How the Local Government Credit Ratings Strengthened in 2021

In any credit rating analysis of a city’s fiscal strength, there are typically two key factors to consider:

 

• The level of taxation a municipal government’s tax base will bear

• The level of essential services that can be provided based on the local government’s taxing authority

There are various ways credit ratings can view both indicators; however, the underlying logic is the same. Let’s take a quick look at General Obligation (GO) debt and how local governments were able to weather the consequences of COVID-19. GO debt is typically backed by the ‘full faith and credit pledge’ to levy unlimited—although, in some cases limited—ad-valorem property tax to meet its debt service obligations. The ad-valorem tax is based on the value of the property. For city governments, property tax revenues are often the main source of general fund revenues, which are used to maintain services like police, fire, public works, etc.
 

• Sustainability of the Tax Base: When reviewing the revenue streams for local governments, it’s critical to pay attention to their tax base, which includes its citizens, employers, and other businesses, to see how a pandemic or other natural disasters can negatively impact livelihoods. In addition, it’s also important to see how state and federal governments will intervene in events like the COVID-19 pandemic. A sustainable and diverse tax base will be able to better weather the impacts of natural disasters; for example, a diverse set of employers providing jobs to residents and an educated workforce will likely add to the sustainability of revenue sources for a local government. In recent years, we saw the tourism sector bearing the brunt of COVID-19; local governments that relied on the tourism sector as one of their main revenue streams were impacted the most.

Along the same lines, local governments like cities, counties, and special districts, with a diverse set of revenue streams like property tax, sales tax, and other taxations, maintained their levels of pre-pandemic revenues. This also helped them maintain essential services and not see reductions in their service levels, further garnering a positive outlook from the rating agencies.
 

• Fiscal Strength and Preparedness: Prior to the pandemic, many local governments started building contingency plans, both financially and operationally, to address an event like COVID-19. The preparedness came in different forms: building cash reserves for utility agencies, setting financial reserves for contingencies or an economic downturn, and materializing policies at the governing levels to address fiscal preparedness. These plans helped many local governments to be extra vigilant and act promptly at the start of the pandemic. For example, many local and state governments assumed the pandemic would have a severe impact on all their revenue sources, but primarily sales tax revenues, as it was originally assumed consumer spending in America will likely take the largest hit, as people are staying home or not able to work. Given that, local governments didn’t budget for high revenues and, in turn, adjusted their expenditures to reflect the revenue loss assumption; however, the actual revenue loss due to COVID-19 was not as high as originally anticipated.

This also helped credit rating agencies to assess the financial preparedness of respective local governments and provide a positive outlook as they emerge from the pandemic.
 

• Federal Help to Local Governments and the Public: The federal government’s economic stimulus funds, both for the American public and local governments, helped tie the earlier points about tax-base sustainability and fiscal preparedness. The federal stimulus funds not only helped provide financial security for the public, but it also helped stimulate local economies by increasing consumer spending. Furthermore, federal funds also helped local governments with recovering lost revenues due to COVID-19.

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As we are adjusting to living with the COVID-19 pandemic, local governments are also emerging with an understanding of its real impacts on their operations. There are concerns surrounding supply chain disruptions and inflation expectations; however, local government operations seem somewhat insulated from these immediate issues. It’s also important to note smaller local governments that either didn’t have diverse revenue streams or weren’t fiscally prepared to handle the impacts of COVID-19 continue to feel the strain.

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