Nobody really paid much attention when DeKalb County’s debt was downgraded five notches at the end of March by the rating agency S&P. Immediately thereafter, S&P withdrew its rating of DeKalb, saying that the county had not provided enough information for S&P to make any kind of accurate assessment.
The Atlanta Constitution-Journal (De Kalb is one of five counties that — roughly speaking — make up the Atlanta, Georgia metropolitan area) ran a story about how embarrassing it was. But other than that, the news didn’t create much of a stir.
Except at Citi, which issued an alarmed report, suggesting that DeKalb County might be the proverbial canary in the coal mine for the broader muni bond market. FT Alphaville picked up on the Citi report and republished excerpts:
Our primary concern for the muni market is simply this: DeKalb County is not some small, out-of-the-way community with limited size and resources; it is a county of roughly 750,000 people, nearly 8% of Georgia’s total population. For the county to apparently let its problems fester to such a degree as to warrant a five-notch rating downgrade and ratings suspension from S&P raises potential concerns regarding rating stability and effective budgetary management at the local government level.
Investors are not used to seeing such dramatic and harsh rating actions. While we do not believe that a substantial number of other local governments have painted themselves into a corner to the extent that DeKalb County has, this wrenching change in rating status has the potential to generate additional credit concerns in the municipal market, particularly if this pattern occurs in a handful of other local governments.
In response, DeKalb County officials said what you would expect them to say (they were “surprised” and “disappointed” by S&P’s decision) and pledged to get their house in order. But the transparency question raised by S&P (how can we rate municipal debt if we can’t see the financials that under-gird it) lingers over the entire $3 trillion muni market.
The FT picks up the thread today:
“DeKalb may be the tipping point for disclosure,” (a broker) says. “The lack of information worked previous to the downturn in the economy, but I don’t think it will work with investors anymore.”
Disclosure, or the lack of it, is a raw nerve in the $3,000bn muni market, which has become rattled by fears of rising local defaults. Municipalities are not required to register their securities with the Securities and Exchange Commission and are not therefore subject to the same disclosure requirements as corporate bond issuers. Furthermore, there are more than 50,000 issuers of munis, including counties, cities, school districts and other local bodies, making problems hard to spot.
Matt Fabian, managing director at Municipal Market Advisors, says one reason why rating agencies may be acting more aggressively with patchy disclosure is regulation. New rules, set out in the Dodd Frank Act, have been introduced after rating agencies came under fire for miscalculating risk in mortgage debt before the financial crisis.
If greater transparency is required from municipal governments all across the United States, DeKalb will no longer be exceptional. It will be one of many local governments downgraded and then dropped altogether by ratings agencies.
Assuming that happens, what happens next? No one really wants to find out. Everyone wants DeKalb to be the exception that proves the rule, even though everyone knows it’s not.