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Some munis can have higher ratings than U.S.: S&P

NEW YORK (Reuters) - Some states and local governments may retain their coveted AAA ratings despite the fact the United States has lost its top rating, according to Standard & Poor's Ratings Services.

Analysts and traders had been concerned the rating agency would apply a "sovereign ceiling" to state ratings, the idea that ratings within a country should not be higher than the rating of the national government.

Another round of negative muni headlines could rattle retail investors, who began fleeing the market late last year on well-publicized predictions of mass bond defaults that have yet to materialize.

"Pursuant to our criteria, the fiscal autonomy, political independence, and generally strong credit cultures of U.S. states and local governments can support ratings above that of the U.S. sovereign," S&P said in a report released late on Monday.

But the rating agency, which downgraded the United States to AA-plus with a negative outlook on Friday, will be examining all municipal ratings in the context of specific federal funding cuts, which won't be known until later this year, an official said on Tuesday.

"Where are the actual reductions going to be? Where will they hit and when?," Steve Murphy, a S&P managing director, told Reuters. For details, click on [nN1E7780JK].

Congress has until year end to find $1.5 trillion in spending cuts with a bicameral, bipartisan commission charged with identifying at least $1.2 trillion in savings by November 23.

States, cities and other local debt issuers that have low dependence on federal funding and that can weather declines in federal assistance could be rated higher than the United States, S&P said in its report.

"We expect that in most instances in which state and local governments have ratings above that of the U.S., the differential will be limited to one notch," S&P said.

The states that S&P currently rates triple-A are Delaware, Florida, Georgia, Indiana, Iowa, Maryland, Minnesota, Missouri, Nebraska, North Carolina, Utah, Virginia and Wyoming.

"S&P's report will probably give a lot of comfort to municipal professionals that they're not going to have to deal with downgrades because of a formula," said Richard Larkin, senior vice president at Herbert J. Sims & Co, Inc. in New Jersey.

The United States warrants different ratings between the U.S. government and regional and local governments because "in effect, what you have are sovereign states within a sovereign state", Larkin said.

The S&P report also made sense to Mike Nicholas, chief executive officer of Bond Dealers of America, the trade association for dealers and banks focused on U.S. fixed-income markets.

"State debt -- GO debt -- is not tied to U.S. Treasuries, not dependent on the U.S. government as a backstop. It shouldn't be affected at all," he said.

Not all market players saw it that way.

Chris Mier, a managing director at Loop Capital Markets in Chicago, said the market may be in for a period of reverse calibration of muni ratings, which were lifted in recent years to match rating agencies' global scales.

"If the U.S. government is AA-plus you can't have a half dozen of states at AAA ratings, or local units at AAA ratings," Mier said in a Monday conference call. "Clearly, in order to keep the system logical and coherent there's going to be a lot of downgrades."

A slew of muni debt directly related to the U.S. government, including prerefunded bonds secured by Treasuries and certain housing debt, were downgraded late Monday by S&P to AA-plus with a negative outlook from AAA.

The rating agency said in July ratings on this debt would move in "lockstep" with the federal government's rating.

On Monday, S&P stripped top ratings from several local government investment pools due to exposure to investments in Treasuries and U.S. government agency securities.

Assured Guaranty Municipal Corp, the only active insurer of muni bonds, had the outlook on its AA-plus rating revised to negative from stable. Ratings on muni bonds backed by federal leases and on about $26.2 billion of bonds issued by the Tennessee Valley Authority were cut to AA-plus from AAA.

The actions followed a move on Thursday by rival Moody's Investors Service, which slapped a negative rating outlook on five top-rated states and hundreds of local governments it had tied to U.S. debt woes.

(Reporting by Chip Barnett, additional reporting by Karen Pierog in Chicago and Lisa Lambert in Washington; Editing by Andrew Hay)

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