Sell Side

S&P Eyes Separate Criteria for State Ratings

Standard & Poor’s is proposing to separate and update its methodology for rating state credits, a move aimed at providing greater detail to clients and incorporating the idiosyncratic position states occupy within the municipal world.

The agency on Tuesday issued a 20-page report outlining the new criteria, and over the next month is seeking comments from issuers. They hope to implement the proposed methodology this summer.

Ratings are unlikely to change as a result of the proposal. The “same general analytic framework” will be maintained, the report said, but it aspires to offer investors a quantitative and qualitative method of comparing one state to another.

“There would be state-specific benchmarks and ratios, and also a lot more clarity about the government framework, which has always been a big part of state ratings,” said Robin Prunty, who co-authored the report.

One reason for the new criteria is the success of Build America Bonds, the taxable municipal asset class created last year that has drawn demand from buyers unfamiliar with the muni market.

In December, Standard & Poor’s said it was making efforts to “enhance comparability of our ratings and provide taxable investors with a way to assess debt relative to sovereign peers outside of the U.S.”

Those measures, such as ratios of tax-supported debt to gross state product, would be comparable under the proposal.

The analytic framework uses five broad categories: government framework, economy, budgetary performance, debt and liability profile, and financial management. The categories are then subdivided into more specific metrics.

The agency proposes rating each metric on a scale from 1 (the strongest) to 4 (the weakest), and then averaging to develop a score for each of the five broader categories. The five categories are then weighted equally to produce a numerical score which corresponds with the ratings scale.

“What this allows is for the investor to sit there and see a layout of all 50 states, be able to measure them on different little inputs, and see where they rank compared to each other,” said Derek Bonifer, muni research director at BMO Capital Markets. “You’re going to be able to look at the numbers and say, 'Okay, which state has more flexibility and an easier time of raising taxes?’ ”

Greater transparency should give issuers a better understanding of how to improve their ratings.

“My state may not end up with the highest credit rating as a result, but I really respect the fact that they laid out their cards on the table so that I can’t just whine when I don’t get the highest ratings,” said Laura Lockwood-McCall, director of debt management for Oregon. “It’s kind of like the teacher laying out for the students exactly how they are going to grade them. But it’s a tough curve.”

Critics, however, say the new methodology fails to recognize that munis have a much lower default history than similarly rated corporate debt.

“The best that can be said about this proposal is that, if it’s adopted, S&P would discriminate against taxpayers in a more transparent fashion. The inequality would be brought out into the open,” said Tom Dresslar, spokesman for California Treasurer Bill Lockyer.

Richard Larkin, director of credit analytics at Herbert J. Sims & Co., agreed that states should be rated with different criteria, but he said the five broad categories shouldn’t be equally weighted.

“I believe government framework should count for more in the weighting process — that is why states should have higher ­average ratings than local governments,” he said. “S&P is correct in its statement that the typical high credit profile for states should be AA or higher. I personally ­believe that in assessing risk of ­default, most states should carry AAA GO ratings.”

But Prunty said upgrades as a result of the proposed new methodology were unlikely, and she strongly denied that the proposal had any connection with Moody’s Investors Service and Fitch Ratings’ recent recalibrations to a global scale that resulted in thousands of upgrades.

Others see a direct link.

“There’s clearly a tie here to the fact that Moody’s does this massive ratings change,” said Justin Hoogendoorn, managing director of strategic analytics at BMO. “S&P is doing it under the radar, while Moody’s is trying to make this big splash.”

“Essentially they are saying, 'if the environment gets better, we can probably upgrade ratings and ultimately be to where Moody’s just changed things to,’ ” he said. “But if the environment continues to deteriorate and the U.S. has larger and larger problems, I don’t think S&P wants to be in Moody’s predicament that you make this massive upgrade and then all of a sudden you start downgrading.”


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