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Credit Ratings and Risks

David R. Kotok
Sun Mar 5, 2023

My colleague John Mousseau published a piece on what is happening in Florida with a political attack on municipal bond credit ratings. I fully agree with John’s analysis. 
Some readers responded positively to John’s message and thanked Cumberland for publishing on this subject. Others readers responded critically, saying that we were taking a political position.
So, after receiving and reading diverse views from readers, clients, and after some internal discussion, let me try to expand on this important topic. Here’s the link to the original piece written by John Mousseau: “Florida Takes Municipalities Out to the Woodshed,”


Cumberland Advisors Market Commentary – Credit Ratings & Risks by David R. Kotok


First, the issue for us is not about woke or not woke or about ESG or not ESG. It is about the role of a credit rating agency, and it is about how the $4 trillion municipal bond sector uses credit ratings. 
Wokeness or anti-wokeness is irrelevant for credit. Frankly, in my personal view, it’s a distraction used for political manipulation purposes. Try this: Ask ten people for the definition of woke or anti-woke. I have done so, and their answers were all different. No answer can pertain to an analysis of the ability of a municipal bond issuer to pay its bills. 
As an independent professional municipal bond portfolio manager, we try as hard as we can to avoid the distraction of political culture wars, whether they are launched from the far left or the far right. We may have differing views about issues among our group, but we don’t mix them with the business of portfolio management. 
Rating agencies are independent bodies. Their fees are paid by the bond issuers, which means they are ultimately paid by the bond buyers and bond investors. Rating agencies offer opinions after an in-depth analysis of the ability of an issuer to pay principal and interest on its bonds. The ratings cover bond issues with longevity up to 30 years or even longer. 
In my career, I have been involved in giving financial advice regarding municipal bond issuance involving billions of dollars. In every case, there was extensive disclosure required, along with detailed projections articulating the risks involved and the rationale behind the credit rating. That is what the Florida intervention with rating agencies threatens.
Florida’s position has been widely reported in the media. It is described as an attempt to tell the rating agencies what to rate and what not to rate, what to say and what to exclude and, even worse, how to rate or not to rate. Why? Because the Florida political position is, “We don’t like what you may say, so we don’t want you to say it.” 
Let’s unpack that. 
Every single utility bond of any type, whether water or sewer or electric power or municipal servicing for landfills or trash processing, has long-term environmental disclosure requirements. Just look at the stories of toxic waste cleanups and defaulted bonds, and you can see why the rating is so important. So, the rating agency must assess environmental circumstances and risks. The same applies to airport bonds or healthcare bonds or toll road bonds or a lot of other types of municipal financings. Ratings are not perfect because they must make estimates about the future. Rating agencies do have the benefit of massive databases of history.
John Mousseau wrote about the need for ratings to be fully independent. He is absolutely correct.
Let me add that if they are not independent, they won’t be used by bond buyers and bond investors. If a rating agency ever succumbs to political pressure about what to say, we as professionals can no longer trust that agency. In our business we need the truth, and we need risks to be clearly and honestly discussed. If we don’t get that, we don’t buy the bond.
That is why John pointed to an actual bond issue that was penalized on the day the Florida political position became public. Because of the timing, John was able to estimate the actual cost to the bond issuer.
The political issue is not just in Florida. This spreading use of punishment by state and local governments because of a social war politics is growing in the United States. Here’s an example from a recent general-obligation bond issue decision from Louisiana. The source of this quotation is a Bloomberg report:  

Craig Cassagne, Assistant Attorney General with the Louisiana Department of Justice, sought to exclude Barclays Plc (BARC), JPMorgan Chase & Co (JPM), Morgan Stanley (MS), RBC Capital Markets, UBS Group AG (UBSG), and Wells Fargo (WFC) from managing Louisiana’s negotiated municipal bond deals. And because the state had already removed Bank of America Corp. (BAC) and Citigroup Inc. (C) from its syndicate group over gun policies — it would leave few other major investment bank options.

So, Louisiana will auction bonds in straight competitive bidding versus a full underwriting and selling team. We shall see if we can estimate what the final costs to Louisiana will be. The one thing we believe is that the final costs to Louisiana will be higher than they would otherwise be.
Let’s move to Texas.
Here's the Texas rule related to excluded firms: And here’s the reference link to the list of excluded firms: Specific companies in one of those lists include Blackrock, Inc; BNP Paribas SA; Credit Suisse Group AG; Danske Bank A/S; Jupiter Fund Management Plc; Nordea Bank ABP; Schroders PLC; Svenska Handelsbanken AB; Swedbank AB; UBS Group AG. In total, Texas blacklists 347 funds that would otherwise be investments to help Texas’ returns.
Texas is issuing $3.6 billion of natural gas securitization bonds. The bond issue has been authorized. We will only know the actual cost to Texas at the time of issuance when the underwriting syndicate is finished. So, we must guess at what the cost savings would have been if market forces were allowed to work unrestrained on behalf of Texas taxpayers and rate payers. 
In the Florida Pasco bond deal of $345 million, John’s estimate of additional cost was a $875,000 a year over 15 years or about a $13 million added burden on taxpayers. Using the same reference for the $3.6 billion Texas bond deal, we can guesstimate that the additional cost will be 10-to-20 times the Pasco deal or as much as $250 million over the life of the bonds.
Let’s be clear here since some detractor emails will inevitably arrive. We’re not telling the state or local jurisdiction what to do. That is not up to us.
It is up to the citizens in each jurisdiction to determine if they want to incur these types of costs that are imposed by market forces as a response to culture-war politics. Cumberland doesn’t decide that for them. We do decide which bonds to buy for our clients and which issuers to avoid. We do that purely on their merits. 
Bottom line: Professionals in the financial arena, and particularly in independent money management firms like Cumberland, do not succumb to threats or distractions from the political culture war extremists, left-wing or right-wing. We’re hired by our clients to call it as we see it and to represent our clients.
At Cumberland Advisors, we will continue that tradition as we have done for the last 50 years.

David R. Kotok
Chairman & Chief Investment Officer
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