Global Scale Credit Rating
Treasurer Bill Lockyer of California is pushing the bond rating agencies to eliminate separate rating scales for tax-exempt and corporate bonds. In March, he circulated a letter to all state treasurers asking them to join him in his efforts. His work has not gone unnoticed by the rating agencies (at least Moody’s and Fitch). Even Congress has held hearings regarding this topic.
His argument is based on default rates. A single A rated tax-exempt issuer has a similar default history as that of a triple A rated corporate issuer. Single A municipal issuers end up purchasing bond insurance so they can receive the lower interest rate associated with a triple A rating (that was before the recent implosion of the monoline insurers). A common scale would eliminate this cost for lower rated municipal issuers because they would be triple A.
Having a global scale seems to make some sense then. However, the rating agencies consider factors, other than default rate, when assigning ratings. Four general areas are considered in a rating agency analysis: 1) Economic factors; 2) Debt structure; 3) Financial factors; and 4) Management strategy.
So what does this mean if Treasurer Lockyer is successful in his quest? We would see all issuers of bonds, both municipal and corporate, on the same rating scale. But I wonder if the world is unchanged in practical terms.
From Shakespeare’s Romeo and Juliet we read, “What’s in a name? that which we call a rose by any other name would smell so sweet.” The same applies here. Municipal credits will still need to be differentiated from one another. Both California and Virginia could be triple A, but they are still not the same credit. It doesn’t matter what you call them there is a difference in the credits. As a bondholder, I would much prefer a Virginia bond over a California bond. The rating agencies will still have to differentiate by expanding the scale to quadruple A or adding a 1-5 designation to the triple A scale.
This leads to market pricing. Even if the credits have the same rating, I have to believe that the market will continue to price credits differently. Large institutional buyers do their own credit analysis. They will make their own differentiation. The best credits will continue to issue debt at an interest rate that is lower than the weaker credits. Will the best credits get an even lower interest rate? I doubt it. Municipal bond credits will continue to trade at the same levels as they have historically. Again, the need for bond insurance will continue.
This will play out over the next several months. The nice thing about Utah is we don’t have a dog in this fight because we already have a gilt-edged AAA bond rating. It saves us millions of dollars per year.
Tags: municipal bonds, Ratings, tax-exempt