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State Bond Ratings and the Credit Crunch

Leonard Gilroy
March 31, 2009, 2:24pm

Stateline.com has an interesting read today on the nuances of state debt financing in the current credit climate, and one of the main takeaways is that state fiscal responsibility is perhaps more critical today than ever:

Georgia's recent $614 million bond sale is a hopeful sign that even financially struggling states are now finding it easier to borrow, five months after the credit markets tightened in the aftermath of the Wall Street collapse.

The state sold the general obligation bonds Feb. 4 to pay for dozens of transportation and education projects. The interest rate of 1.61 percent on the five-year bonds was the lowest such rate in 20 years, delighting officials in a state with a budget shortfall that has swelled to $2.2 billion. [...]

Analysts said Georgia’s sale showed how at least one type of borrowing is having success: high grade, AAA-rated municipal bonds sold by a state government. Delaware ($225 million) and Minnesota ($400 million) also recently completed similar sales. [...]

While borrowing still is difficult for states, high-grade general obligation bonds are appealing to small investors because they yield more interest than Treasury bonds. Nine in 10 of the buyers in the Georgia sale were state residents. "The bond offering gave Georgians the opportunity to invest in the state while strengthening their own portfolio," said Gov. Sonny Perdue (R). [...]

In Georgia's case, Fitch Ratings, one of the companies that assign states their credit ratings, said the state’s triple-A rating "is the result of its conservative debt management, consistent maintenance of sound finances and a diversified economy."

Also be sure to check out a related Stateline article here on the brewing conflict between certain states and the ratings agencies:

Frank, Lockyer and others are focusing on the disparity between how the agencies rate municipal and corporate bonds. They want the firms to be more consistent, arguing that municipal bonds usually are rated lower than commercial bonds despite the fact that governments rarely default compared to corporations, according to data supplied by Moody's and Standard & Poor's. [...]

The ratings agencies say just because state and local governments hardly ever fail to pay their debt does not mean they should automatically receive high credit ratings. Economic assumptions vary from state to state, and bond ratings should reflect those differences, they say. California has a new $8 billion budget gap after closing a $40 billion deficit in February.

"The market looks to us to identify and analyze" the differences between state and local governments, Standard & Poor's said in a statement. "We believe our ratings do that." Laura Levenstein, senior managing director of Moody's, told Congress last fall that if Moody's used the corporate scale, most of the municipal bonds would fall between AAA and AA. "This would eliminate the primary value that municipal investors have historically sought from ratings—the ability to differentiate" among various bonds, she said. The ratings agencies say that although it is rare, governments do default, most recently in Vallejo, Calif., and Jefferson County, Ala.

Government and corporate operations differ substantially, the rating agencies say, which argues against a universal rating system. Corporations can move faster than governments can if they run into financial trouble by restructuring, refinancing, declaring bankruptcy, moving overseas or shutting down altogether. Governments must continue operating, even if they cannot repay their debt. [...]

Spokesmen for Fitch and Standard & Poor's, which downgraded California bonds from A-plus to A in February, said the lower ratings reflected the state's precarious financial condition, especially its reliance on one-time revenue, temporary tax increases and borrowing to balance its budget in the next two fiscal years.

Leonard Gilroy is Director of Government Reform


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