A recent research piece published by S&P on 2/23/12 titled “State And Local Credit Quality Remained Resilient Last Year, Prediction Notwithstanding”, helps summarize why speculation that there would be a system wide collapse of credit quality by states and localities did not materialize. The large drop in tax revenues, and the increased burdens on assistance services, made some municipal investors assume credit downgrades and defaults were inevitable. Yet S&P believes there are structural reasons that this has not happened.
Highlights of S&P’s research:
- Credit analysis on all issuers must be treated differently. Credits are individualized and need to be analyzed on a case-by-case basis.
- Debt service is a small portion of a municipality’s budget, and is a priority to other payment obligations. On average, state’s debt service averages 4% of its expenses, for localities it is a bit higher. Including unfunded pension obligations this changes to roughly 7-15% of expenses.
- Municipalities have delevered (issued less debt) and lowered spending in recent years to offset declining revenues. Fiscal adjustments have also come in the form of revenue increases, through higher taxes and/or fees. Ultimately this combination has been the core to maintaining credit quality during fiscally challenging times.
- Deterioration and changes in credit quality, in most cases, occur in a slow grinding fashion. Individual management by the municipality is very important to adjust to changing fiscal situations. Subtle changes today can make a big difference in the future.