LOS ANGELES -- While the imminent cuts to federal spending from sequestration will be painful for states and local governments, that pain would set in gradually and most issuers are well-positioned to face it, according to the three major ratings firms..
Standard & Poor’s said in reports Thursday that state and local governments and their affiliated entities can handle the implementation of $85 billion in cuts from the federal budget.
Mandated cuts to federal spending, known as sequestration, began March 1. Absent action by Congress, the federal government will phase in $1.2 trillion in cuts over the next 10 years, with $85 billion occurring this fiscal year ending Sept. 30.
In a report titled “Sequestration is Another Bump in the Road to Recovery for U.S. State and Local Governments,” Standard & Poor’s analysts said the effects will be mildly negative in broad terms, but have the potential to apply more acute credit pressures to specific jurisdictions. However, many issuers have had time to prepare for the possibility of the looming cuts.
“States and many local governments have been actively monitoring developments at the federal level, and we believe they have evaluated the potential effects of sequestration in their revenue forecasts and budgets,” said Standard & Poor’s credit analyst Gabriel Petek.
The report noted that direct fiscal implications for states are limited by the fact that Medicaid is exempted and that indirect macroeconomic effects could be material but are likely manageable.
State and local jurisdiction issuers that will feel the effects more acutely than others include some education and public safety programs, ports, airports that rely on federal funding, and jurisdictions home to military bases.
Public finance infrastructure issuers, on the other hand, are unlikely to be harmed by the budget cuts, according to the second report from Thursday, “Sequestration Unlikely to Hurt Municipal Infrastructure Issuer Credit Quality.”
The report notes the essential nature of services such as drinking water, sewer service, solid waste disposal, and electric grid reliability, saying the issuers responsible for these services are unlikely to be impeded.
In the third report, “Municipal Enterprises to be Pressured by Sequestration; Public Housing Authorities Most Directly,” analysts said that the sequestration will have various effects on these sectors. Many issuers in the higher education and healthcare sectors receive some form of federal funding and could be negatively affected by the spending cuts. The housing sector, in which nearly all municipal housing transactions have at least one form of federal support, will be affected most directly.
Fitch Ratings weighed in Friday with a report on the Federal cuts, calling them “manageable for U.S. public finance entities.”
The firm said credit impacts will be isolated and no near-term ratings actions are expected even though the funding reductions will place a financial burden on issuers that have already faced significant fiscal pressures in recent years.
“We continue to believe that broader cuts that the Federal government may implement as it confronts deficit reduction are the larger concern for public finance credits,” Fitch said, noting that the $85 billion in sequestration cuts are only 0.5% of U.S. GDP.
Moody’s Investors Service said in a report Thursday that sequestration will have direct impacts on hospitals and universities that receive federal support, as well as housing authorities that receive capital funding appropriation. State and local issuers with high concentrations of defense employment and procurement will be especially affected, the report said.
While the sequestration would be a credit negative for public finance issuers, most effects will be felt gradually as spending reductions are phased in, Moody’s assistant vice president and analyst Sarah Vennekotter wrote in the report.
“For state and local governments, many of which rely on economically sensitive income and sales taxes, sequestration will mostly be felt through lower government purchases and lower incomes of federal employees and contractors caused by staff cuts, furloughs and contract terminations,” she said.
Moody’s plans to publish more research on the specific impacts of the sequester in the coming weeks.
