U.S. states, cities, towns and other issuers of municipal debt likely will suffer more credit downgrades than upgrades in 2011, with the overall outlook negative for the third straight year, Moody's Investors Service said Thursday.
Reasons for the gloomy prediction include the still-fragile economic recovery the end of the federal stimulus plan and growing "anti-tax" movements spurring politicians to back budget cuts and layoffs, even though they could depress growth.
Still, Moody's identified some positive trends, including rising sales and income tax collections, improving unemployment rates and still-manageable borrowing levels.
Although the rising costs of retirement benefits weigh on credit ratings, this is a longer-term issue, Moody's said.
The debt burden of states "is relatively affordable," as it amounts to only 6.1 percent of state gross domestic product versus 103.8 percent for the largest industrialized nations, Moody's said.
Despite all the hoopla over whether defaults in the $2.9 trillion municipal market will surge -- historically they have been under 1 percent -- Moody's said it did not expect any states to stop repaying general obligation debt, which is backed by an issuer's full faith and credit.
The risks are a bit higher for counties, cities and towns. Moody's said it expects "a modest increase" in defaults among them, but bondholders should recover much of their money.
"We also expect a number of 'near misses,' or cases where defaults are in sight but averted, especially for those local governments that have spent down their reserves, already turned to one-shots like asset sales, have exposure to enterprise risk, face rollover risk for their debt or face a political impasse," Moody's said.
The term "enterprise risk" refers to nontraditional ventures, such as when an issuer backs the debt or operations of power plants, hospitals or nursing homes, the report said. Issuers who borrow for cash flow or that have to find new credit guarantors for variable-rate bonds might not succeed in rolling over their debt.
For both states and cities, 2011 might be the most difficult year of the downturn because so many of the easier budget cuts have already been made, Moody's said.
As a result, taxpayers can look forward to reduced spending in areas previously considered "politically immune," including public schools and police and fire departments, it said.
The revenue from property taxes, the mainstay for many localities, likely will keep declining because assessments of homes and buildings are often smoothed out over time. That means lower prices are still being factored into the tax base.
There also is a negative cascade effect: as the federal government's stimulus plan ends this year, the amount of money states receive declines, and they in turn will slash spending for localities, Moody's said.
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