Key Change by S&P Boosts Smaller Issuers

By: Dr. Jay H. Abrams
Chief Municipal Credit Analyst

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Standard & Poor’s overturned years of conventional wisdom and now says that sound management, a good financial position and other factors are more important than size in determining a municipality’s credit profile.

As a result of the change, S&P raised the credit ratings of 29 municipalities in the northeast and, in a separate action, upgraded 250 special infrastructure districts.

S&P’s change in thinking was reflected in two separate rating commentaries, in which it said smaller, often more rural localities and limited purpose special districts can achieve credit ratings equal to, or better than, larger cities and counties.

Diverse economies favored bigger communities

Traditionally, rating criteria favored bigger, more economically diverse communities. Larger municipalities could expect higher ratings owing to their broad revenue bases and ability to absorb the loss of a major taxpayer or employer. However, the recent economic downturn has shown large cities struggling, while many smaller communities have illustrated an unanticipated level of stability in this challenging economic environment.

Twenty-nine municipalities in the northeast saw their ratings raised by S&P due to the rating agency’s belief that, “stability and sound management practices characterize many governments, and that most will successfully manage through current conditions.” Other characteristics of the newly upgraded credits were, “good financial positions, with stable revenue streams, coupled with low debt burdens and very limited capital plans.”

The smaller communities cited by S&P all have populations below 15,000 or a total real property value of less than $500 million. The stability and flexibility these communities have displayed makes up for their lack of economic diversification, and offsets the stronger revenue bases of larger cities.

Texas MUDs also upgraded

In a separate rating action, S&P also upgraded 250 special infrastructure districts, known as Municipal Utility Districts (MUDs). These districts primarily provide water, sewer and electric service, or the construction of roads, street lights and other basic infrastructure prior to residential and commercial development.

Similar to Community Development Districts in Florida, or Metropolitan Districts in Colorado, MUDs are typically created at the request of developers intending to pass infrastructure costs on to both present and future owners of a residence through the issuance of bonds, rather than front loading the cost on the initial home owner as part of the home’s purchase price.

In raising the ratings on these small single purpose units of government, S&P noted strong oversight of MUD bond issuance by the state of Texas, excellent financial performance and stable housing values. 

Texas has not experienced the large drop in housing prices seen elsewhere simply because prices never appreciated as rapidly as they had in other areas during boom years. Following the upgrade action, S&P now rates eight such districts in the “AA” category, 145 in the “A” category and 124 as “BBBs.”

S&P’s recognition of the solid track record of small communities and special districts confirms what astute bond purchasers have always known: Bonds issued for essential public services have a strong record of repayment.

The size of a community is a less important indicator of credit quality than is financial stability. Further, the two rating actions discussed above illustrate the strength and stability of local governments and their ability to withstand a difficult economic environment.
 
Municipal issues continue to promise an extremely high likelihood of repayment and remain a consistent source of strength in times of economic uncertainty.

9/16/2009