Since early last year, the number of “AAA”-rated localities has more than doubled, according to a newly released Standard & Poor’s report. Over the last 1 ½ years, despite the withering economic downturn, changes in rating criteria combined with a number of first-time rated “gilt edge” communities served to produce an increase of 86 communities now rated in the top “AAA” category.
Although many states and cities are feeling a strong revenue pinch from declining economic activity within their borders, those at the top of the scale are seemingly more immune – the very definition of “AAA.”
Issuers rated at the top of the credit pyramid are expected to ride out weak economies and revenue downturns without breaking a sweat. Strong, diversified economies combined with hefty fund balances are expected to counterbalance the loss of a major employer or taxpayer while providing sufficient financial wherewithal to weather flat-to-lower revenues that accompany a weak economy. Issuers rated down the scale generally have more narrowly based economies and slimmer financial cushions.
Of the newly rated “AAAs,” S&P raised 65 from the “AA” category, with the remaining 21 representing communities never previously rated.
‘AAA’ rating reflects strong fundamentals
An examination of the new “AAAs” shows that neither location nor size were factors in the ratings. Several issuers, including Minnetonka Beach Village, MN, and Bloomfield Hills, MI, have populations under 4,000. Others were major population centers including Phoenix and San Antonio, with 1.5 million residents each.
Common to all the new “AAAs” is above-average wealth levels, low unemployment, strong property values and generally lower debt levels.
S&P candidly admits that it has consciously been revising its rating standards to reward past performance and better recognize a community’s track record in timely repaying its debt. Pressure from Washington, bond issuers and the public to reflect the excellent payment record of municipal bonds in their credit ratings has led to a reappraisal by all rating agencies of past rating practices.
The gap between high corporate debt ratings and those assigned to municipal issuers remains contentious in the face of the collapse of the sub-prime real estate market. Much of the debt that packaged bad real estate loans has since been downgraded to junk or actually defaulted, while municipal bonds have continued to exhibit the strong repayment record for which they are known.
Traditionally, rating agencies have been tightfisted in their willingness to assign “AAA” ratings to municipal debt. Now, 169 local governments carry S&P’s top rating, up from 70 in late 2006.
Moody’s has also been under pressure to better reflect the payment record of municipal issuers in its debt ratings. A general reassessment of all muni ratings has been underway for some time at Moody’s, with the aim of rewriting credit evaluation standards to allow higher ratings for traditional municipal issuers.
New ratings reflect reality
Historically, municipal issuers had been rated more on a qualitative relative scale intended to give investors a sense of comparative credit quality in a muni market that tends to be less liquid, localized and dominated by small issue size. Municipal bond ratings were designed to distinguish among issuers, rather than indicate likelihood of default, since so few ever did. Corporate ratings, in contrast, have sought to statistically predict default potential in a market more national in scope, with more household names and with a higher default experience.
S&P’s recent move to increase its “AAA” rated category better reflects the reality of the municipal market. Investors and issuers are demanding ratings that have better predictive value, and the rating agencies are beginning to listen. The last 18 months have been trying for issuers of municipal debt. But, at long last, the stellar quality of many municipal issuers is finally gaining the recognition it deserves.