Moody's Moving to Global Muni Scale

WASHINGTON — Moody's Investors Service plans in mid-April to move to a global scale for its municipal bond ratings so that they are more in line with its corporate debt ratings, after postponing the initiative during the height of the financial crisis.

The rating agency's announcement of the move came a day after Senate Banking Committee chairman Christopher Dodd, D-Conn., unveiled a redrafted financial regulatory reform proposal that would mandate such changes, similar to the reform bill the House passed in December.

The little-noticed provision in Dodd's 1,336-page bill would require the Securities and Exchange Commission to pass rules requiring the nationally recognized statistical rating organizations that it oversees to consistently use the same symbols to rate municipal and other types of debt.

The NSRO provision suggests, but does not explicitly state, that the ratings would have to be based on the probability that an issuer of a security or money market instrument will default, fail to make timely payments, or otherwise not make payments to investors in accordance with the terms of the security.

Though Moody's had said it would revisit its plans for the recalibration when the markets calmed down, its announcement came on the heels of Dodd's release of his bill and prompted lawmakers and market participants to suggest the rating agency was responding to the legislation.

"That's probably what clinched it," House Financial Services Committee chairman Barney Frank, D-Mass., said in a brief interview yesterday, referring to Dodd's bill, which he noted reflects language on uniform ratings that he championed in the House bill.

"It's going to save money for municipalities, it's a tax-reduction measure," Frank said, adding that he wants the other major rating agencies to emulate Moody's.

Rep. Michael Capuano, D-Mass., a member of the committee and vocal critic of Moody's, joked that yesterday was the only time he could recall that Moody's had made him happy. He said it doesn't matter if their timing was prompted by the regulatory reform legislation. "Whatever it takes is fine by me," Capuano said. "They did the right thing. I'm glad they're showing leadership."

Gail Sussman, Moody's group managing director, denied that the agency's timetable is related to regulatory reform legislation, saying Moody's has been discussing the issue of rating comparability with market participants since 2001.

"In light of market developments and changes in the composition of buyers of municipal bonds, we believe greater comparability across sectors and transparency will make our ratings more useful as tools for measuring credit risk," she said. "Moody's believes that a single rating scale for all types of securities best serves all market participants including issuers, investors and intermediaries."

Richard Raphael, executive managing director and head of U.S. public finance at Fitch Ratings, said his agency continues to review the issue, after suspending a similar initiative in early October 2008. Raphael said Fitch "expects to relay its updated perspectives to the market in the near future."

Standard & Poor's has long maintained that it already uses a uniform scale across all major credit sectors, though it has upgraded hundreds more municipal credits than it has downgraded in recent years as a result of an updated default study.

Moody's said yesterday that it will take about four weeks to fully replace all of its 70,000 "sale-level" ratings for outstanding muni bond issues of 18,000 issuers. The recalibrations will be implemented in stages, with changes generally occurring for all ratings within a given sector on the same day. Local government ratings will be recalibrated by individual states or groups of states.

Moody's, which has used a separate rating scale for U.S. muni bonds since 1918, cautioned that the recalibration will "not represent a change in our opinion of the credit quality of the affected issuers."

In recent years, issuers, lawmakers, and other market participants have complained that municipal ratings are unfair because muni bonds, while generally rated lower than corporate debt, have much less of a chance of going into default.

The National Governors Association, National League of Cities, Government Finance Officers Association, and other muni market groups pushed for Dodd's uniform ratings provision.

Tom Dresslar, spokesman for California Treasurer Bill Lockyer, who also pressed for such legislation, said Moody's unified scale will provide ratings that "more accurately reflect the de minimis risk of default of tax-backed municipal bonds, including California's."

"Now we'll see how the market reacts and how much the move pays off for taxpayers in this state and across the country that have borne the financial burden of an unfair system that has lasted far too long," he said.

Dresslar said it is "heartening" that the Senate and House versions of financial regulatory reform are now tracking each other on the uniform ratings issue. However, he said Lockyer's staff will have to study the Dodd language. Lockyer and others have concerns about provisions in the House bill that would allow NRSROs to establish "complementary ratings" based on factors that are unique to an issuer, which they fear would water down the broader uniform ratings requirement.

Richard Ciccarone, head of municipal research at McDonnell Investment Management, said the new methodology Moody's released suggests that the changes to issuers' interest rates will be most pronounced for debt rated in the Baa category, which the rating agency said could be upgraded as much as three notches, possibly resulting in 100 basis points of savings.

But Ciccarone said the impact of the rating changes will be hard to gauge this year. It will be harder to distinguish, he said, because the changes will come amid a sharp decrease in supply of tax-exempt bonds — as issuers have sold taxable Build America Bonds — that has kept tax-exempt yields quite low.

The prevalence of BAB issuance "distorts" the real impact the rating changes will have on the marketplace, especially among higher-rated general obligation bonds, he said.

John Hallacy, head municipal strategist at Bank of America Merrill Lynch, said Moody's indicates that the rating changes will have the largest impact on GO debt, as well as water and sewer bonds, certain utilities, and municipal utility districts.

"They're saying that with GOs, recovery is very high, if and when a default happens," he said, adding that it's an open question how much tax-exempt yields will decrease once the recalibration is complete.

"Will tax-exempts move? I think generally the answer is yes, though maybe not immediately," Hallacy said.

Moody's said that a key driver for the recalibration is the market's increasing desire for rating comparability between municipal and non-municipal sectors, given the growing number of cross-over investors active in both tax-exempt and taxable markets. With the rating changes, Moody's expects that municipal and the other sectors it rates will show similar average default and loss rates over long periods of time.

States and localities' GO ratings will on average rise by two notches above their current ratings, "with a range of zero to three notches," Moody's said. Ratings at or above Aa3 on the municipal scale will receive less upward movement than those rated below Aa3, it said.

For bonds backed by sales and special tax obligations, their ratings generally will move up by only about one notch, mostly because they are backed by narrower, more restricted revenue streams, Moody's said.

Some municipal ratings in non-tax-backed sectors may not change because they are already aligned with the global scale, the agency said. These include ratings on housing, nonprofit health care, private higher education, public power, toll road, state revolving funds, bond banks, charter schools and land-secured issues, as well as federal leases and tax-exempt bonds backed by corporate credits,.

Moody's said its short-term municipal ratings are already aligned with short-term ratings in other global sectors.

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