Moody's Investors Services said on Wednesday that most issuers in the U.S. municipal bond market are well insulated from shock, but added that some could be weakened during significant market volatility.
Most municipal issuers are somewhat weaker than they were prior to the last major market disruption, said Moody's Managing Director Timothy Blake in a statement. This is why some may face significant stress if hostile market conditions emerge.
While downgrades could happen in an environment of diminished market access and tight liquidity, Moody's does not expect debt defaults or widespread downgrades of more than a notch.
Events in the municipal sector as well as in the global sovereign or banking sectors could create market volatility, Moody's said. It added that global developments of a political nature could also generate volatility.
The agency's comments came after another rating agency, Standard and Poor's, said state and local governments with the highest ratings are not at risk because of its decision to downgrade U.S. debt.
S&P cited political factors as a reason for the U.S. downgrade.
State and local governments that issue debt to fund operating deficits or rely on short-term notes for seasonal cash flow needs may have greater exposure to risk in a volatile market, Moody's said.
It added that those entities that need to roll over bond anticipation notes for interim construction financing, who have bonds with mandatory puts, or are struggling with expiring letters of credit and other liquidity backstops may also be at risk.
Blake said he does not expect state and local governments to use the same tactics they deployed to address their recent budget crises because their tax revenues have yet to return to the levels collected in 2007, the last year before the recession caused revenues to collapse.
(Reporting by Lisa Lambert, additional reporting by Caryn Trokie in New York; editing by Chizu Nomiyama and Jeffrey Benkoe)