Despite facing unprecedented credit pressures caused by the recent recession, the municipal market weathered the storm with remarkably limited credit deterioration, according to a recent report by Moody’s Investors Service.
While downgrades have outpaced upgrades for the past 10 consecutive quarters, less than 6% of the 18,000 municipal credits that Moody’s rates have been either upgraded or downgraded in the last 12 to 18 months, according to the Aug. 31 report, “U.S. Municipal Rating Revisions through the Great Recession.”
“This report shows, for the rated sector, that this clearly has been a period of pressure and stress, but the amount of large credit movement has been pretty rare,” Bob Kurtter, managing director of public finance, said in a phone interview Thursday.
While the credit struggles of some municipalities have been widely publicized, they “are not characteristic of the sector itself,” he noted.
Of the credits that Moody’s rates, most of the downgrades were limited to one or two notches, the report stated. There were 102 multi-notch downgrades, which Moody’s defines as those that move more than two notches, but none at the state level.
At the local level, which accounts for the largest percentage of the Moody’s-rated universe, only 22 counties, cities, and school districts experienced multi-notch downgrades. Those with limited revenue sources, for instance, were prone to sharp declines in credit quality when and if a primary revenue source was impaired due to reduced state aid, property tax revenues, or liquidity, according to the report.
For instance, in November 2010, Moody’s downgraded Atlantic City, N.J.’s general obligation and guaranteed bonds by three notches to Baa1 from A1 largely due to its heavy reliance on the declining gaming industry. Eleven casinos account for approximately 74% of the city’s tax base.
The city’s gaming industry came under significant pressure from the legalization of gambling in neighboring Pennsylvania, Connecticut, and New York.
Meanwhile, other counties, cities, and school districts that suffered multi-notch downgrades were those that had inadequate financial tools or resources to weather financial disruptions that led to the modest amount of downgrades at the local level.
But the serious downgrades were modest, Kurtter said.
“This has been a period of extraordinary stress for governments across the country,” he said. “Governments responded very strongly to the pressures that they have been experiencing, and most of them have been pretty stable, given the high degree of stress.”
Many implemented spending reductions, addressed workforce issues, and focused on building cash reserves, among other strategies to avoid multi-notch downgrades in the changing economic environment, he said.
“They had to make painful decisions as the economy started weakening and we went through this cycle,” he said.
Overall, most of the Moody’s-rated credits survived the recession virtually unscathed, said Chris Holmes, vice president of public finance and author of the report.
“Evidence of large multi-notch downgrades is slim,” he said in the same phone interview with Kurtter. “The marketplace understood that these severe downgrades are few and far between, and by and large, [municipalities] have been able to navigate relatively well,” Holmes added.
The last time that upgrades outpaced downgrades was back in 2008 at the beginning of the recession, before any noticeable impact was felt on municipal credits, he noted.
Holmes said more recently the housing sector was one of the most heavily impacted by the recession, and is still struggling amid the weak U.S. economy.
In fact, of the 102 multi-notch downgrades, 59 were housing-related and more than half of those were multifamily affordable housing projects — limited recourse projects that are significantly affected by poor rental market conditions, investment problems, and-or counterparty downgrades, as well as dips in occupancy.
Downgrades in the sector are a testimony to the severity of the housing downturn in some regions and the associated impact on state housing finance agencies, according to the report. For instance, eight of the large multi-notch downgrades were housing-related credits in Florida.
“Housing numbers are not improving,” he said. “They got a temporary reprieve in 2009 and 2010, but housing prices have declined and the key regions that were impacted are going to continue to feel the effects.”
Besides housing bonds, other downgraded credits across various municipal sectors have faced many challenges, according to the report. Not-for-profit hospitals that are susceptible to downgrades have dealt with lower patient volumes, a weaker payer mix, and increased competition, while most higher education institutions that were downgraded have significant tuition resistance, weak fundraising results, and declining state aid. Many are lower-rated and have a more regional draw, weaker pricing power, and less diversified revenues.
Despite the mostly positive outcome of the report, Moody’s maintains a negative outlook on all major public finance sectors for the next 12 to 18 month horizon and expects downgrades to continue to outpace upgrades over that time.
Financial strains on municipal credits are likely to persist given a backdrop of high unemployment, anemic gross domestic product growth, high fixed costs, and growing off-balance-sheet liabilities, according to the report.
In addition, public finance credits in all sectors are confronted with a depletion of stimulus funds that were provided by the American Recovery and Reinvestment Act of 2009, while a wide array of credits will also be affected by federal deficit reduction efforts that will lead to looming budget cuts, according to the report.
“While we are not in the depths of the Great Recession anymore, the recovery is very weak and that leaves many credits across the spectrum of muni finance under stress,” Kurtter said. “We expect there will be continued credit pressure reflecting the continued weak economy.”
