Ratings upgrades still outpace downgrades as rated universe of munis grows

Municipal issuers have seen more upgrades this year than downgrades, continuing a trend that began in 2021, while the overall rated universe of muni issuers has also grown.

If current economic conditions persist, the trend will likely continue for the foreseeable future, market participants said.

The total rated share of the market increased in the first quarter this year, Municipal Market Analytics, Inc.reported, encompassing 94% of the muni market. MMA’s metric, ratings per dollar of par issued, reached its highest level since 2019. Around 65% of par issued last quarter also had more than one rating.

In the first quarter of 2024, S&P had 153 upgrades against 79 downgrades; Fitch upgraded 45 issuers and downgraded 13. According to S&P’s quarter 1 report, finances were the main driver for rating actions, leading to 93 of the upgrades and 38 downgrades. KBRA had no upgrades or downgrades in Q1, but had 13 upgrades and three downgrades in 2023.

“KBRA’s growing market share helped to push the percentage of par issued with 3 or 4 ratings up about 3 percentage points to almost 33%,” MMA noted. Single, dual, and non-rated issuance fell in the first quarter from 2023’s results.

Elevated rating activity benefitted the agencies with market share at Moody’s, Fitch, and KBRA posting gains and S&P holding steady when compared with 2023″ MMA noted. Moody’s claimed the highest percentage at about 77%, followed by S&P at about 73%, Fitch at about 44%, and KBRA at about 13%.

“KBRA’s gains in market share are most pronounced in the multiple ratings categories; the agency rated over 19% of par from issuers that came to market with more than one rating during the quarter and KBRA’s greatest presence continues to be in the three-rating category, collecting a share of about 27%,” MMA wrote. 

As the rated market share grows, the driving force behind the rate of upgrades is the overall strength of the economy, according to Fitch Ratings Senior Director Michael Rinaldi. Revenue sources for municipalities, such as sales and property taxes, are doing very well. 

Rinaldi also credits “continued prudent management,” which he said has led to a buildup of reserves. 

The most common rating action, Rinaldi said, is an affirmation — about 93% of Fitch’s rating actions leave the issuer’s rating unchanged. 

But when a rating does change, upgrades outweigh downgrades almost 4:1, Rinaldi said.

In 2023, S&P Global Ratings’ rated universe had 1,157 upgrades, even more than its 870 upgrades in 2022.

This trend exists in nearly all sectors of US public finance. It’s most pronounced in transportation, where the upgrade- to-downgrade ratio was 40:1 last year, S&P said. 

The exception to the trend is healthcare, which has struggled with labor shortages since the pandemic. Higher education has also struggled, and its situation will likely worsen as enrollment problems persist. In 2023, higher education institutions still had more upgrades than downgrades, but last quarter, S&P issued five upgrades and six downgrades.

Nick Kraemer, analyst for S&P, noted that municipalities are generally very stable, and upgrades in the sector have historically outpaced downgrades in the sector.

Not surprisingly, the beginning of this upgrade streak coincided with an influx of federal stimulus money. This certainly contributed to municipalities’ financial success. Now, those funds are finally running out, and revenue projections, while still positive, don’t have the extreme year-over-year growth of previous years. Municipalities will have to cope with a slightly less rosy financial picture, Rinaldi said. 

“Many governments have increased programs over the last several years, because [they think] ‘Hey, we’ve got all this cash, there are needs in the community,'” Rinaldi said. “Now, as the revenues are taking a step back a bit, and [with] the federal aid gone, how do they adjust?”

One of the biggest current challenges to municipal credit ratings is a shortage of accountants, Patricia Healy wrote in a commentary for Cumberland Advisors. Local governments often struggle to recruit talent, so a national wave of accountants retiring with too few replacements has hit municipal issuers especially hard. 

Municipalities have thus struggled to complete financial statements on time, which led S&P to place almost 200 issuers on CreditWatch negative last month, Healy wrote. 

“We note that this shortage of accountants comes at a time when the Securities and Exchange Commission and investors are requiring more detailed disclosure, including climate-related information,” Healy added. 

Climate change presents a more long-term danger to municipalities’ credit, according to Municipal Market Analytics. Over time, natural disasters will become more and more common; the destruction they wreak will simultaneously require great capital repairs and damage governments’ ability to collect revenue, the firm said.

Some cities could also face falling revenues from a decline in commercial property values, Rinaldi noted. The rise of remote work has likely damaged the property values of office buildings.

On the other hand, Rinaldi said, the last three years have left cities well-prepared to deal with any potential revenue problems. 

Similarly, Moody’s Ratings predicted in its 2024 outlook report that problems from projected slowing revenue will be offset by falling inflation, flush reserves and strong governance.

The endpoint of the current trend in upgrades may be a plateau. Municipalities will eventually reach the cap of their state’s credit rating. The median credit rating at the moment, Kraemer noted, is an A plus, and the pace of upgrades slowed last quarter, with overall credit quality making its smallest gain since 2021. 

Recently, Kraemer said, he was surprised to learn that a town in Cape Cod where he vacationed had been downgraded.

“It’s because their town staff is 80,” Kraemer said, “and they want to retire.”