By Yali N’Diaye

WASHINGTON (MNI) – Should the U.S. bankruptcy law change to allow
states to file, “the ability to file and the practicality of such
filings would be a key component of our assessment of the credit quality
of the sector,” Standard & Poor’s said in a special comment Wednesday.

That said, the rating agency maintained its view that states are
committed to fix their budget woes for their own benefit, adding that
the cost of filing bankruptcy would tend to outweigh the benefits.

This is especially true given the small portion that debt servicing
represents in states budget, an average of just 4%.

So even if the ability to file for bankruptcy was given to states,
it is “unlikely that a state would consider a bankruptcy filing as an
option to address current or future budget gaps based on the financial
implications,” S&P said.

Still, should the law change, “We would evaluate our criteria
relating to the institutional and government framework that is part of
our review of the sector,” Standard & Poor’s said.

And based on the rating history of municipalities — which unlike
states can file for bankruptcy under the current law — that evaluation
might translate into a negative rating action.

Standard & Poor’s indeed noted that in the cases it was concerned a
local government would file for bankruptcy despite the availability of
other options, “we generally have lowered ratings.”

The rating agency said Monday it does not expect any “notable
increase in defaults among our rated issuers,” despite the budget woes
of state and local governments that will force them to better manage
their liquidity and pay greater attention to bond market conditions.

States themselves, while urging Congress to give them greater
flexibility to manage their budgets, have been reassuring the public
they have no intent to ask for the ability to file bankruptcy, which
would be counterproductive.

And while states have also said they have no intent to ask for a
bailout, lawmakers have joined their voices to say they have no intent
to provide one.

The three major rating agencies have been saying they do not expect
a major wave of defaults from municipal borrowers, although land-backed
bonds especially from unrated issuers are more at risk.

The agencies have also said states’ general obligations are less at
risk than revenue bonds. But even so, Standard & Poor’s Wednesday
affirmed, “the U.S. municipal water, sewer, and drainage utility sector
should continue to see rating stability this year despite the impact of
state budget pressures on the numerous communities it serves.”

So no bankruptcy, no bailout, and no “noticeable defaults” have
been the recent messages from various parties.

And in a conference call Wednesday, DWS Investments’ muni team
stressed the need to differentiate, adding the recent headline fears
have created opportunities in a universe where valuation of credit has
become “a little distorted.”

It seems muni investors — 70% of them retail — need to be more
reassured and get over the dire predictions from banking analyst
Meredith Whitney in particular, was the implication.

The latest data from the Investment Company Institute suggest
investors’ concerns over states and municipalities’ financial woes are
still present. And Congressional Budget Office Director Doug Elmendorf
Wednesday said the nation’s state governments are facing a “tremendous
financial squeeze” and “large and very serious problems” in financing
are still significant.

The ICI reported Wednesday that municipal bond funds had estimated
outflows of $5.75 billion in the week ended January 19, accelerating
from $2.4 billion the week before.

Since the end of November, municipal bond funds have consistently
experienced outflows, totaling nearly $23 billion since the week ended
Dec. 1, 2010. This is on top of outflows of $7.7 billion in November.

And now, some observers are wondering whether large players are
gaming the muni market, while reports indicate the Securities and
Exchange Commission is inquiring about Illinois’ public statements about
its pension funds.

Asked by Market News International, the SEC declined to comment on
both issues.

Large unfunded pension liabilities are a recurrent “credit
challenge” in credit rating agencies’ assessment of states.

And Illinois is no exception.

On Wednesday, Moody’s assigned an A1 rating and negative outlook to
the State of Illinois’ General Obligation Bonds, Taxable Series of
February 2011, the proceeds which will pay for the state’s statutorily
required pension contributions in the fiscal year ending June 30.

Moody’s repeated that Illinois’ “Very large unfunded pension
liabilities” remain a challenge.

There are fears such liabilities might even be underestimated
because of the way pensions report their funding status.

That led Rep. Devin Nunes (R-Calif) to introduce in December the
Public Employee Pension Transparency Act designed to enhance state and
local government accounting and disclosure of financial liabilities,
including the cost of pension plans.

The bill, cosponsored by the new chairman of the House Budget
Committee Paul Ryan, was received coldly by the nation’s state and local
government organizations.

** Market News International Washington Bureau: 202-371-2121 **

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