Ratings

The qualities found in a highly-rated small issuer are similar to highly-rated larger-size issuers: economic strength, above-average financial performance, strong management, and manageable debt levels. However, the way toward reaching these performance benchmarks can be different for smaller municipalities. Some of these differences are:

• The relative economic strength of a smaller municipality may be based on its proximity to a larger economic center, provided that its own local economic base is also stable.
• Financial performance depends not only on the level of reserves but also on cost pressures and budgeting flexibility. Many smaller governments have fewer responsibilities than their larger counterparts, which can mean less budgetary pressure and volatility. High fund balances on a dollar basis aren't the only way to demonstrate financial strength; operational or budgeting flexibility or a demonstrated ability to implement other creative solutions can also elevate credit quality.
• Management practices at governments of all sizes show their strengths through a variety of planning and policy techniques as measured by Standard & Poor's Financial Management Assessment (FMA). While smaller governments may lack the staff to justify the maintenance of intricate policies and reporting mechanisms, more limited policies and planning may still be adequate for the existing level of operating risk. Policies and processes identified through the FMA help demonstrate the overall strengths of a municipality, regardless of size.
• While a lower population or market value can lead to higher debt ratios on a per capita or market value basis, the capital pressures facing a smaller municipality are often lower than on a larger entity.

A smaller municipality can be highly rated if it is able to overcome the credit factors that typically constrain a rating. A smaller-size municipality's tax base isn't automatically a negative factor, particularly if the composition of the base is diverse. However, a smaller base can also lead to more tax base concentration, given that there are fewer taxpayers. Like size, concentration in and of itself doesn't have a negative impact on the rating. However, should the dominant taxpayer(s) close or scale back operations to the point where it hurts the local economy -- and consequently the municipality's financial position -- the rating could be affected.

Similarly, a limited budget size with little operational flexibility and a susceptibility to revenue and expenditure pressures -- without ample financial cushion -- can also weigh on the rating. Pressure can come from unexpected capital expenditures, which could have a more significant impact on a small government. For instance, a new police car costs the same amount regardless of the population size it serves; if the purchase is not budgeted, the toll on a smaller budget could be significant.

High debt levels, either on a per capita or market value basis, or high carrying charges that push up fixed costs in a small budget, can also hurt ratings. Higher fixed costs can result in less budget flexibility and a greater burden on the taxpayers. While debt is only one factor in Standard & Poor's analysis, a smaller municipality with an onerous debt burden is likely to have a lower rating.

While none of the issues discussed is radically different from our analysis of larger issuers, it is important to note that the way economic and financial stability can be measured is different. Stability and flexibility can be of even greater importance for municipalities that don't exhibit as much diversity as larger ones, or those that rely on an economy they have little or no control over, such as a neighboring metropolitan area. Even with these potential challenges, smaller municipalities have the ability to achieve higher ratings, making the case that size isn't really everything.