S&P Says Many Munis Can Keep AAA After Downgrade of 11,500 Linked to U.S.

Q

By Sarah Frier, Michelle Kaske and William Selway - Aug 10, 2011 12:34 PM ET

Standard & Poor’s, which lowered thousands of municipal-bond ratings tied to the federal government, won’t make further downgrades until details of U.S. spending cuts are settled.

“We don’t have enough information,” Steve Murphy, managing director of U.S. public finance for the ratings company, said in a telephone interview yesterday. “We know the states that are reliant on the federal government, we know the locals that are reliant on the federal government, but we don’t know what the cuts are.”

S&P cut about 11,500 securities to AA+ in the $2.9 trillion municipal-bond market after the company downgraded the U.S., according to data compiled by Bloomberg. They include school- construction bonds in Irving, Texas; debt backed by a federal lease in Miami; and a bond series for multifamily housing in Oceanside, California.

On Aug. 2, the Senate voted 74-26 to raise the nation’s debt ceiling until 2013 along with automatic spending cuts to enforce $2.4 trillion in reductions in the next 10 years. It followed an agreement in the House of Representatives.

While the measure specifies $917 billion in discretionary spending cuts over 10 years, the rest is left to a panel of 12 members of Congress, split evenly between Republicans and Democrats, which is supposed to come up with recommendations by Nov. 23.

Assessing the Impact

“The vote on the bill is due by Dec. 23, so we’ll know what we need to know as far as what the impact on municipalities is going to be,” Murphy said in a conference call today.

The ratings company is waiting for information about size, location, type and duration of spending cuts, he said. When the details are released it won’t just be top-rated issuers affected, he said.

“We’re talking about all our credits on a case-by-case basis,” Murphy said.

The Aug. 8 rating cuts also affected debt backed by federal mortgage guarantors Fannie Mae and Freddie Mac and so-called pre-refunded bonds, which are paid off with income from Treasuries bought with borrowed funds. No state general- obligation ratings were changed, and S&P said many borrowers should remain AAA.

“They made it clear that there are going to be states that can continue to be AAA, and that was a concern,” said Tom Kozlik, director of municipal credit analysis for Philadelphia brokerage Janney Montgomery Scott.

Top Grades

Both Moody’s Investors Service and Fitch Ratings kept their top grades for the U.S. government last week. Moody’s said the outlook was negative.

States and local governments are “well-insulated from capital markets volatility because they do not depend on market access to meet their most critical funding requirements,” Moody’s said today in a report.

S&P still scores the general-obligation debt of nine states AAA. The country’s “decentralized governmental structure” calls for an independent review of state and local government credits, 3.9 percent of which have AAA ratings, S&P said. A state rating generally can only be one level above the federal government, Murphy said.

Individual Fright

Institutional money managers are worried that individual investors, who depend more heavily on credit analysis companies, will start selling their municipal holdings, said R.J. Gallo, who manages about $900 million as a senior vice president at Pittsburgh-based Federated Investors.

“If it prompts them to sell munis, it has a price impact, and then I might react in terms of what bonds I want to sell or buy,” Gallo said in a telephone interview.

Investors withdrew about $861 million from U.S. municipal- bond mutual funds in the week through Aug. 3, according to Denver-based Lipper U.S. Fund Flows. It was the second straight week of net withdrawals and the biggest since April.

The S&P downgrades had been anticipated and didn’t remove market uncertainty, said Neil Klein, who manages $925 million in fixed-income assets at Carret Asset Management LLP inNew York.

Kozlik said S&P would likely publicize any state rating cuts by first changing its outlook, as is traditionally done.

S&P, in lowering the U.S. on Aug. 5 from AAA, cited politics in congressional negotiations to increase the federal debt ceiling and said lawmakers failed to reduce spending enough.

To contact the reporters on this story: Sarah Frier in New York at sfrier1@bloomberg.net; Michelle Kaske in New York at mkaske@bloomberg.net William Selway in Washington atwselway@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net