Super Downgrades on Local Governments Increase in March

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Following a year that saw more downgrades than upgrades, the rare “super downgrade” appears to be gaining steam among local government credits.

According to Municipal Market Advisors, Moody’s Investors Service and Standard & Poor’s have issued a total of 71 super downgrades — rating cuts of three or more notches — on local government credit ratings in the past six months.

For this month through March 14 alone, the ratings agencies issued 23 super downgrades, compared to 13 in February and only 4 in January.

“While these few dozen super downgrades are just a tiny minority of the thousands of rating assignments ongoing at the agencies, their incidence does imply that credit deterioration in the local government sector is both rapid and unexpected, at least to the rating agencies themselves,” MMA analysts said in a recent report.

These multi-notch downgrades “pack an outsize punch to investor confidence and liquidity as they undermine assumptions of credit and valuation stability” according to the report, authored by Matt Fabian, Lisa Washburn, and Robert Donahue.

When Standard & Poor’s downgraded Davenport, Indiana’s general obligation bonds to A from AA, the credit’s ordinal ranking within Standard & Poor’s rated credits was dramatically repositioned in a single year. Before the action, an estimated 75% of the agency’s ratings were below Davenport’s, but only about 35% were below the rating following the action.

“This was, therefore, not only a dramatic shift in the absolute but also the relative opinion of Davenport’s creditworthiness,” analysts said.

The report points to tardy municipal disclosures as part of the problem.  Based on a sampling of issuers involved in recent actions, the most recent audit available on EMMA is often from fiscal year 2011, in which year tax collections were based on economic activity from 2010 or earlier, according to MMA analysts.

“This development is concerning in its own right: not only does it suggest a level of rating and/or credit volatility inconsistent with historical trends, but also that the traditional regime of annual financial disclosures, annual credit reviews may no longer be adequate for this asset class,” analysts said.

Naomi Richman, a managing director in Moody’s public finance group, says the numbers of multi-notch downgrades — 12 in March and 6 in February for Moody’s — are still really low and don’t stand out as a dramatic trend.

“It’s consistent with our expectations that we gave in our annual outlook report,” Richman said. “I don’t think it signifies anything other than the general negative outlook that we have on the sector and the stressful environment for a lot of issuers.”

She also noted that the amount of multi-notch downgrades will vary from month to month, and sometimes depends on when financial information from local governments is received. It’s common that governments publish this information only once a year, up to 12 months after the end of their fiscal year.

“It ebbs and flows,” Richman said. “If we’re in a timeframe where more financial statements are being released, then we’ll have more of them being analyzed, and perhaps more rating activity.”

The spike in multi-notch downgrades follows years of negative outlooks and a majority of downgrades on the local government sector.

For the fourth straight year, Fitch Ratings gave more downgrades than upgrades last year, according to a report released on Wednesday. About 4.8% of Fitch’s municipal ratings were downgraded, compared with 2.5% of ratings upgraded.

The tax-supported sector, which represents 56% of public finance ratings, led the negative rating activity with downgrades topping upgrades by 3.8 to 1.

Among states, California-based ratings topped downgrades last year, followed by Texas, Florida, and Michigan.

Moody’s also dropped more ratings than it lifted last year, downgrading a record of $311 billion of public finance debt, an increase of 60% from the year before.

Standard & Poor’s had a more positive ratings trend last year, with 447 downgrades and 567 upgrades.

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