Moody’s Investors Service kicked off a wide-scale “upward shift” in municipal credit ratings yesterday, assigning stronger grades to 34 states and Puerto Rico.
This is just the first salvo in what is likely to be a four-week blizzard of ratings “recalibrations” among most of the 18,000 states and localities whose debt Moody’s rates.
Last month, the New York-based rating agency unveiled a plan to hoist the ratings on most of the universe of state and local government debt.
Moody’s has long held municipalities to a higher rating standard than sovereign governments, corporations, or structured products.
The municipal scale represented a ranking of municipal credit quality based on “distance to distress” rather than default probability.
This generally meant municipalities have been stuck with lower ratings than other types of issuers despite what in many cases were stronger histories of repayment.
Last month, the agency said it was going to recalibrate its municipal ratings scale to align it with the scales assessing the creditworthiness of other types of issuers.
Moody’s plans to standardize the scales so that all borrowers are assessed on the same criteria, and a rating means the same thing regardless of whether the issuer is a city, a sovereign nation, or a retail chain.
The rating agency initiated these changes yesterday by applying the recalibration to states.
California and Puerto Rico were the biggest gainers under the Moody’s recalibration.
Each was bumped three notches — the maximum ratings ascension under the recalibration.
California is now rated A1. Puerto Rico is rated A3.
Five states — Indiana, Tennessee, Texas, New Mexico, and Iowa — are newly rated Aaa.
Of the 16 states not assigned a higher rating, nine could not go any higher because they are already rated Aaa.
Four — Florida, Minnesota, Kansas, and Washington — are rated Aa1, which the recalibration algorithm Moody’s published last month did not necessarily bump to a higher rating. The outlooks for all four states were raised to stable from negative.
Moody’s does not assign ratings to Nebraska, South Dakota, and Wyoming. Moody’s also adjusted its ratings on the District of Columbia and certain other local governments in six states.
Fitch Ratings earlier this month began enacting a recalibration on similar grounds, lifting ratings on tens of thousands of municipal bonds.
Moody’s still plans to recalibrate ratings for local governments and housing and enterprise issuers.
Municipal analysts are still trying to gauge how investors are going to respond to these recalibrations.
Some have said they expect the market to make its own distinctions, meaning a newly minted triple-A like Indiana would trade at a spread to a holdover triple-A like Maryland.
Phil Villaluz, head of municipal strategy at Advisors Asset Management, is in this camp.
“I think it’ll be a minimal effect, if any, in terms of prices and spreads,” he said.
As Moody’s and Fitch have stressed, the recalibrations do not signal any improvement in credit quality. The new ratings are a different way to express the same credit opinion. That opinion is already reflected in bond prices, Villaluz said.
Others have said yields sooner or later will conform to the new ratings.
In his latest weekly report, Morgan Stanley Smith Barney municipal strategist George Friedlander wrote that he expects at least a modest boost for municipal credits assigned higher ratings.
Once these new ratings become the norm, he wrote, the market simply may not pay attention to the old ratings.
Friedlander expects a jump especially for credits that cross a “letter-rating boundary.”
California and Puerto Rico, for instance, went from ratings starting with “B” to ratings starting with “A.”
Friedlander outlined a number of problems the recalibrations pose to the municipal market.
Rating deterioration may be harder to spot, he said, because the top ratings now describe a broader range of bonds.
Comparing historical spreads may become difficult, he said. Take the spread of the single-A rated 10-year municipal over the triple-A. What does that historical spread mean now that most of those A-rated credits have been moved up the ratings scale?
“Pre-recalibration credit spreads and post-recalibration credit spreads have significantly different meanings,” he said.