Pub. 8 2013-2014 Issue 1

May | June 2013 25 Extraordinary Service for Extraordinary Members. E FFECTIVE JAN. 1, 2013, BANK regulators implemented new standards for municipal in- vestments that require most banks to adopt a new approach to the credit analysis process. The biggest take away is clear: credit ratings will no longer serve as sole justification for credit quality. Fortunately for most community banks, credit ratings have become an afterthought in the credit review pro- cess. The first blow came several years ago when, in the wake of the financial crisis, the lion’s share of monoline credit insurers lost their AAA ratings and the associated ratings on insured munici- pal bonds. Investors soon realized the importance of analyzing the underly- ing credit profile of the municipality, regardless of ratings or credit enhance- ment features. Regulators also have addressed the appropriateness of using third-party research. While the use of a reliable third party to aid the bank in its credit analysis process is acceptable, third-party analysis is neither required nor appropriate as the only assessment of credit quality. In the same way that it is no longer acceptable to rely solely on credit ratings, a third party cannot be the only assurance the institution has to justify credit quality. In the absence of a third party’s credit rationale, using third-party data is sufficient so long as the institution can justify a credit opinion internally. Amidst much speculation as to how to implement a robust credit analysis framework, the FDIC, OCC, and the Federal Reserve have set out clear guidelines for what they expect in determining the permissibility of municipal investments. Below is a summary of those guidelines to aid your institution in implementing such a framework. The bottom line is this: examiners must see proof of an internal credit analysis process. New Regulations for Municipals in 2013: Dodd-Frank, Section 939A Drew Simmons , The Baker Group Key Factors for All Municipal Investments 1. Confirm spread to UST is consistent with bonds of similar credit quality. 2. Confirm risk of default is low and consistent with bonds of similar credit quality. 3. Confirm capacity to pay and assess the financial and operating per- formance through internal credit analysis. 4. Understand local demographics/ economics. Consider unemploy- ment data, local employers, income indices, and home values. Key Factors for General Obligation Bonds 1. Evaluate the soundness of a mu- nicipality’s budgetary position and review management experience. 2. Determine the stability of tax rev- enues and the issuer’s taxing au- thority. 3. Consider debt profile and level of unfunded liabilities. 4. Identify the diversity of revenue sources. Key Factors for Revenue Bonds 1. Assess the source and strength of the revenue structure for municipal authorities. 2. Consider obligor’s financial condi- tion and reserve levels. 3. Compare annual debt service and debt coverage ratio. 4. Review credit enhancements, legal covenants, and nature of the project. Many banks already have estab- lished internal credit analysis pro- cedures, utilizing key credit metrics such as those highlighted in The Baker Group’s Municipal Credit Profile. As shown in the example on the following page, this allows the investor to perform a pre-purchase credit analysis that is both useful and efficient. These credit metrics are derived from the bond’s of- ficial statement, financial statements, and other relevant filings from the Q Dodd-Frank — continued on page 26