Lockyer's Rating Proposal Gets Mixed Response From Market

WASHINGTON -Market participants expressed mixed views yesterday about a plan floated informally by California Treasurer Bill Lockyer to either petition the three major credit agencies to harmonize their municipal rating scales with corporate ratings, or ask the Securities and Exchange Commission to amend its Rule 2A-7 on money market funds to take into account the different rating scales.

The proposal, for which Lockyer is soliciting support from other issuers, may be finalized as early as today, and it already has the backing of issuers from a handful of states and a number of localities or state-level authorities that believe municipal bonds are much safer investments than their ratings suggest, especially when compared to corporate ratings.

"We're not going to be asking that every municipal issuer be rated triple-A," said Tom Dresslar, a spokesman for Lockyer. "All we want is that the ratings reflect the risk of default. Theoretically, you could have gradations in the triple-A rating."

The proposal, first reported Sunday night by the New York Times, comes amid downgrades to bond insurers that have led to failed auctions in the auction-rate securities market for roughly the past six weeks. The turmoil has spread to other arenas, such as variable-rate demand bonds. In response, House Financial Services chairman Barney Frank, D-Mass., has announced a hearing on municipal bonds for March 12. A congressional source said yesterday that the hearing will include at least two panels, consisting of issuers and private-sector market participants, and possibly a third panel of regulators.

Though supporters of the Lockyer plan said it is unlikely to resolve any of the market's short-term problems, it would improve matters in the long-term, by, among other things, making it easier for money-market funds to buy munis. Rule 2a-7, which governs the types of securities that money market funds can hold, currently stipulates among other things that these funds can't purchase securities rated below double-A and does not make a separate distinction for a municipal rating scale.

Historically, issuers have harmonized the differences in their muni ratings with the corporate rating scale through bond insurance, but as the insurers have been downgraded, money market funds have suddenly been unable to purchase lower-rated munis.

"It's a longer-term project to get the rating agencies to harmonize the scales or to get the SEC to change 2a-7, but it's something that's got to be fixed," said Roger Anderson, executive director of the New Jersey Educational Facilities Authority, an ardent supporter of Lockyer's plan.

Anderson said that most munis would earn either triple-A or double-A ratings, but that the rating agencies could include variations at the top of the scale so that investors could still differentiate between them.

For instance, the highest-rated gilt-edged muni could be rated "AAA1." But there could be as many as seven variations of a triple- or double-A muni bond, signified by their respective number on the scale.

Frank Hoadley, Wisconsin's capital finance director and chairman of the Government Finance Officers Association's committee on debt management, said that his committee probably would not have time to weigh in on the proposal until it next meets in June for the issuer's group's annual meeting.

Sources who asked not to be named and were familiar with Lockyer's plan were skeptical about it.

"The treasurer of California may want to characterize the quality of his state's debt as better than it is," one source said. "At this point, I'm not sure it's best to call their debt triple-A because there's a lot of it and they don't have the best financial ratios."

California's general obligation bonds are currently rated at the A1/A-plus level by the three rating agencies. In October, when the state sold a $250 million taxable GO issue, it obtained a global scale rating from Moody's Investors Service of Aaa. That global scale rating cost the state an additional $25,000, above the $46,200 price of the municipal rating, plus a $6,250 annual charge to monitor the global scale rating. To date, only Moody's has mapped muni ratings to its global scale.

Spokesmen for Standard & Poor's and Moody'sdeclined to comment on Lockyer's proposal yesterday, saying they had not yet seen it.

But Michael Belsky, the group managing director of the U.S. public finance group at Fitch Ratings, suggested wholesale changes to the muni ratings scale are unnecessary.

"We've had a market that's functioned well for decades and investors have incorporated the difference between a municipal rating, which measures relative value among other municipal credits, versus corporate ratings that are more focused on default and recovery," Belsky said. "If everything becomes the same, I'm not sure that's a good thing for the market."

Belsky stressed, however, that Fitch is always open to hearing from market participants, as did Thomas J. Lemmon, a spokesman for Moody's.

Meanwhile, another market source who asked for anonymity said that corporate equivalent ratings will only muddle the "views" available to investors. "Ratings are a report card as much as anything," he said.

He also criticized the assumption of Lockyer's supporters that money spent on bond insurance is essentially wasted, saying, "Bond insurance saves the borrower money or they would not be using it - this fact seems to be missing from any of these accounts."

An issuer source who is skeptical of Lockyer's plan said that the existence of the two different scales "simply doesn't matter."

"These are two different markets with different investor bases," the source said. "Recalibrating the two different scales in and of itself solves nothing, nor do I think it's going to magically make a difference in the price of a municipal bond."

The source said there are only four areas of public finance in which a municipal bond rating is compared directly to a corporate bond rating and in which it is important for market participants to understand that relationship between the two scales. They are: transactions wrapped with bond insurance, the sale of taxable municipal bonds, transactions involving tax-free money market funds, and swap counterparty arrangements.

In the latter instance, swap counterparties protect each other from downgrades by insisting on collateral agreements, which in turn are usually based on assumptions about potential downgrades from existing ratings.

"You have to understand how the two ratings compare in the first place and you have to make adjustments for the comparison of a municipal versus a corporate rating before you begin those discussions," the source said. "If you don't, you're going to be out of whack."

Rich Saskal contributed to this article

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