Moody's: Bad Time for Localities

WASHINGTON - This recession will likely result in more rating downgrades for local governments than any other during the last 40 years because it will be deeper and longer lasting, Moody's Investors Service warns in a new report.

"Given the widespread nature of this downturn and its possibly unusual depth and duration, [it] may have a more significant impact on ratings than prior cycles," Moody's said in its report: "Impact of the Credit Crisis and Recession on Local Governments."

The national recession has sparked a number of factors that will negatively affect local governments in the coming year, including falling home prices that threaten property tax collections, a short-term market unfriendly to issuers that rely on cash-flow borrowings, and a reduction in state aid, the report said.

"With the recession now appearing to have spread to most regions and sectors of the economy, few local governments will escape the difficult choice between raising taxes ... and cutting services in order to balance their budgets," the report said.

Property tax revenues, which make up about 72% of local governments' tax receipts nationwide, are expected to fall more quickly than in other recessions, the report said. Some localities have yet to feel the effects of the housing market downturn due to a built-in lag time for their property tax assessments, but most will still feel the effects earlier than in previous downturns, the report said.

"More rapid downward reassessments of property values will, consequently, result in more rapid property tax revenue reductions," Moody's said. "With the unprecedented increase in property values during the recent housing boom, property taxes now comprise a greater proportion of many local governments' revenues. This increase in revenue concentration will make the property tax reductions many governments are likely to experience even more acutely felt and difficult to manage."

As a result of falling home prices, other tax revenues also will decline, Moody's said.

The rating agency cited as an example sales taxes, which comprise 16% of local government tax structures. In recent years, home equity loans have fueled consumer spending. But when the values of their homes decline, homeowners tend to curtail their spending, Moody's said.

Local governments also are exposed to a variety of other property-related revenues that fluctuate with the property market, including real estate transfer taxes, building permit fees, and mortgage recording fees.

"Given the nature of the downturn and sharp contraction in new home construction, the magnitude of the declines in these revenue sources will likely be precipitous," the report said.

Turmoil in the municipal market may shut out of the short-term market those local governments that are reliant on cash-flow borrowing for operating liquidity, which may cause their long-term credit quality to weaken, Moody's warned.

Regular issuers of cash-flow notes, such as states, will be more able to maintain affordable market access, but less frequent issuers will find it more costly to access the market, the report said.

Additionally, the market will make long-term borrowing for funding operations a more risky move than before, the rating agency said.

"With the option to purchase triple-A bond insurance almost entirely foreclosed, lower-rated entities will be even more exposed to reduced capital market access," Moody's said.

Municipalities are also vulnerable to state and federal governments' financial stress. Localities may find it harder to balance their budgets if states are no longer providing them with as much assistance, Moody's added.

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