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 CITY COUNCIL AGENDA ITEM NO. 15


Meeting Date: May 13, 2008

Subject/Title: Adopt a Resolution supporting reform of the bond rating system to eliminate discrimination against municipal bonds, authorizing the Mayor or designee to sign a letter protesting the double standard in bond ratings, directing staff to send the letter to the three major bond rating agencies and to register the City as a member of the coalition of public agencies supporting the reform.

Submitted by: Kerry Breen, Business Services Manager

Approved by: Pam Ehler, Director of Finance and Information Systems



RECOMMENDATION
Adopt a Resolution supporting reform of the bond rating system to eliminate discrimination against municipal bonds, authorizing the Mayor or designee to sign a letter protesting the double standard in bond ratings, directing staff to send the letter to the three major bond rating agencies and to register the City as a member of the coalition of public agencies supporting the reform.

PREVIOUS ACTION
None.

BACKGROUND
The turmoil in the municipal bond markets has brought into focus the higher standards imposed by the three major rating agencies in rating municipal bonds as compared to ratings for corporate bonds, mortgage-backed securities and other debt instruments. As most investors know, state and local government entities rarely default on their bonds. Yet municipal ratings fail to reflect that fundamental fact.
The rating agencies own studies show governmental, or municipal, issuers default much less than corporate issuers.
• Municipal bonds rated Baa by Moody’s have experienced a default rate of only 0.13 percent, while corporate bonds rated Aaa by Moody’s have defaulted at four times that rate, or 0.52 percent.
• Corporate bonds rated AAA by S&P have defaulted at almost twice the rate of municipal bonds rated BBB (0.60 percent and 0.32 percent, respectively). Standard & Poor's acknowledges that the historic rate of defaults of A-rated municipal bonds is 0.23 percent, while that of corporate bonds is 2.91 percent - or 13 times greater.
• Of all general obligation municipal bonds rated by Moody’s between 1970 and 2006, only one issuer defaulted.
• For a tax-backed bond rated BBB or better by S&P, the likelihood of default over a 20-year period is only 0.03 percent.

The downgrades of several bond insurers, and the higher costs that imposed on many municipalities with variable rate bonds backed by those insurers, has led to calls for rating agency reform. In many cases public agencies seek bond insurance to secure higher ratings, thereby equalizing the differences between how municipal and corporate bonds of comparable risk are rated. This added cost to compensate for the discrimination against municipal bonds is staggering. California state officials estimate they have spent $102 million on bond insurance between 2003 and 2007 for $9 billion of bonds in order to secure higher bond ratings (and lower interest rates as a result).

California State Treasurer Bill Lockyer has been leading the campaign nationwide to end discrimination in municipal bond ratings. He was recently joined by 10 other state treasurers and financial officers from a number of local agencies, including the City of L.A., in calling on the three major rating agencies to examine their practices and treat municipal bonds on par with corporate bonds that expose investors to the same level of risk.

Standard & Poor's objects to the call for reform, claiming they have one consistent rating scale, despite the evidence of their own default studies to the contrary. Fitch acknowledges the existence of two scales and has announced it is undertaking a review of whether they should continue using two scales or move to a single scale. Moody's has taken the greatest strides. The firm announced that it will assign a corporate-equivalency rating (what it calls a global scale rating or GSR) alongside the traditional municipal rating to any municipal bond at the issuer's request.

Recently the board of directors of the League of California Cities unanimously endorsed the call for reform in the municipal bond rating system to end the historic discrimination against municipal issuers that has cost taxpayers billions of dollars in higher interest and bond insurance costs. Current ratings practices also mislead investors by grossly inflating the risk of buying municipal bonds and also undermine the effective functioning of a transparent market. The League sent a letter (attached) to the three rating agencies, endorsing the reform of the bond rating system. Other agencies and individuals supporting the reform effort are listed on a website established by Treasurer Lockyer for this purpose. (http://www.treasurer.ca.gov/ fairbondratings/index.asp).

Staff recommends adoption of the attached resolution endorsing the reform campaign and calling on the municipal bond agencies to end discrimination in the rating of municipal bonds; to treat taxpayers the same as corporations and rate municipal bonds based on the risk of default; and to create a unified, global rating approach that treats all issuers equally, and better serves taxpayers and investors. The City can further voice its support for ratings reform by sending the attached letter to the three rating agencies, with a copy to California State Treasurer Bill Lockyer, and to register the City as a member of the coalition of public agencies supporting the nationwide effort to reform how bond rating agencies grade state and local bonds.

FISCAL IMPACT
There is no fiscal impact associated with this action. Interest expense and bond insurance savings may be realized if the ratings agencies modify their methodology of rating municipal bonds.

Attachments:
Resolution
Letter to Three Major Ratings Agencies

RESOLUTION NO.

A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF BRENTWOOD SUPPORTING REFORM OF THE BOND RATING SYSTEM TO ELIMINATE DISCRIMINATION AGAINST MUNICIPAL BONDS, AUTHORIZING THE MAYOR OR DESIGNEE TO SIGN A LETTER PROTESTING THE DOUBLE STANDARD IN BOND RATINGS, DIRECTING STAFF TO SEND THE LETTER TO THE THREE MAJOR BOND RATING AGENCIES AND TO REGISTER THE CITY AS A MEMBER OF THE COALITION OF PUBLIC AGENCIES SUPPORTING THE REFORM

WHEREAS, the recent turmoil in the municipal bond markets has brought into focus the higher standards imposed by the three major bond rating agencies in rating municipal bonds as compared to ratings for corporate bonds, mortgage-backed securities and other debt instruments; and

WHEREAS, issuers of municipal bonds rarely default on the bonds they sell to finance streets and roads, public buildings, bridges, flood protection and water systems, and other critical infrastructure, yet municipal bond ratings fail to reflect that fundamental fact; and

WHEREAS, the rating agencies even acknowledge this disparity, but they ignore it in their ratings. Standard & Poor's, for example, acknowledges that the historic rate of defaults of A-rated municipal bonds is 0.23 percent, while that of corporate bonds is 2.91 percent - or 13 times greater; and

WHEREAS, despite the relative default rates shown by their own data, the rating agencies continue to discriminate against municipal issuers, requiring public agencies to secure expensive bond insurance in order to secure bond ratings comparable to those of private corporations; and

WHEREAS, the rating agencies base their ratings of corporate bonds on the risk the issuer will default. Their ratings of municipal bonds, in contrast, have little relationship to the risk of default. This difference provides a substantial economic benefit at the expense of taxpayers across the nation; and

WHEREAS, a coalition of state and local public agencies, led by California State Treasurer Bill Lockyer, has called on the three major rating agencies to examine their practices and treat municipal bonds on par with corporate bonds that expose investors to the same level of risk. The Treasurer also testified before the House Financial Services Committee on March 12 about the need for reform.

WHEREAS, the response by the rating agencies to the call for reform has been uneven. Moody’s has taken the greatest strides, announcing it will assign a corporate-equivalency rating (what it calls a global scale rating or GSR) alongside the traditional municipal rating to any municipal bond at the issuer's request; and

WHEREAS, the current double-standard by rating agencies: (1) drains billions of dollars from taxpayers’ pockets in the form of unfairly high interest rates; (2) forces taxpayers to pay even more money to buy bond insurance – insurance they would not have to purchase if municipal bond ratings accurately reflected the slight risk of default; (3) misleads investors by grossly inflating the risk of buying municipal bonds; and (4) undermines the effective functioning of a transparent market.

NOW, THEREFORE BE IT RESOLVED that the City Council of the City of Brentwood

1) calls on the major municipal bond agencies to end the double standard in the treatment of municipal and corporate bonds; to treat taxpayers the same as corporations and rate municipal bonds based on the risk of default; and to create a unified, global rating approach that treats all issuers equally, and better serves taxpayers and investors, and

2) authorizes the Mayor or designee to sign a letter protesting the double standard in bond ratings and directs staff to mail the letter to the municipal bond rating agencies, with a copy to California State Treasurer Bill Lockyer, and

3) directs staff to register the City as a member of the coalition of public agencies supporting the nationwide effort to reform how bond rating agencies grade state and local bonds.

PASSED, APPROVED AND ADOPTED by the City Council of the City of Brentwood at a regular meeting held on the 13th day of May, 2008 by the following vote:
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