WASHINGTON — The prospect of significant cuts in federal spending has become a larger factor in municipal credit risk than ever before and will affect some municipal issuers as well as have repercussions on the broader economy and financial system, Moody’s Investors Service said in a report Monday.
“While reducing federal government spending is a credit positive for the United States, it will be a credit negative, to varying degrees, for U.S. states, local governments, and other municipal entities,” the rating agency said in its report, “The Impact of U.S. Federal Fiscal and Economic Strain on Municipal Credits.”
Moody’s noted that if the Joint Select Committee on Deficit Reduction does not reach agreement on how to reduce the deficit by $1.5 trillion by Nov. 23, automatic federal spending cuts of $2.1 trillion or more over the next decade could be triggered. Even if the committee devises a plan, proposed federal spending cuts are expected to be a significant part of it, the rating agency said.
These cuts could have major adverse impacts on states with a high degree of dependence on federal revenues, health care institutions reliant on federal revenues in connection with Medicare and Medicaid, and housing finance agencies that rely on federal subsidies or insurance.
Moody’s said 51% to 60% of the total governmental funds of four states — Arizona, Louisiana, Mississippi and South Dakota — come from the federal government. For 21 other states, including California, New York and Florida, 41% to 50% of their governmental funds come from the federal government, it said.
Less affected by federal spending cuts would be local governments — except those in the Washington, D.C., area where there are high concentrations of federal employees — nonprofits, and issuers involved in infrastructure financings, Moody’s said.
Although Jack Dorer, the Moody’s analyst who authored the report, pointed out in an interview that local governments in states hard hit by federal funding spending cuts may suffer a trickle down effect.
“Federal spending reductions would significantly strain state budgets at a time when most are struggling to reach structural balance after the Great Recession,” the rating agency said.
But states have significant flexibility to eliminate or reduce programs for which they receive federal funds, if aid is cut, it said.
“While there are likely to be rating and outlook changes over time, we do not expect wholesale shifts in ratings as most issuers have demonstrated a willingness and ability to make significant adjustments to address budgetary pressures,” the report said.
Moody’s said it will monitor state and local government and conduit borrower ratings by looking not just at the impacts of federal budget cuts, but also at the weakness in the economy and the resulting pressure on issuers’ budgets, as well as the degree to which there is heightened capital market volatility, and the ability of issuers to marshal financial resources to mitigate any problems.
