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Raters Address Calls for Unified Rating Scale

All three rating agencies addressed demands for creating a unified rating system last week, answering the calls that have echoed in the wake of the auction-rate security crisis and the congressional hearing convened earlier this month.

On Thursday, Fitch Ratings named Robert Grossman to head a review of "harmonizing" the corporate and public finance rating scales and Moody's Investors Service issued a request for comment on a new policy that would assign both a municipal rating and a global rating scale to an obligation upon issuer request.

Meantime, Standard & Poor's said they already have a global scale, which is used across all sectors.

The issue of a single global rating scale has found traction in recent months. While Standard & Poor's and Moody's have both had a global rating scale for a number of years, market participants were not concerned with the concept until several months after the credit crunch first hit in early August.

"The market sentiment began to change in the fourth quarter of 2007," said Gail Sussman, group managing director for U.S. public finance at Moody's. "I believe one of the drivers of that sentiment was the increasing concerns with regard to stability and the credit strength of the financial institutions and the financial guarantors."

More recently, about two weeks ago, the House Financial Services Committee held a hearing in which they brought up the need for a single rating scale that takes into account the historically low default rates of tax-exempt debt. Ahead of that hearing, 17 state and local issuers led by California Treasurer Bill Lockyer joined Congress in asking for a single rating scale to reflect the low risk of municipal default.

"End the double standard and create a unified, global rating approach that treats all issuers equally, and better serves taxpayers and investors," Lockyer wrote in a letter to the editor in yesterday's edition of The Bond Buyer.

Central to the discussion going forward will be the form of the rating scales. It seems to be an evolving process, though one thing is certain. All three agencies have conducted default studies in recent years, and while each one featured subtle differences, all of them came to similar conclusions: municipal issuers default on debts far less than do corporations.

However, there is more to it than default rates, and both municipal and corporate issuers have very different financial and risk profiles, said Dennis Tripp, a private portfolio manager and longtime veteran of the market.

"I don't really quite understand how you map munis to corporates," Tripp said. "A corporation and a municipality are completely different animals, they serve completely different masters and purposes."

That is one of the considerations Fitch will have to review as they conduct their review. In looking at the possible "harmonization" of the two rating scales, Fitch has assembled a group of multi-disciplinary analysts. The rating agency will look to pursue a two-pronged path: determining the credit equivalencies between munis and corporates and then getting investor feedback, said Grossman, Fitch's chief credit officer.

As the most recent agency to review this issue, Fitch will have an opportunity to choose its own solution while considering the various merits and drawbacks of those favored by Moody's and Standard & Poor's.

"Would the market be best served having one scale, or better to develop a separate scale?" Grossman said.

Standard & Poor's has been using a global rating scale for years, and believes it is the best way to gauge the creditworthiness of municipal issuers.

"We believe it is important to have one global rating scale that is widely understood, which is why we use the same scale across all sectors," said Standard & Poor's spokeswoman Mimi Barker last week.

Does that mean a AA-rated muni is considered to be the same as a AA-rated corporate?

"Yes," said David Wargin, a spokesperson for Standard & Poor's. Municipal bonds are already rated higher than corporate bonds, with about 99% of all munis investment grade, versus only 20% of corporate bonds, according to Standard & Poor's.

Officials like Lockyer seems to prefer a single scale, but Moody's will keep a municipal scale in addition to the global rating scale, while making it easier to understand the conversion table used to map munis to the global ratings.

"Based on feedback we've gotten from the market so far, we believe [maintaining the municipal rating] is an essential component," Moody's Sussman said.

That feedback is evolving, which is one reason Moody's is again seeking comment.

"There are many users of municipal ratings and we want to make sure we get all of their opinions," said Lisa Washburn, team managing director for U.S. public finance at Moody's.

At this point, it is not clear whether all market participants agree with the concepts currently under discussion, or whether municipals need to mapped to the corporate scale. Investors, trade groups, underwriters, issuers, traders, and others all bring their own approach to the issue.

Among issuers, the Government Finance Officers Association has yet to formulate an opinion, said Frank Hoadley, the chairman of the GFOA debt committee and Wisconsin's capital finance director. Moody's has set an April 15 deadline for comments, before enacting any new policy in May. It is a deadline Hoadley would like to make, but it is still too early to tell what the comments might be.

"The committee is in the preliminary stages of forming a task force to draft a policy position for consideration by the board," Hoadley said.

Some market participants have been vocal in warning that changing the rating scales, or altering them in some way from where they are now, is an exercise that should be carefully considered. In fact, as historically low default rates are used to illustrate the low risk of munis, the underlying finances for issuers are softening.

"It may be an inopportune time to do this haphazardly," said Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management LLC. "You have got to be very careful."

Ciccarone said that states and localities face real estate woes that could negatively affect property tax pledges embedded in their general obligation bond issues, just as they start to see spiraling costs associated with pension and retiree health care liabilities. It is a view shared by some investors.

"They are looking backwards at these historical default rates and they are absolutely correct. However, the debt levels and the pension problems are off the charts now," said B. Clark Stamper of Stamper Capital and Investments Inc. "If you don't adjust for that you won't be doing anybody a service, and they might end up like the CDO ratings."

Meanwhile, other groups are lining up to support the move to a more unified rating scale. The National Association of Independent Public Finance Advisors added its voice in a resolution that was approved earlier this month and sent to House Financial Services Committee chairman Barney Frank, D-Mass., but not released publicly until yesterday.

The one-page resolution, which was approved unanimously by the group's board, says that the current system of credit ratings for munis "leads to inappropriate market discrimination against state and local government credits costing enormous amounts annually that could be better invested in public programs and infrastructure."

The resolution went on to urge the rating agencies to take "prompt affirmative action to create appropriate categories of corporate equivalency ratings" for munis that eliminate the market discrimination resulting from the current rating structure.

"What we have right now results in substantial costs for municipal governments, either in terms of prices in the market or in terms of having to buy bond insurance," said Robert Doty, vice president of NAIPFA and president of American Governmental Financial Services Co.

Andrew Ackerman contributed to this story.


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