S&P says states can be rated higher than US

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Triple A-rated US states and local governments do not face automatic downgrades after Standard & Poor’s historic move last week to strip the US sovereign of its top-notch status, the rating agency said.

Steven Murphy, head of US state and local ratings at S&P, said the agency would instead decide later this year whether to downgrade states and local governments based on measures to reduce federal budget deficits.

“The federal spending reduction plan is key to how we will look at the ratings going forward – what programmes will be cut, where, geographically, [the cuts] will be and the time frame,” Mr Murphy said.

However, ratings of state and local governments are not directly constrained by the US sovereign rating, S&P said. Local areas retain significant governing power under the US constitution, allowing them to raise taxes and cut spending to address strained budgets. But this ratings differential can generally be limited only to one notch, the agency said.

Some municipal bond market participants praised the move as a recognition of the strength of US state and local governments, and expressed hope that highly rated “munis” would attract safe-haven buying.

Others questioned the logic that some local bonds could be safer than debt backed by the US government. “That is a difficult point to try to defend,” said Christopher Mier, a strategist at Loop Capital, a broker and investment bank. “The US is massively larger and more economically diverse than any single unit of government and [it] can print money.”

S&P cut the US long-term rating by once notch to double A plus and warned of the potential for further downgrades. S&P rates 13 US states triple A.

Separately, S&P cut the triple A ratings of about $120bn of municipal bonds that it said were directly linked to the federal government. These bonds, from various issuers, have structures that include receiving interest payments from Fannie Mae and Freddie Mac, the housing entities that are in government conservatorship and have already been downgraded, or being backed by US Treasuries directly.

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