Determinants of Municipal Bond Ratings for General‐Purpose Governments: An Empirical Analysis

Abstract

In the wake of the destabilization of the tax-exempt bond insurance industry, this paper presents an ordered probit model of the determinants of the credit ratings of 965 county and city governments from throughout the nation. The underlying Moody's rating of these governments is posited as a function of a vector of publicly available economic, demographic, governmental, fiscal, and financial variables. The empirical results demonstrate the relative importance of economic base diversity, the growth rates of earnings, and population as well as existing full faith and credit debt on credit ratings. Additionally, our findings support the proposition that the existence of tax limits reduce the perception of credit quality, while expenditure limits raise credit ratings.

Economic Crises, Economic Structure, and State Credit Quality Through‐the‐Cycle

“…Palumbo and Zaporowski () and Stallmann et al () find a negative association between expenditure limits and credit ratings. Evidence on revenue limits and their relationship with credit quality, however, is negative in Grizzle () and Stallmann et al ().…”

“…Per capita personal income, as a proxy of economic wealth, is significant and generally positive in the literature (Capeci ; Uyar and Escarraz ; Johnson and Kriz ; Marlowe ; Krueger and Walker ; Jimenez ). For example, Palumbo and Zaporowski () argued (and confirmed) that a decline in this measure may reduce the tax base, and as such would be evaluated negatively by credit rating firms. However, the evidence of this association is mixed or weak in Farnham and Cluff () and Stallmann et al (), and insignificant in Zhao and Guo () and Grizzle ().…”

“…Simonsen et al () proposed that more populous jurisdictions have more resources and human capital for superior government capacity. In other studies, population size is also a proxy for tax base or sophistication in capital market access (e.g., Farnham and Cluff ; Capeci ; Marlowe ; Palumbo and Zaporowski ; Johnson et al, ). Therefore, greater levels of population may be positively correlated with state credit ratings.…”

Assessing Municipal Bond Default Probabilities

“…Consequently, the ratings assigned to these insured issuers were AAA -reflecting the estimated credit quality of the insurer. During the 2007-2008 financial crisis, all monoline bond insurers went out of business or suffered ratings downgrades (Palumbo & Zaporowski, 2012).…”

Infrastructure Reporting and State Bond Ratings

“…The results for per capita income and unemployment rate are consistent with prior state bond rating models (Johnson et al () and Martell et al (). Palumbo and Zaporowski () found their economic diversity measure statistically significant in their study of counties and cities. They used a set of socioeconomic variables, including income, population, unemployment, economic diversity, and state aid along with a set of debt and revenue measures.…”