In a significant move affecting the landscape of public finance, S&P Global Ratings recently placed over 400 state and local government issuers under observation as it rolled out a revised rating methodology. This initiative, which was implemented earlier this month, marks a new direction for credit assessments of U.S. governmental entities. The updates introduce a unified scoring framework while enhancing the institutional framework assessment, a step designed to refine the process of governmental ratings across various jurisdictions. While the core elements remain intact, the alterations promise to facilitate greater transparency and comparability in the evaluation of creditworthiness among global government sectors.
One of the most notable changes is S&P’s decision to increase the weight assigned to the institutional framework assessment. This adjustment signifies a departure from the traditional method where the government’s individual credit characteristics dominated the landscape. By distinguishing the institutional framework from individual credit profiles, S&P aims to offer a more nuanced understanding of creditworthiness. Jane Ridley, a senior director at S&P, articulated this sentiment, noting the agency’s ongoing desire to evolve its criteria for clarity and effectiveness. The updated framework not only aids investors in navigating their choices but also streamlines the assessment process for a wide array of governmental entities.
The updated criteria exhibit a flexible approach, making distinctions among various types of government entities—states, counties, municipalities, school districts, and special districts. By redistributing budget reserves and liquidity from the budgetary performance category to a separate factor for individual credit performance, S&P aims to clearly illustrate their significance in debt service and operations during financial distress. This nuanced approach acknowledges the unique challenges and financial structures each type of government entity faces.
For counties and municipalities, the adjustments to the weighting of key credit factors reflect a substantial reorientation of priorities in the assessment process. Previously, the economy held a 30% weight compared to debt and liabilities at 10%. The new structure levels the playing field with a balanced 20% allocation for these factors, thereby addressing the intricacies of economic conditions and their direct correlation with credit performance.
Responses to S&P’s updated methodology have generally been positive, with organizations like Municipal Market Analytics, Inc. praising the enhanced flexibility of the new approach. By integrating a more adaptable scoring system, S&P is poised to maintain relevant credit assessments while navigating the unpredictable nature of modern financial environments. This forward-looking strategy signals S&P’s commitment to evolving alongside the financial markets and governmental operations.
Despite the anticipated impact of the changes, S&P stated that over 95% of the approximately 10,700 public ratings reviewed under the new criteria would remain unchanged. Any adjustments are expected to result in minimal movement, typically around one notch higher or lower. This stability indicates that, while the methodology has been revised, the fundamental characteristics of most governments remain robust and creditworthy.
S&P’s recent updates are representative of a broader trend among credit rating agencies regarding methodological revisions. Moody’s Ratings recently updated its assessment of special tax instruments, while Fitch Ratings revised its local government rating criteria earlier this year. This heightened scrutiny and frequent evaluations stand in stark contrast to the pre-2008 financial crisis landscape, where such reviews were rare. The evolution in rating practices emphasizes the need for increased vigilance and adaptability in response to changing economic conditions.
Ridley affirms that the impetus for S&P’s methodology review is not tied to any immediate market shifts but reflects a consistent aim to enhance transparency and usability. This commitment to ongoing assessment ensures that S&P’s criteria remain relevant, allowing for effective ratings that accurately reflect government capabilities and challenges.
Looking ahead, S&P plans to conduct thorough reviews of those issuers placed under observation within the next six months. Meanwhile, those entities subject to the new criteria without the under-observation designation will be reviewed during the routine annual surveillance. Ridley emphasized the importance of careful deliberation in refining the criteria, acknowledging the diversity in governmental operations across the U.S.
S&P’s refined rating methodology signifies a crucial step in enhancing the transparency and comparability of credit ratings for state and local governments. By re-evaluating their approach, S&P aspires to not only improve the accuracy of assessments but also foster greater confidence among investors and stakeholders navigating the complexities of public finance. As the financial landscape continues to evolve, these methodological updates will play an essential role in shaping government creditworthiness evaluations in the future.