Maryland & Local Government Credit Ratings Appear Safe For Now

While there has been speculation that the credit ratings of Maryland and certain local governments may be at risk based on the recent downgrade of the United States credit rating, Maryland’s AAA rating seems safe for now.  The concern has been generated by the actions of Moody’s Investor Services and Standard & Poor’s (S&P). 

While Moody’s had previously stated that if it downgraded the US credit rating, it would also review the credit rating of Maryland and several of its local governments, Moody’s issued a press release on August 2 confirming the Aaa bond rating for the United States following the raising of the national debt limit.  However, Moody’s rating outlook for the US is now negative.

Moody’s placed the rating on review for possible downgrade on July 13 due to the small but rising probability of a default on the government’s debt obligations because of a failure to increase the debt limit. The initial increase of the debt limit by $900 billion and the commitment to raise it by a further $1.2-1.5 trillion by yearend have virtually eliminated the risk of such a default, prompting the confirmation of the rating at Aaa.

In confirming the Aaa rating, Moody’s also recognized that today’s agreement is a first step toward achieving the long-term fiscal consolidation needed to maintain the US government debt metrics within Aaa parameters over the long run.  The legislation calls for $917 billion in specific spending cuts over the next decade and established a congressional committee charged with making recommendations for achieving a further $1.5 trillion in deficit reduction over the same time period. In the absence of the committee reaching an agreement, automatic spending cuts of $1.2 trillion would become effective.

In assigning a negative outlook to the rating, Moody’s indicated, however, that there would be a risk of downgrade if (1) there is a weakening in fiscal discipline in the coming year; (2) further fiscal consolidation measures are not adopted in 2013; (3) the economic outlook deteriorates significantly; or (4) there is an appreciable rise in the US government’s funding costs over and above what is currently expected.

In a separate press release on the same day, Moody’s also confirmed the Aaa rating with a negative outlook of those financial institutions directly tied to the US government, including  Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and the Federal Farm Credit Banks.

Subsequently, Moody’s announced on August 4 that five states and 303 other public finance issuers, including counties and municipalities, that would have been subject to possible credit review and downgrade if the US were downgraded will maintain their Aaa rating, but would determine their outlooks on a case by case basis.  Because of its heavy reliance on federal and military employment, Maryland was one of the five states.  Maryland local governments and entities on the list include:  Baltimore, Harford, Howard, Montgomery, and Prince George’s Counties; the Cities of Bowie and Rockville; and the Washington Suburban Sanitary District. 

With the raising of the federal debt ceiling, the risk of a U.S. default is removed, and the Aaa ratings assigned to the U.S. government, and directly and indirectly linked U.S. public finance ratings have been confirmed. While these indirectly linked issuers’ outlooks were moved to negative as a group based on the identification of certain shared characteristics, their outlooks will be reviewed on a case by case basis in the coming weeks. In order to have a stable outlook, an issuer will need to have credit quality that could be expected to remain higher than that of the U.S. government in the event that the sovereign were downgraded from Aaa.

August 4 Baltimore Business Journal article on Maryland retaining its Moody’s Aaa bond rating

August 8 Baltimore Sun article on the county impact of Moody’s announcement

Unlike Moody’s, S&P did downgrade the US credit rating to AA+ and subsequently downgraded those financial institutions directly linked to the US government, including Fannie Mae and Freddie Mac.  As chronicled in an August 8 Baltimore Sun article, S&P’s action prompted speculation that Maryland would also be downgraded.  However, a state downgrade now seems unlikely.

In an August 7  Frederick News Post article, Senator David Brinkleystates that the S&P downgrade would not directly lead to a lowering of Maryland’s credit rating.

Maryland Sen. David Brinkley said the Senate Budget and Taxation Committee was told Friday night that Standard & Poor’s would not lower the state’s credit rating along with the federal government’s.  Maryland was warned 10 days earlier by Warren Deschenaux, director of policy analysis for the Department of Legislative Services, that its credit rating could be at risk because Maryland’s financialwell-being is so entangled with the federal budget. Of the approximately $34 billion the state spends a year, about $20 billion comes from the federal government in the form of reimbursements for Medicare, Medicaid and other programs, Brinkley said. Maryland also has a low cash reserve, which put its credit rating in further jeopardy.

Brinkley said he believes the state has access to enough money for the remainder of this fiscal year and for next year, but he said the General Assembly would likely look to rein in spending during the legislative session in January.

Senator Brinkley’s assessment was seemingly confirmed when S&P announced that it would not automatically lower the ratings of at-risk states.  An August 9 Washington Post blog post details Maryland’s optimism that it will be able to maintain is AAA rating.

Despite recent warnings, Maryland Gov. Martin O’Malley (D) and state finance officials expressed optimism on Tuesday that the state may be spared a credit downgrade in the wake of Standard and Poor’s decision to cut its rating on long-term U.S. debt.

The comments came after S&P issued a release saying it would not consider top ranked state and local governments “directly constrained” by the new federal rating.

Specifically, S&P said the nine states and small fraction of local governments that have maintained long-term AAA status may continue to be ranked one notch above the federal government. Maryland, Virginia and many local governments in the two states have AAA ratings from S&P.  …

“We are pleased to see that Standard & Poor’s is looking at the states individually,” Maryland state Treasurer Nancy Kopp said in a statement. “We believe that Maryland’s prudent fiscal management will be viewed positively by the rating agencies as they review the states.”

August 9 Baltimore Sun article on Maryland reaction to the S&P announcement

While the developments are good news in the short-term, Maryland and its local governments could remain at risk in the long-term.  Maryland’s workforce is heavily dependent on federal and military employment and the State still faces an ongoing deficit in its operating expenses.  Additionally, Maryland is approaching its spending affordability limit on the amount of bond debt it can sustain, meaning that the State must either limit future bond issuances or increase its own borrowing limit.  The bond rating agencies will certainly monitor how Maryland addresses these challenges over the next several years.

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