Municipal credit quality deteriorated in the second quarter, reflecting fiscal problems in Puerto Rico, New Jersey and Chicago, according to Moody's Investors Service.
Moody's downgrades outnumbered upgrades 149-107, the rating service said Monday, the first time in three quarters more ratings were cut than raised. In terms of par value the quarter was overwhelmingly negative, with Moody's downgrading $120 billion and upgrading $26 billion.
The biggest downgrades by par value were to Puerto Rico and its associated credits, New Jersey, Chicago, and other credits affected by an Illinois Supreme Court ruling on pension reform. Together these accounted for 92% of the debt downgraded.
In terms of sheer numbers, local governments accounted for 78% of the quarter's downgrades, according to the report prepared by Moody's assistant vice president Mark Lazarus and seven others. Moody's downgraded 108 local governments and upgraded 73 in the quarter.
Analysts said local governments are still reeling from the Great Recession, which led to a five-year period in which Moody's downgrades had outnumbered upgrades. Tom Kozlik, managing director at PNC, said revenues still aren't rising as fast as they were before the recession.
"While the U.S. economy has been experiencing a long slow economic recovery, the same cannot be said for all of public finance credit quality," he said.
A number of local governments have been drawing on their reserves for a few years and thus have structurally imbalanced budgets, he told The Bond Buyer. "It is even more problematic to think about the credit-related consequences these local governments will experience when there is another economic downturn." Many of the local government downgrades were in states whose own credit was weakening, said Richard Ciccarone, president of Merritt Research Services. In these states the state government may normally provide support for the local governments and the fact that this support in doubt probably contributed to Moody's dropping some of them.
In Monday's edition of Municipal Market Analytics' Weekly Outlook, managing director Lisa Washburn drew on another Moody's report to point out increasing distress in the local government sector. From the end of 2011 to the end of 2014 the percent of the sector with speculative grades doubled to 0.6%, Washburn said, referring to Moody's July default study as its source. During the same period, the percent of all municipal issuers below investment grade went from 1.3% to 1.6%.
"The growing below investment grade population suggests that the incidence of defaults among rated credits could increase modestly in coming years," Washburn wrote. "In the local government sector we expect that expenditure growth related to long-term liabilities will outpace revenue gains and service cuts and expense deferrals will become less palatable."
Higher education was another sector to which Moody's gave more downgrades than upgrades. Moody's downgraded 19 issuers totaling $2.9 billion and upgraded 3 issuers for a total of $356 million.
Moody's upgraded more than it downgraded in the housing and infrastructure sectors. While it shifted only 10 ratings in these sectors, the shifts affected about $7.1 billion.
In explaining the public finance sector's greater number of downgrades in the quarter, Lezarus and his associates pointed to "weakened financial performance in regions experiencing a slower economic rebound and competition within the healthcare and higher education sectors."
Ciccarone said in the wake of Puerto Rico's move towards default and Chicago's downgrade into junk, Moody's professionals may have felt a psychological need in the quarter to be tougher on other credits.
Moody's has too many municipal credits in the Aa category, Ciccarone said. He noted that the agency rated Chicago Public Schools in this category as recently as 2012. On May 13 Moody's downgraded this school system and its $6.2 billion in outstanding debt to Ba3.
