is dedicated only to capital funding or when capital
needs are large. Debt service reserves also take on
less importance in cases where debt service cover-
age will be maintained at very high levels, such as
2x maximum annual debt service or higher. In these
cases, debt service reserves equal to half of maxi-
mum annual debt service, ones only funded when
coverage falls below a specified level, or in some
cases not funded at all, may be sufficient.
Special Tax Ratings Can Exceed A GO Rating
A special tax bond rating can exceed that of a
municipality’s GO rating in certain circumstances—
when an issuer’s base shows broad economic diver-
sity, revenues show good stability in economic
downturns, debt service coverage levels are strong,
and legal covenants provide strong protection or
are analytically less relevant. Special tax ratings
may rise above an issuer’s GO rating, since as a
practical matter, the pledge of special tax revenues
may place bondholders ahead of unsecured GO
bondholders. Chapter 9 of the U.S. Bankruptcy
Code specifically provides that a municipal bank-
ruptcy filing, “does not operate as a stay of applica-
tion of pledged special revenues, which includes
special excise taxes, to payment of indebtedness
secured by such revenues”. Although case law is
limited by the small number of municipal bankrupt-
cy filings, it would appear sales tax bondholders
would have a strong priority interest in the event of
municipal distress, allowing sales and special tax
ratings to exceed a GO rating. However, heavy
sales tax bond issuance could potentially weigh
down a GO rating. Special tax supported debt is
included in Standard & Poor’s calculation of an
issuer’s direct GO debt burden ratio, and could
result, in unusual cases, in a downgrade of a GO
rating when high debt service costs hamper the abil-
ity to balance a general fund budget.
Economic Concerns
The health of the local economy is central to the
rating process. As it does when rating other types
of municipal issues, Standard & Poor’s initially
evaluates the diversity and growth potential of an
economy. A poorly performing or concentrated
economy may limit the upside potential of a bond
rating, despite high debt service coverage. The main
emphasis is on the breadth of the tax base, both by
diversity of retailer, and on the items taxed.
Generally, levies on the widest range of items earn
higher ratings than those on limited categories of
goods and services, (for example, a tax only on
restaurant sales may somewhat narrow the tax
base, as might a sales tax jurisdiction dependent on
a limited number of auto retailers, while inclusion
of retail grocery sales may provide greater tax sta-
bility). Standard & Poor’s reviews cyclical factors,
such as tourism, that could cause fluctuations in tax
receipts. A large and diverse employment base will
provide some protection against swings in retail
purchases of area residents. A larger geographic
jurisdiction also mean less likelihood that a resident
will visit a retailer outside an issuer’s taxing juris-
diction if a retailer closes down.
Under certain conditions, the diversity of retailers
can be another rating factor, particularly for nar-
row retail bases.For instance, in a very small town,
a large portion of revenues may come from one
shopping mall or an auto dealership that may face
future out-of-town competition, or whose propri-
etor may fold. Standard & Poor’s may ask for a list
of the top 10 retail outlets as a percentage of total
sales to help allay concerns of retail concentration,
or provide retail sales by economic sectors. As an
example, a concentration in auto dealerships may
indicate especially cyclical retail sales.
Confidentiality laws may preclude the release of
actual names of the largest retail generators. In such
cases, Standard & Poor’s can review retail figures
without the release of the specific name of the
retailers. Large population bases may be assumed
to contain a diverse retail base, while smaller
municipalities may be deemed to carry some risk of
concentration when precise retail concentration fig-
ures are unavailable.
One positive factor regarding sales taxes is that
revenues continue to be remitted when a sales tax
vendor declares bankruptcy, but remains in opera-
tion; conversely, however, tax revenue will come to
a halt if the retail store closes or relocates outside a
jurisdiction. In such cases, it is helpful that nearby
alternative shopping outlets are still in town.
Sometimes, even major cities can suffer when a
large retail mall opens in a suburb, drawing off
shoppers. For this reason, high retail sales per capi-
ta are closely analyzed.Implications Of Growth Trends
Growth trends may depend on the type of taxes.
One of the strongest credit features of sales-tax rev-
enues is that they are inflation driven. Revenues
and debt service coverage will increase in inflation-
ary periods, even when a local economy does not
grow in real terms. On the other hand, gas taxes
are usually derived from a per gallon tax that does
not grow with inflation. Nevertheless, gas taxes
also tend to remain relatively stable in recessions
and depend more on population growth. Income
tax receipts also show general stability over time,
especially for large economic bases, due to the
broad-based nature of the tax. Each type of special
tax will be examined on its own merits for possible
future growth and cyclicality.Special Tax Bondshttp://www.standardandpoors.com 71