UPDATE, 7:20 p.m.:
The National League of Cities said today that S&P’s decision not to downgrade all triple-A municipal ratings despite the downgrade of the federal government confirms that “the overwhelming majority of municipal debt issued by general-purposes local and state governments remains highly rated and secure.”
The organisation, which represents 19,000 U.S. cities, towns, and villages, said in a statement:
“Concern about the municipal market is now being driven by lack of confidence in the economy and the rating agencies’ assessments that federal policy responses have been inadequate — not local leaders failing to pay their debts or balance their budgets.
To be sure, local and state governments continue to confront declining or slow growth in revenues as a result of the Great Recession and 2011-2012 will present many general purpose governments with difficult choices. But, the overwhelming majority of local and state governments are continuing to balance their budgets and meet their debt obligations.”
ORIGINAL, 12:54 p.m.:
The ratings agency said last night that it isn’t a given that state and local governments will lose their triple-A rating in conjunction with the U.S. downgrade. In fact, S&P called public finance credits “among the most stable and predictable in the world.”
In a statement, the ratings firm said that there are a number of other considerations that could prevent municipalities from getting their ratings cut, highlighting the decentralized governmental structure and “distinct credit cultures” of local governments. Another major factor is the ability of a state and local government to withstand cuts in federal aid.
S&P also noted that some local governments have shown a “greater commitment to fiscal discipline or a more resilient local economy” that justifies a higher rating than the federal government.
Less than 4% of U.S. public finance ratings demonstrate the characteristics deserving of an AAA rating, the agency said in a release.
We do not directly link our ratings on U.S. state and local governments to that of the U.S. sovereign debt rating for reasons outlined in our criteria. However, we recognise generally that U.S. state and local governments’economic performance is frequently similar to the nation and they share responsibility for some spending items with the federal government. Yet individual state and local governments’ funding interdependencies with the federal government vary considerably. A minority of state and local obligors rated by Standard & Poor’s have achieved the highest long-term rating of ‘AAA’. We expect that many of these obligors, particularly those with relatively low levels of funding interdependencies with the federal government or those that, in our view, are likely to manage declines in federal funding without weakening their credit profile, should be able to retain ratings above the U.S. sovereign rating if we would otherwise assign ratings above the U.S. sovereign rating based on our view of other rating factors. However, in light of the potential for common economic and credit environments between the U.S. and state and local governments, we expect that in most instances in which state and local governments have ratings above that of the U.S., the differential will be limited to one notch.
- It is possible for state and local governments to have higher ratings than the U.S. sovereign rating, most likely by no more than one notch.
- We derive our credit ratings by evaluating a borrower’s individual credit factors based on our credit rating criteria
- A factor in rating a state or local government above the U.S. is whether it is insulated from negative federal intervention in fiscal management.
Our credit rating criteria allow for a higher rating on a state or local government than on the sovereign if, in our view, the state or local government demonstrates the following characteristics
- The ability to maintain stronger credit characteristics than the sovereign in a stress scenario.
- An institutional framework that is predictable and that is likely to limit the risk of negative sovereign intervention.
- The projected ability to mitigate negative sovereign intervention by a high degree of financial flexibility and independent treasury management.
Pursuant to our criteria, the fiscal autonomy, political independence, and generally strong credit cultures of U.S state and local governments can support ratings above that of the U.S. sovereign.
Ability To Maintain Stronger Credit Characteristics Than The Sovereign In A Stress Scenario
A central feature of our U.S. public finance criteria is the independence of individual state and local governments from the federal government. In part, this is based on our view of the Tenth Amendment to the U.S. Constitution, which provides that rights not expressively given to the federal government remain with the states. Although our ratings reflect the role of the federal government in state and local finances and economies, we believe that this decentralized governmental structure in the U.S. suggests that we also analyse state and local government credit quality independent of the federal impact.
When viewing credits on a standalone basis, we expect that some state and local governments in the U.S. are capable of maintaining relatively consistent credit quality even through a period of stress at the sovereign level. Compared with many of their peers on a global basis, U.S. state and local governments function with a high level of revenue independence. Specifically, most state revenues (including almost all discretionary revenue) are derived within the states themselves, i.e., they do not come from the federal government. Revenues are even less linked to the federal government at the local level (although some state-shared revenues originate with the federal government). In addition, historically we have found that state and local governments generally have distinct credit cultures backed by well-established frameworks that provide for enforcement of important public finance laws. We view this to be important in the U.S. public finance setting because we predominantly assign issue ratings as opposed to issuer credit ratings. Debt issues in the U.S. municipal market tend to be backed by dedicated taxes, revenues, or fees and include specific protections that are legally enforceable in the U.S. context.
Given the depth and magnitude of the U.S. economy, state and local governments operate within a wide range of disparate economic bases throughout the country. We have found that some state or local economies regularly perform differently from that of the U.S. as a whole. Our criteria describe how we analyse the attributes of state and local economies and incorporate our analysis into our ratings. Beyond analysing economies in isolation, however, we have observed that some state or local governments have more favourable balances between resources and responsibilities (i.e., they may be less leveraged) than the federal government. We believe that certain state and local governments have historically shown a greater commitment to fiscal discipline or a more resilient local economy, which may be reflected in ratings higher than that of the U.S. government. In a minority of cases (3.9% of U.S. public finance ratings), state and local governments currently demonstrate what we consider to be particularly strong credit characteristics consistent with our highest rating and, thus, are rated ‘AAA’. Because we have assigned these ratings based on our view of individual rating factors pursuant to our criteria, we believe these ratings are appropriate notwithstanding the downgrade of the U.S. sovereign debt rating.
A Predictable Institution Framework, Financial Flexibility, And Independent Treasury Management
In our view, the institutional framework for U.S. public finance is among the most stable and predictable in the world. We believe this is primarily a result of the constitutional separation of power between the central and sub-national levels of government that is intended to restrain intervention in state and local government administration.
U.S. state and local governments enjoy considerable financial autonomy from federal intervention. State–and in many cases local–governments have authority to establish and maintain laws pertaining to tax rates and collections, as well as the ability to add new taxes and other forms of revenue generation. In practice, receipt of federal funding typically requires a state or local government to satisfy various mandates, such as providing certain levels of service. And yet, participation in some of the programs for which federal funding is provided is voluntary. This includes Medicaid, the largest federal-state jointly financed social service.
In addition, U.S. state and local governments’ treasury management is independent from the U.S. federal government. Although we consider stress scenarios in which federal disbursements could be delayed or reduced, thereby inflicting cash flow disruptions, state and local government obligors with ‘AAA’ ratings have, in our view, strong access to liquidity, likely allowing them to bridge such episodes.
Criteria Support Possibility Of ‘AAA’ State And Local Government Ratings
Participation in the U.S. economy and legal system provides a platform in which state and local governmental obligors can generally manage their finances and debt portfolios with considerable independence and without material risk of negative sovereign intervention. In light of this independence, our ratings largely reflect our view of local economic characteristics or state-level laws that may impede or strengthen state and local credit quality to varying degrees. Credit implications from these factors are detailed in our relevant criteria documents.
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