Nobody knows exactly what the long-term impact of the United States losing its AAA rating from Standard & Poor’s means for municipal bonds, but that didn’t stop the experts from speculating.
The muni team at Janney Capital Markets noted that tax-exempts performed well last week and continued to strengthen Monday, but with supply at just $3.2 billion last week and maybe $2.2 billion this week, the market hasn’t been tested.
“State and local government issuers as well as the essential services sector have remained impressively resilient to credit pressures post-recession,” Janney strategist Alan Schankel wrote Monday, but “the coming week’s new-issue calendar is again sparse, so munis are unlikely to face any real challenge in the short term outside of the specter of ratings downgrades.”
Michael Pietronico, chief executive at Miller Tabak Asset Management, thinks the reaction to the downgrade could have been worse had it come earlier in the financial crisis when a federal bailout of states was a more plausible notion.
“Since it is widely believed that the federal government is not in any position to bail out states, most municipal participants recognized that the notion of the federal government as a backstop was unrealistic, and has largely been discounted,” he wrote.
A bigger long-term threat, Pietronico added, is deep cuts to the federal budget.
“States that rely heavily on government spending — such as Virginia and Maryland, which are home to many federal employees and defense contracts — could suffer,” he wrote.
Tom Dalpiaz, portfolio manager at Advisors Asset Management, said he didn’t believe the sovereign credit downgrade would have any meaningful impact on borrowing costs for state and local governments.
“The municipal bonds likely to be affected are among the most highly rated in the municipal universe,” Dalpiaz wrote.
Chris Mauro, head of muni research at RBC Capital Markets, focused on the potential for another knee-jerk sell-off. He said retail investors, who make up roughly two-thirds of the muni market’s investor base, could be spooked by headlines pronouncing “thousands” of muni bond downgrades.
The muni market includes about 1.2 million individual CUSIP numbers that identify individual bond issues. That compares to 75,000 in the corporate world, Mauro pointed out. So even if muni downgrades are limited to credits directly linked to the sovereign credit — such as pre-refunded munis and housing bonds backed by Fannie Mae and Freddie Mac — the aggregate number of bonds impacted could be eye-popping.
Moody’s Investors Service, for instance, last month listed 7,000 muni ratings that would be downgraded in lockstep with the sovereign credit.
The market may already have been given a preview of the impact last Thursday, when Lipper FMI reported $860 million of net muni bond outflows. Mauro called that figure — the biggest outpouring since mid-April — “uncomfortably reminiscent” of heavy redemptions seen from November 2010 to May.
Meantime, Standard & Poor’s affirmed the AA-plus ratings on the two bond insurer platforms run by Assured Guaranty Ltd. but revised the outlook to negative from stable due to their holdings of Treasuries.
The move was made in conjunction with downgrading five top-rated insurance companies to AA-plus and giving four other AA-plus insurers a negative outlook
“The rating actions reflect … our view that the link between the ratings on these entities and the sovereign credit ratings on the U.S. could lead to a decline in the insurers’ financial strength,” Standard & Poor’s said. “This is because these companies’ businesses and assets are highly concentrated in the U.S.”