A Dose of Downgrades
Wall Street's opinion of state debt has been heading south this year. Local ratings may not be far behind.
The credit-rating party is over. State and local issuers of municipal bonds are experiencing the largest number of downgrades in at least seven years.
So far this year, Standard & Poor's Corp. has lowered the ratings on three states and changed the official outlook on nine to negative. Moody's Investors Service, which downgraded two states, has earmarked six as troubled. And that situation is likely to get worse. "The outlook is negative for almost every state," says Claire Cohen of Fitch. "The bad years are adding up."
It isn't just the revenue fall-offs in the states that has credit rating analysts sharpening their downgrade pencils. In the past two budget cycles--fiscal 2002 and 2003--many states drained rainy day or other reserve funds, securitized tobacco money or took other non- recurring measures to address major shortfalls. Those "easy" fixes are no longer available. With the 2004 budget on the horizon, credit analysts are looking at, in Cohen's words, "what states do with the ugly picture they have."
Robin Prunty, who heads up public finance for S&P, will be studying the "difficult actions"--tax increases, spending cuts or both--that most states will be forced to face. "It's going to be a much more challenging budget environment in 2004," she says.
Some of those cuts may come on the backs of local governments. So far this year, most localities have been able to maintain or improve their credit ratings. The current economic downturn has not affected property values and that, in turn, has protected the property-tax base on which most localities depend.
Those that also rely on sales taxes are starting to feel some fiscal pain, but the more menacing problem for localities is what distressed states do about local aid. So far, only a few states have tampered with local-aid formulas. Where they did, though, local ratings went down. According to a roundup of 2002 rating changes by Moody's, state spending adjustments contributed to rating reductions of eight school districts.
More states may "adjust" local-aid as they come to terms with the third year of high-stress budgeting. "Local governments are going to feel the pinch," says Fitch's Cohen. "Even if states don't pass through their problems, in this kind of revenue climate, revenues aren't going to be growing. And ultimately, if states are under pressure long enough, it finds its way to the local level."
Ratings for other muni-bond-issuing sectors have also been weakening. Health care bonds, affected by reimbursement rates to some health care providers, have experienced more downgrades than upgrades this year, as have bonds in the housing and transportation sectors.
Despite the negative outlook for many issuers, there is no freefall ahead for state and local ratings. "We don't see any risk of imminent defaults, and that's worth emphasizing," says Renee Boicourt, managing director for public finance at Moody's. "Relative to corporate bonds, credit-rated municipal bonds--even when they are at their greatest level of stress--rarely default. We don't see this as cataclysmic by any means."