How Financial Institutions Manage Their Exposure to U.S. Municipalities

This article is written and published by S&P Global Market Intelligence, an independent division of S&P Global Ratings.

Financial institutions have faced challenges when accounting for U.S. municipal exposures to rated and unrated issuers given the impact of the COVID-19 pandemic. During the pandemic, 90% of American cities saw their incomes drop and 76% their expenses higher,[1] leaving a potential for deterioration of reserves and a negative impact on credit quality. This blog examines some of the effects of the pandemic on the industry.

The COVID-19 pandemic and the municipal authorities

Looking at the impact of the pandemic on state, local governments, higher education, health care, transportation and utilities, S&P Global Ratings[2] saw 204 downgrades per debtor, as shown in Figure 1.

Figure 1: Impact of COVID 19 on state, local governments, higher education, healthcare, transportation and public services.

In January 2021, S&P Global Ratings’ view on the municipal sector remained negative, given the level of pressure induced by the pandemic and the recession.[3] On March 11, 2021, however, the America Rescue Plan was enacted to accelerate the country’s recovery, promising to benefit many. S&P Global Ratings has revised all municipal sector outlook to stable or change from what they were for most of last year, with stable implying that the rating is unlikely to change over the next year. perspective period, which can be up to two years. Concerns remain about how much support will be ongoing and what might happen if it ends. That said, the situation is better than a year ago, although sensitivities still exist in some sectors, such as higher education, health care and transport which have a higher percentage of negative credit outlook. than other municipal segments.

A closer look at the impacts of the pandemic

S&P Global Market Intelligence (“Market Intelligence”) conducted an analysis in January 2021 on the impact of COVID-19 on cities, counties and school districts using its proprietary models and dashboards. Beginning in October 2020, U.S. municipal issuers began publishing their first audited financial statements for the period ending June 30, 2020. Using its Automated Public Finance Rating Tool (PFAST), the team Market Intelligence examined data from 1,548 municipal issuers to understand the impact of the pandemic on local communities. PFAST is a CUSIP-driven automated portfolio monitoring tool that generates credit sub-scores and final scores in minutes. These scores serve as an early warning indicator by taking advantage of the most recent financial and economic data updated monthly. The results of the analysis revealed five important findings:

  1. Credit quality was disturbed. Overall, the credit quality of local authorities has deteriorated as the release of fiscal 2020 results reflecting the impacts of COVID-19. In fact, 37% of the 1,548 entities considered experienced a reduction in their credit score.[4]
  2. The reduction in credit score varied. In most cases, the deterioration in credit has been mild and due to lower economic scores. This is usually a reduction of a notch. When there is an increase in economic risk combined with an increase in financial risk, it is generally more likely to be two or three notches.
  3. Higher unemployment led to lower economic scores. In parts of the country where the pandemic has been intense, there have been substantial increases in unemployment. On average, for the entities considered, there was a 1.5% increase over pre-pandemic levels, although in some cases it doubled or tripled.
  4. Expenditure growth outpaced income. COVID-related spending has increased and economically sensitive income has declined, especially entities more dependent on sales and income taxes. This created a gap between expenditure and revenue, as shown in Figure 2.

Figure 2: Expenditure Growth Outpaced Revenue in 2020

Source: “What’s the Bottom Line: Credit Impact of COVID 19 on US Municipals”, S&P Global Market Intelligence. February 23, 2021. For information only.

  1. There were fewer reservations. As expenses grew faster than income, as shown in Figure 3, many entities referred to as rainy days or general fund balances. When there were lower economic scores and a reduction in fund balances, the models suggested reductions in credit scores of several notches.

Figure 3: Faster growth in spending led to low reserves


Source: “What’s the Bottom Line: Credit Impact of COVID 19 on US Municipals”, S&P Global Market Intelligence. February 23, 2021. For information only.

Areas to watch

As the road to recovery begins to unfold, future performance will likely depend on affiliation with revenue streams, federal stimulus, or other credit and geographic considerations. Market Intelligence believes that there are several critical areas that need to be closely monitored. This includes:

American states. It will be important to see how the new focus of the Biden administration on many policies – including stimulus packages, healthcare, trade and energy – takes hold. In addition, it will also be important to monitor the continued distribution and uptake of COVID vaccines, which are essential for any return to normal levels of social and economic activity. Structural budget balances will also be critical in maintaining credit quality, with governments often maintaining balanced budgets by using reserves, cutting programs or even instituting layoffs. Variations in terms of different regional economic conditions and responses to the pandemic will continue to have implications for credit quality.

Local Governments. A significant stimulus package of 155 billion dollars has been allocated to local governments, which is important. However, state-level pressure from weaker reserves can pose challenges for local governments. In addition, economies that take longer to recover will continue to be under more pressure on sales, taxes and other revenues. The housing market is strong and unemployment is improving, but the recovery in retail and commerce will take time to reach pre-pandemic levels.

Higher Education. A successful vaccination is essential for resuming in-person activities. The pressure on state revenues can particularly affect the funding of public schools, and spending related to COVID will likely result in lower margins and make cash flow a higher priority. The challenges facing the education sector do not affect all schools equally, so there will be haves and have-nots.

Health care. The prevalence of COVID-19 cases and patient preferences for elective health care are likely to vary by provider and region. Containment of COVID-19, efficient vaccine distribution and higher vaccination rates will help facilitate the return of volumes. Stresses on margins, revenues and expenses related to COVID-19 and changes in the industry, especially workforce issues, can lead to lower margins and lower cash flow. Demand for services, proactive strategic management and institutional characteristics continue to support credit quality, but they require substantial investment. Additionally, credit quality could continue to widen between the strongest and weakest providers after COVID.

Transport. An anemic and uncertain recovery, collapsing transport demand and changing behavior will put pressure on finances. The capital needs are great and the pandemic has not altered the long-term capital needs to expand and replace aging infrastructure. Business and international travel (especially intercontinental) will take longer to recover, and some of the business demand could be lost permanently to video conferencing as companies review their budgets and speed up their environmental programs. Airlines with access to government support and capital markets have been able to accumulate liquidity, despite their heavy losses. Liquidity levels are likely to decline somewhat for most airlines and, apart from a few strong budget airlines, unencumbered collateral to secure new borrowing is declining, so a turnaround in operating results is crucial. .

Looking forward

There has been a return to credit stability in the first two quarters of 2021, and S&P Global Ratings expects this to continue for the remainder of the year.[5] The breakdown of US public finance ratings remains strong and the negative outlook accounts for around 6% of total ratings, up from around 8% at the same time last year. Despite these generally positive trends, challenges remain as the pace of vaccination has slowed and COVID variants have accelerated in the United States and around the world. The recent increase in the delta variant again highlights the regional variations and uneven health outcomes that have been observed throughout the pandemic. It will be important for financial institutions to stay on top of the rapidly changing municipal market to avoid unwanted risks and to capitalize on any emerging opportunities.


[2] Credit ratings are prepared by S&P Global Ratings, which is analytically and editorially independent from any other analytical group of S&P Global.

[4] S&P Global Ratings does not contribute or participate in the creation of the credit ratings generated by S&P Global Market Intelligence. The lowercase nomenclature is used to differentiate S&P Global Market Intelligence credit model scores from credit ratings issued by S&P Global Ratings.


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Marianne R. Winn

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