S&P’s new rating methodology means review of 400 muni credits

S&P Global Ratings placed more than 400 state and local government issuers under criteria observation as the agency adopts updated U.S. government rating methodology it instituted earlier this month.

Under the new criteria, there is a single scored framework and a common set of weights for all U.S. governments, including the issuer’s individual credit profile and the institutional framework assessment. 

While the criteria are largely the same as before, the significant change is the greater weight given to the institutional framework assessment and its separation from the government’s individual credit profile. According to S&P, these changes have improved comparability in their analysis of all local and regional governments worldwide. 

“We’re always looking at our criteria to see where we could make changes, if we need to make changes,” said Jane Ridley, senior director and sector lead at S&P.

“We want to make it easier for investors and for users, and so this update is really a move to rate factors similarly across portfolios,” she said.

“The primary reason for the changes is to consolidate,” said Sarah Sullivant, associate in S&P’s State and Local Government Ratings Group. “We always use our criteria consolidation and revision opportunities to increase transparency. We wanted to improve consistency within our U.S. public finance market in terms of the way that we look at ratings across different types of governments.”  

The new criteria takes a flexible approach to addressing states versus counties and municipalities, versus school districts and special districts. 

For states, S&P relocated budget reserves and liquidity from budgetary performance to a separate individual credit performance factor. The move “highlights the role reserves and liquidity play in paying debt service and supporting operations during times of distress,” according to the agency.

For counties and municipalities, the agency updated the weights for the five key credit factors of the individual credit performance to 20%. Previously, debt and contingent liabilities was weighted 10%, while economy was 30% of the analysis. Additionally, there was a reorientation of initial economy assessments to reflect broader regional indicators; annual pension, other post-employment benefit costs and county per capita income were all added to the initial assessment. 

For school districts and special districts, the scored framework and institutional framework assessment were introduced. 

Municipal Market Analytics, Inc. lauded S&P’s criteria update.

“The flexible approach — versus a more prospective scorecard approach popular after the global financial crisis — is increasingly important in maintaining relevant credit assessments amid uncertain conditions,” MMA wrote in its Sept. 16 Weekly Outlook. “This approach should encourage a more forward looking, nimbler analytics process.”

About 10,700 public ratings are within the scope of the newfound criteria. Across all the applicable ratings, it is expected more than 95% will remain unchanged, S&P said. Of those expected to be impacted, the change will generally be either a single notch higher or lower. 

“The projected impact on outstanding ratings is minimal across the portfolio,” Sullivant said. “And what’s driving those changes is not any particular characteristic of the district per se, but the move from an unscored to a scored framework. Among the issuers that might move the most, the reason for those changes will most often be because of the reweighting of the debt and liabilities assessment and economic assessment.” 

S&P is not alone in reviewing its methodology.

Recently, Moody’s Ratings updated its approach to special tax instruments, aligning with its view that operational and financial profiles of the government, along with an evaluation of the security pledge, are the primary factors in credit quality. Now, the agency utilizes the broadness of the revenue pledge, coverage, factors such as debt structure, reserves, management utility, and essentiality to assess pledges. 

Earlier this year, Fitch Ratings revised its U.S. local government rating criteria.

Prior to the 2008 financial crisis, methodology reviews were comparatively infrequent, MMA said. Since then, rating agencies have increased their focus on surveilling at both the credit and methodology level, resulting in more robust and documented processes for reviews, and increasing the likelihood of tweaking existing standards. 

“There wasn’t a market shift or anything else that spurred this methodology review,” Ridley said. “We periodically review and update our criteria to ensure transparency and ease for users. To our understanding, responses to the recent change have been largely positive.”

S&P will review those placed under criteria observation within six months. Those under the scope of the new criteria, but without the “under observation” label, will be reviewed in the course of their regular annual surveillance. 

“We went through the criteria really thoughtfully and very carefully,” Ridley said. “We know that governments operate similarly in the U.S. and elsewhere, but that there are very different factors that also weigh into that. So having one kind of criteria for all governments in the U.S. — not separate for school districts, city, county, and states — just says that we really are looking at all governments the same way.”