Despite recent warnings from some financial experts that the ongoing financial troubles of state and local governments will lead to municipal bond defaults, state credits remain much more stable than corporate credits, Moody’s Investors Service said Wednesday.
No state has defaulted on its bond debt since the 1930s, while non-financial U.S. companies have an average annual default rate of about 2% or 2,000 defaults, according to Moody’s records. The relative overall credit strength of states is the reason all of them are rated between A1 and Aaa, while only 4% of U.S. non-financial companies are rated that high, Moody’s said in a special comment it released to the market.
“While most non-financial U.S. companies have speculative-grade ratings, we expect the ratings of all states to remain solidly entrenched in investment grade,” the agency said.
Moody’s analysts “expect that state ratings will remain relatively resilient and that no state will default on its general obligation debt,” the report said. “Moreover, in the very unlikely event that a state were to default on its [GO debt], the ratings reflect our expectation of very high ultimate recoveries on missed payments, supporting our view that such obligations pose generally much lower credit risk to investors than most corporate debt.”
The report follows a flare-up of concerns about state financial woes threatening to destabilize the municipal bond market. Market participants, including banking analyst Meredith Whitney and investor Warren Buffett, have recently warned of possible muni bond defaults due to over-borrowing. This week, the Pew Center on the States observed that states are borrowing more funds than they are collecting in revenue, though the group did not warn of defaults.
Moody’s countered these concerns with an argument that state debt carries with it certain stabilizers that do not exist in corporate debt, such as that governments generally cannot leave bondholders in the lurch. Debt service payments often have legal priority over other commitments.
The rating agency used Illinois as an example in its comparison of state and corporate debt, because Illinois is the lowest-rated state at A1 with a negative outlook and has serious budget and pension problems.
Monthly revenues in Illinois are required to be used for GO debt-service payments before anything else
The state has issued more than $7 billion of long-term debt this year, and is expected to issue another $3.8 billion of pension debt this year, Moody’s said. It has serious budget and unfunded pension and retiree health care problems, analysts noted.
However, Illinois is much better positioned than corporations to raise revenues without also spending more.
A two percentage-point increase in Illinois’ income tax rate would “essentially eliminate the annual budget deficit,” the report said.
If the state sales tax and income tax were raised that much, it would generate a $2 billion annual operating surplus, Moody’s added.
Similarly, Illinois can cut certain costs without losing revenues in the way that a company would, analysts said.
“We expect states to remain under credit pressure for the next few years,” the report said. But “even the credit position of the lowest-rated states is underpinned by important fundamental strengths … that support higher credit standing than the vast majority of U.S. corporate issuers.”
