WASHINGTON - Standard & Poor's upgraded a greater percentage of local government ratings than it predicted it would, on a quantitative basis, in applying new criteria to those ratings over the past year, the rating agency said in a report.
"We attribute the difference to qualitative analysis and updated information," the rating agency said in the report, which was released Friday. The primary credit analysts on the paper were Lisa Schroeer and Christopher Krahe.
S&P has applied the new criteria to more than 4,000 U.S. local government issuer and general obligation bond ratings since the criteria was released in September 2013. Of those ratings, 55% were unchanged under the new criteria, 41% were increased and 4% were decreased, according to the report. Most rating changes were by one notch, and the majority of ratings that changed shifted to the double-A category from the single-A category, the rating agency said.
When the criteria were released, S&P predicted 60% of ratings would stay the same, 30% would be raised and 10% lowered, acknowledging the actual results were likely to be different. The predictions from September 2013 were based on quantitative or numerical estimates, but analysts also use qualitative methods in determining the actual ratings, according to the report.
Local government credits receive scores based on seven different factors. The initial score for each factor is based on numerical data, but the scores can be raised or lowered based on things that S&P believes to impact credit quality that can't directly be quantified. Additionally, analysts can adjust numerical data to reflect a more accurate picture of the issuer's performance, S&P analysts told The Bond Buyer.
"We go beyond the issuer's financial statements and take into account, when appropriate, management's actions and any circumstances that could cause financial data to be skewed," S&P said in the report.
Additionally, local government ratings were affected by the strengthening underlying economy. "The credit conditions for local governments have been improving," Schroeer said in an interview. She and Jeff Previdi, S&P managing director overseeing local governments in the East and Midwest, pointed out that the assessed and market values of property have been stabilizing and that unemployment has been declining.
S&P's local government ratings were questioned in a July report by Janney Capital Markets municipal credit analyst Tom Kozlik. He warned in that report that some of the ratings may be too high and out of step with current credit conditions.
In response to S&P's new report, Kozlik agreed that there are positive qualitative factors that can contribute to a local government's credit quality. He also said he thinks "that the push for S&P to make their criteria more transparent is good."
However, Kozlik said in an interview that "there's been an unprecedented amount of credit deterioration at the local government sector, and S&P is not accounting for that." He added that there are many local governments that think their revenues will rebound to pre-recession levels, but that the revenues won't actually do so in the short-run.
Schroeer said in an interview that S&P's rating distribution for local government credits is supported by a historically low default rate.
Previdi said that the rating agency's criteria have more negative overrides than positive ones "to capture the different ways that credits can get into distress." He added that when evaluating ratings, S&P analysts will talk to governments' managers about their plans for how to correct situations that could be credit negative.
S&P had three goals when it decided to update its methodology for local government rating. The first was to make ratings more comparable across geographies and sectors by taking into account the local government sector's overall stability. The second was to enhance the transparency of the methodology, including its qualitative adjustments. And the third was to make the forward-looking components of the analysis explicit, according to the report.
"We believe the results highlight that the criteria were not a wholesale change to our view of the sector, but built on the previous criteria while enhancing comparability, transparency, and forward-looking analysis," the S&P analysts wrote. "The criteria allow us to appropriately capture not only the sector's overall strength, but also let us analyze pockets of stress we have seen in local governments."
