Industries Banking/Finance

Out of their hands

Commonwealth, localities await fate of their triple-A bond ratings

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Print this page by Robert Burke

When one of the nation’s major credit-rating firms warned in July that it was looking at downgrading the prized triple-A status of Virginia and some of its best-run localities, there wasn’t much state and local leaders could do except complain. Which they did.

Gov. Bob McDonnell called the debt-ceiling standoff in Washington,  a key reason for the potential downgrade, “embarrassing.” Frustrated leaders from eight Northern Virginia localities asked in a joint statement why they should be punished “because of the federal government’s failure to deal with the ongoing crisis.” The statement was signed by the mayors and board chairs of Alexandria, Arlington County, Fairfax City, Fairfax County, Herndon, Loudoun County, Prince William County and Vienna.

Now once more their fate is largely out of their hands. The debt-ceiling agreement between Congress and the White House included creation of a 12-member congressional “super committee” that will have until Nov. 23 to find another $1.2 trillion in proposed spending cuts over 10 years. If it fails, the debt deal calls for more than $1 trillion in automatic cuts that would hit hard in both defense and federal agency spending. That would be bad news for the Old Dominion, which ranks second in the U.S. (behind Alaska) in per capita annual federal spending, at almost $20,000 per person, according to U.S. Census data.

Figuring out what it will really mean “gets very difficult without knowing the nature of those cuts,” says Ric Brown, Virginia’s Secretary of Finance. For now state and local financial officials are providing data to the rating firms and trying to figure out what’s next. Moody’s Investor Service, one of the three major firms, put Virginia on its watch list.

In August Standard & Poor’s downgraded the federal government’s triple-A rating, the first time that has happened. After the federal downgrade it was expected that states and municipalities would be downgraded, too, but S&P quickly said it wasn’t ready to take that step. Henrico County, in fact, announced in mid-August that all three major rating services — Moody’s, S&P and Fitch — had reaffirmed its AAA rating for a $73.5 million bond issue.

Brown says that for the ratings agencies “it’s a world turned upside down” because they now have states with higher credit ratings than the federal government. “They have to make sense of the new order,” he says.
The credit warnings did make many state and local officials nervous but apparently haven’t done much damage. The cost of bond financing isn’t going up for localities and demand is still strong, says Joe Paucke, senior vice president at Davenport & Co., an investment firm based in Richmond. He called the agencies’ watch-listing of Virginia’s triple-A localities “a nonevent” that had no real effect on the bond market.

“Nobody has taken this very seriously at all, quite frankly,” he says. “In terms of day-to-day trading, we have not seen any spreads widen. If any widening has taken place, it’s only because absolute yields are so low, and it may take a little more yield to get it sold.” Paucke says Virginia localities “typically have very conservative guidelines in terms of their budgets, and they’re just fairly well-run.”

Steven Solomon, finance director for Prince William County, says the rating agencies rely too much on the assumption that states are more dependent on the federal government than they are. That model might fit in other nations that have a strong central government, “but it doesn’t really carry over to the United States. The states and cities that we have really have the ability to finance themselves.”

Others in Northern Virginia agree. The region has eight localities on the Moody’s watch list, which doesn’t seem to square with the region’s status as one of the wealthiest in the nation. Gerald Gordon, president and CEO of the Fairfax County Economic Development Authority, says the threat to the region’s economy if budget cuts happen “is a legitimate concern because we are so dominated by federal government contracting.” But he returns to a selling point he’s made before: The county’s economic base is more diversified than ever. If a downgrade of the county’s credit rating did occur, “it would be impactful, but it’s not going to kill us.”
Brown suggests that Virginia might break even or possibly gain some, if the spending cuts involve consolidating some federal programs. He cited the federal Base Closure and Realignment Commission (BRAC), which ended up shifting some jobs into Virginia as it closed sites in other states. “You’d think those [cuts] would hurt Virginia, but after the last round Virginia turned out to have more military than before,” Brown says. “We obviously did have our share of losses too. It cuts both ways.”

Neal Menkes, director of fiscal policy for the Virginia Municipal League, says localities can help their case against a rating downgrade by building up their cash reserves to prepare for any drops in tax revenue. But they’re still vulnerable to events outside of their control. So are the other counties and cities close to the watch-list localities, Menkes says. “Eventually it could filter down to those communities that aren’t as wealthy. Their own revenue situation is going to become even shakier than it already is.”


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