In September 2023, S&P Global Ratings initiated a significant transformation in its approach to assessing the creditworthiness of state and local governments in the U.S. By placing over 400 issuers under criteria observation, the agency implemented a refined methodology aimed at improving the comparability and reliability of public finance ratings. This decision reflects a deliberate effort to enhance transparency in credit assessments while adapting to ongoing economic uncertainties. Given that approximately 10,700 public ratings now fall under this revised set of criteria, the implications of this shift are profound for investors, issuers, and the broader public finance landscape.
The central tenet of S&P’s updated credit rating framework revolves around a unified scoring system paired with a standardized set of weights. This represents a departure from previous practices, where the assessment of individual credit profiles and institutional frameworks were somewhat disjointed. By emphasizing the institutional framework’s role—while separating it from the issuer’s individual credit profile—S&P aims to create a more holistic view of financial health.
The rationale for incorporating a more prominent institutional assessment lies in its potential to provide greater clarity regarding the operational environment within which these governments function. According to Jane Ridley, Senior Director at S&P, the intent was to streamline the rating process, enhancing usability for investors while maintaining a high standard of analytical rigor.
One of the most striking adjustments in the new methodology involves the treatment of budget reserves and liquidity. For state governments, these elements have been redirected from budgetary performance metrics to individual credit performance factors. This shift acknowledges the critical role that reserves and liquidity play in ensuring timely debt service payments—particularly during economically challenging seasons.
In terms of weighting within the credit factor assessments, the revisions reveal an intention to prioritize the nuances of various governmental layers. For instance, municipalities and counties now reflect a 20% weight on five critical indicators, a notable increase from previous allocations which favoured debt and economy components disproportionately. This not only seeks to promote a more balanced view of financial health but also mirrors evolving economic realities.
School districts and special districts also saw the introduction of a scored framework and institutional assessment, illustrating the inclusive nature of S&P’s updated methodology. Municipal Market Analytics, Inc. has lauded this flexible and dynamic approach, positing that it mitigates the limitations of rigid scorecards previously employed in credit evaluations, especially following the global financial crisis.
Despite the sweeping nature of these changes, S&P forecasts minimal overall disruption to existing ratings; over 95% of the applicable ratings are expected to remain unchanged. For those ratings that may shift, the adjustments will typically reflect a marginal increase or decrease, depending on how the new weights realign with the issuers’ financial profiles.
Ridley’s observations regarding market feedback have noted a positive reception overall, indicating that many stakeholders in the public finance sector appreciate S&P’s dedication to ongoing revision and enhancement of its rating methodologies. Sarah Sullivant, an associate within S&P’s State and Local Government Ratings Group, emphasizes that these changes revolve around the reweighting of critical factors rather than a fundamental alteration of creditworthiness among districts.
S&P’s initiative is not a standalone action; it aligns with broader trends noted across rating agencies. Moody’s and Fitch Ratings have similarly revised their methodologies in recent months, responding to a rapidly changing economic environment and emerging priorities in evaluating credit quality. For instance, Moody’s enhanced its evaluation of special tax instruments to incorporate operational and financial profiles alongside security pledge assessments.
This collective movement reflects a paradigm shift in the credit rating landscape, pushing agencies towards more proactive and relevant evaluations. The post-2008 financial crisis era has seen agencies place greater emphasis on ongoing assessments, fostering a culture of methodological scrutiny that was less frequent in the past.
As S&P prepares to conduct reviews of those under observation within the next six months, it embodies a critical evolution in the standards that govern public finance ratings. By embracing a unified and transparent framework, S&P aims not only to foster improved consistency across diverse governmental entities but also to navigate the complexities posed by a dynamic economic landscape.
The implications of these changes extend beyond procedural refinements; they represent a recognition of the complexities inherent in governing financial systems across various regions. This evolution in credit rating methodologies serves as a testament to the ongoing responsiveness of rating agencies, demonstrating their commitment to ensuring that investors can navigate the public finance landscape with confidence and clarity.