Municipal credits are finally getting their just due as the ratings agencies have begun the process of ‘mapping’ to the global ratings scale. The three ratings services (Moody’s, S&P, and Fitch) have announced that they would be structurally rerating substantial portions of their municipal ratings universe in order to make the ratings more comparable with those in non-Public Finance Sectors. The global scale ratings assesses the risk of repayment on municipal bonds as compared to the bonds of other global institutions, including corporations, as opposed to traditional municipal ratings, which compare the issuer’s bonds solely to the bonds of other municipal institutions located in the US. Up until now, municipal credits had been evaluated by the ratings agencies with more stringent criteria than corporate credits. Consequently, rating comparisons between the two asset classes misrepresented the inherent safety of municipals.
The ratings upgrades should not be viewed as upgrades based upon credit trends, but rather as confirmation that municipal bond ratings, in general, were too low in comparison with ratings in other credit sectors in terms of the actual default risk within a given rating category. While the global mapping process will be phased in slowly, it will impact the ratings of both tax-exempt and taxable municipal bonds. Ratings for both general obligation and essential service bonds are expected to rise by 1 to 2 notches and all state general obligation bonds will be rated A1 or better. However, there will be limited effect in sectors already perceived as having accurate ratings, such a health care and housing.
What does this mean for today’s municipal bond investors? First of all, the new, higher ratings on many types of credits will increase the demand for some of these credits, particularly on issues currently rated below single-A that will be moved into the single-A category. Some issues may also qualify for purchase by investors that could not buy them at the previous rating levels, based upon internal standards or regulatory rules. As a result, there may be a tightening of credit spreads in some sectors or on some specific issues. Over time, the new higher ratings, together with the easing of budgetary pressures are likely provide some calm to nervous public sentiment by reducing the potential impact of headline risk.