risk (systemic risk) and will be determined only regarding issuer’s risk, they are expected to have higher ratings compared to uninsured bonds.
Structured finance bonds can be insured by “monoline” insurance companies.
The monoline insurance companies are insuring the asset backed bonds issued by issuers of emerging countries, they also do insure the speculative rated securities called “sub-prime” of developed markets’. The interest rate margins of insured bonds are reflecting the insurer’s risk not the issuers.
Another way for the issued bond to have a higher rating than the issuer’s rating is to be guaranteed. The guarantee can be provided by central government of local administration issuing the bond or external institutions (for example international institutions such as IFC-International Finance Corporation).