State, Local Government Downgrades May Increase in '11, Says S&P

Managing liquidity key in constrained revenue environment

Standa4rd & Poor's Ratings Services expects that state and local governments will, for the most part, maintain medium to high investment-grade ratings in 2011, although downgrades may increase in number.

According to "Outlook: U.S. State And Local Governments Must Navigate Turbulent Conditions To Maintain Credit Stability," a report published Monday by the firm, difficult economic and revenue conditions could result in severe budget pressures requiring tough choices by government officials.

"We believe that continued revenue decreases for state and local government may increase fiscal strain on budgets, and monitoring of liquidity will be especially important in 2011," Standard & Poor's credit analyst Gabriel Petek said in a statement.

In addition to managing liquidity, state and local governments will need to continue to make difficult and unpopular budget choices and pay increasing heed to bond market conditions and pension costs.

"However," Petek adds, "we do not feel that such difficulties will cause any sort of notable increase in defaults among our rated issuers."

Among the report's highlights:

  • State and local governments will likely continue to operate in a constrained revenue environment, with many issuers having to make difficult policy choices.
  • Managing liquidity will likely be key for many state and local government issuers.
  • Municipal bond market volatility may increase in 2011, creating a more difficult interest rate environment.
  • A majority of state and local government issuers rated by Standard & Poor's will likely remain medium to high investment grade.

"We expect that there may be an increased number of rating downgrades in 2011, yet we believe the majority of state and local government issuers we rate will likely retain solidly medium-to-high investment grade ratings,” according to the report. “Setting the stage for 2011 is the presence of several notable conditions that, in our view, almost all state and local government issuers will confront.”

 These are:

  • An economic recovery that will likely continue to be weak generally;
  • The persistence of budget gaps requiring difficult policy decisions;
  • The potential for a more challenging bond market for issuers;
  • The heightened role of financial liquidity as a credit quality bellwether among municipal issuers, particularly for those with severe structural budget misalignments and issuers of certain types of variable-rate debt;
  • A new regulatory regime as a result of the Dodd-Frank Financial Reform legislation; and
  • An increased focus on issuer pension and other retiree benefits packages.
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