Despite upheaval in the financial markets, most state and local governments are expected to meet their debt service obligations and continue to have a low risk of default, according to a study by Standard & Poor’s.
In a recently released report, S&P indicated that market turmoil is likely to raise the cost of borrowing for many state and local governments, and although some may feel pinched, they are expected to meet their debt service obligations.
The study, entitled “Market Turmoil and Escalating U.S. Muni Debt Requirements,” indicated the rating agency’s expectation that non-rated municipal bonds are more likely to experience fiscal stress than rated entities as a result of the economic downturn.
Typically, issuers seek a rating when their financial track record is strong and they have accumulated a record of historical operations. Newer startup entities have yet to demonstrate the “staying power” necessary to be considered investment grade. Such borrowers often sell bonds with credit enhancement, if available, or without a rating.
One impact of current market conditions that S&P foresees is that investment grade credits that rely on market access for short term cash flow borrowing may have a more difficult time doing so, and pay higher rates than they have in the past.
California’s recent revenue anticipation note sale was a case in point. The state issued $5 billion in RANS maturing June 22, 2009, at a yield of 4.25%, well above last year’s level.
Past stress ‘successfully managed’
The report further stated: “It is important to note that we routinely assess weaker economic conditions as part of our credit analysis of governments. Although we view the overall trend of economic and credit performance as having been positive over the last 25 years, we note there were times of stress which governments successfully managed.”
Some of the examples included were the post- 9/11 period, the real estate recession of the early 1990s, and the oil problems of the 1980s.
S&P concluded that rating deterioration may occur for some credits, but most have historically learned how to cope with bad times. Since the vast majority of municipal issuers provide “essential” services, great effort will be made to ensure that the municipal bond market’s history of very low defaults remains intact.