How to rate a local government bond in 7 simple steps

September 12, 2013

Standard & Poor’s on Thursday announced an update to how it rates local government general obligation bonds. (AP/Henny Ray Abrams)

New York issued the nation’s first municipal bond just 201 years ago. Now, that bond market is worth roughly $3.7 trillion.

As with any market that large, assessing risk plays a crucial role. And, on Thursday, Standard & Poor’s pulled back the curtain on how it plans to judge bonds issued by more than 4,000 cities, counties, towns, villages, townships and boroughs going forward. The ratings agency says it will use just seven criteria in its judgments.

“Our goal here is to provide the marketplace with a much more transparent view of how we arrive at ratings,” said Jeffrey Previdi, a managing director in the agency’s U.S. public finance practice.

S&P expects the changes will lead to downgrades in 10 percent of its local government ratings. The majority, 60 percent, will likely see no change, and the remaining 30 percent are expected to see ratings upgrades, Previdi said.

The update affects general obligation bonds, one of the two broad types of municipal bonds. (GO bonds are typically paid with tax revenues, while the other kind of municipal bond, the revenue bond, is usually backed by the proceeds from the project being financed.)

GO bond ratings will be based on seven criteria each of which will be given a score of 1 to 5, strongest to weakest, S&P says. Here’s the ratings key:

Half of any rating comes from just two criteria:

  • Economic conditions account for 30 percent
  • The strength of local management and the decisions, policies and practices they implement constitutes another 20 percent of any rating.

The remaining five criteria each make up 10 percent of a rating. S&P looks at:

  • The legal and practical state environment in which a local government operates
  • How flexible the government can be in times of budgetary stress
  • The government’s current fiscal balance
  • How much cash (or cash equivalents) the government has access to
  • The government’s debt as it relates of spending and revenues.

That’s how you rate a local government bond, in 7 easy steps.

Niraj Chokshi reports for GovBeat, The Post's state and local policy blog.
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