WRAPUP 1-Some munis can have higher ratings than U.S.-S&P

NEW YORK Tue Aug 9, 2011 4:16pm EDT

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NEW YORK Aug 9 (Reuters) - Some U.S. states and local governments may retain their coveted AAA ratings despite the fact the United States has lost its top rating, according to Standard & Poor's Ratings Services.

Analysts and traders had been concerned the agency would apply a "sovereign ceiling" to state ratings, taking the view that ratings within a country should not be higher than the rating of the national government.

Another round of negative headlines could rattle retail investors, who fled the market late last year on predictions of mass bond defaults that have yet to materialize.

"Pursuant to our criteria, the fiscal autonomy, political independence and generally strong credit cultures of U.S. states and local governments can support ratings above that of the U.S. sovereign," S&P said in a report released late on Monday.

But the rating agency, which downgraded the United States to AA-plus with a negative outlook on Friday, will examine all municipal ratings in the context of specific federal funding cuts, which will not be known until later this year, an official said on Tuesday.

"Where are the actual reductions going to be? Where will they hit and when?," Steve Murphy, an S&P managing director, told Reuters. For details, click on [nN1E7780JK].

Congress has until year end to find $1.5 trillion in spending cuts with a bicameral, bipartisan commission charged with identifying at least $1.2 trillion in savings by Nov. 23.

States, cities and other local debt issuers that have low dependence on federal funding and that can weather declines in federal assistance could be rated higher than the United States, S&P said.

The report showed state and local governments should not rely on the U.S. government for help, said Richard Ciccarone, managing director at McDonnell Investment Management.

"Where are the Achilles heels if Uncle Sam cuts back?," he said, pointing to possibly lower fund transfers for Medicaid, infrastructure and education. "It's the combination of having their own cash-flow weakness combined with cutbacks in federal support -- that would be the greatest risk for them."

The states that S&P currently rates triple-A are Delaware, Florida, Georgia, Indiana, Iowa, Maryland, Minnesota, Missouri, Nebraska, North Carolina, Utah, Virginia and Wyoming.

Indiana over recent years slashed outlays, shrank the size of government and reduced borrowing, bringing it to its first top-notch rating, said State Treasurer Richard Mourdock.

"The federal government's been doing exactly the opposite in all those areas, and there you have it," he said.

S&P said state and local governments considered better credits than the United States will in most instances have ratings only one notch above the national rating. Currently that results in the highest rating possible, but a further U.S. rating cut could drag those states down, said Chris Mauro, head of U.S. Municipal Strategy at RBC Capital Markets.

State and local governments should have different ratings from the U.S. government because "in effect, what you have are sovereign states within a sovereign state," said Richard Larkin, senior vice president at Herbert J. Sims & Co, Inc in New Jersey.

Mike Nicholas, chief executive officer of Bond Dealers of America, the trade association for dealers and banks focused on U.S. fixed-income markets, agreed.

"State debt -- GO debt -- is not tied to U.S. Treasuries, not dependent on the U.S. government as a backstop. It shouldn't be affected at all," he said.

After years of cutting spending and raising revenue, Utah's Salt Lake City should not have its credit-worthiness questioned "because the federal government and Congress are unable to address the basic workings of government," said the triple-A city's mayor, Ralph Becker.

A ratings drop could push up interest on its debt.

"Right now interest rates are favorable, which allows us to do some important construction projects," said Decker. "A slight change in interest rates changes what we are able to do."

RATINGS CLOUD STILL HANGS OVER MUNICIPAL BOND MARKET

Chris Mier, a managing director at Loop Capital Markets in Chicago, said the market may be in for a period of reverse calibration of muni ratings, which were lifted in recent years to match rating agencies' global scales.

"If the U.S. government is AA-plus you can't have a half dozen of states at AAA ratings, or local units at AAA ratings," Mier said in a conference call on Monday. "Clearly, in order to keep the system logical and coherent there's going to be a lot of downgrades."

A slew of muni debt directly related to the U.S. government, including pre-refunded bonds secured by Treasuries and certain housing debt, were downgraded late on Monday by S&P to AA-plus with a negative outlook from AAA.

The rating agency said in July ratings on this debt would move in "lock-step" with the federal government's rating.

On Monday, S&P stripped top ratings from several local government investment pools due to exposure to investments in Treasuries and U.S. government agency securities.

Assured Guaranty Municipal Corp (AGO.N), the only active insurer of muni bonds, had the outlook on its AA-plus rating was revised to negative from stable. Ratings on muni bonds backed by federal leases and on about $26.2 billion of bonds issued by the Tennessee Valley Authority were cut to AA-plus from AAA.

The actions followed Thursday's move by rival Moody's Investors Service to slap a negative rating outlook on five top-rated states and hundreds of local governments it tied to U.S. debt woes.

Steve Schrager, director of research at SMC Fixed Income Management, said Tuesday's statement may not reassure investors, especially individual investors, a significant force in the municipal bond market, who could be spooked by all of S&P's recent shifts.

"This has to undermine investors' confidence. But this is the point: Where do they go? Where do they put the money?" he said, emphasizing he did not speak on behalf of his firm. "As a retail investor, your head is spinning right now." (Reporting by Chip Barnett, Karen Pierog in Chicago and Lisa Lambert in Washington; Editing by Andrew Hay and Dan Grebler)

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