UPDATE 1-S&P: Automatic U.S. spending cuts unlikely to hurt local issuers

Thu Feb 28, 2013 2:49pm EST

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NEW YORK Feb 28 (Reuters) - Standard & Poor's said on Thursday the $85 billion in automatic spending cuts from the federal budget that could become reality from Friday may have only a minor negative impact for local governments.

That is because most municipalities since the beginning of the recession have shown willingness to impose cutbacks in response to weaker revenue.

"States and many local governments have been actively monitoring developments at the federal level, and we believe they have evaluated the potential effects of sequestration in their revenue forecasts and budgets," said S&P credit analyst Gabriel Petek.

In a separate report on municipal infrastructure issuers, the agency said the primary impact will stem from a reduction of at least 5.3 percent of the federal interest expense subsidy to issuers of Build America Bonds and Recovery Zone Economic Development Bonds, a popular state and local financing program from the 2009 economic stimulus plan.

Legal provisions allowing the issuers to call those bonds at par during an "extraordinary event" may push some public infrastructure issuers to replace the debt by issuing new tax-exempt bonds.

S&P analyst Ted Chapman said "...it is possible that sequestration may also qualify as an extraordinary event. This would, therefore, provide the opportunity for the issuer to sell traditional tax-exempt bonds to refund the taxable BABs and Super-BABs, potentially at a substantial savings."

Federal cuts may contribute to compressed earnings and cash flow at not-for-profit health care providers due to cuts in Medicare, which is not exempt from sequestration, S&P said in a third report.

"The sequestration reductions will, in our opinion, contribute to compressed earnings and cash flow immediately, which could impact credit ratings over time," said analyst Martin Arrick.

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