The ongoing credit crunch is starting to hit mutual funds, according to a recent review by Standard & Poor's that revised credit quality ratings on eight tax-exempt mutual funds.
The agency viewed the eight funds to have material exposures to Ambac Assurance Corp. and MBIA Insurance Corp. - both of which Standard & Poor's placed on negative CreditWatch while lowering their financial strength ratings to AA from AAA on June 5.
A week later, the agency on June 11 adjusted the funds' credit quality ratings, stating that their exposures to bonds insured by Ambac, MBIA, and other non-triple-A rated securities moved their average credit quality into a lower rating category, according the report.
The ratings are assessments of the overall credit quality of a fund and reflect Standard & Poor's views on the level of protection the fund provides against losses from credit defaults. The quality ratings scale ranges from AAAf to CCCf and may be modified by a plus or minus sign to show relative standing within the major rating categories.
At Van Kampen Advisors, the credit quality rating of the Van Kampen California Insured Tax-Free Fund dropped to A-minus-f from Af, after originally being rated AAAf in October 1985. It was adjusted to AAf on Feb. 1 of this year and then to Af on April 11 based on the negative rating actions on Financial Guaranty Insurance Co. in the first quarter. The fund invests at least 80% of its total assets in California municipal securities that are insured at the time of purchase.
At State Street Global Advisors, four of the firm's tax-exempt portfolios in its Standard & Poor's Depositary Receipt family of exchange-traded funds had their credit quality ratings adjusted.
The quality ratings on the SPDR Lehman California Municipal ETF, SPDR Lehman New York Municipal Bond ETF, the SPDR Lehman Municipal Bond ETF, and the SPDR Lehman Short-Term Muni Bond ETF were adjusted to AAf from AA-plus-f.
At Barclays Global Investors, the credit quality ratings for the iShares California Municipal Bond Fund was adjusted to AA-minus-f from AAf, and for the iShares New York Municipal Bond Fund was revised to AA-minus-f from AA-plus-f.
Among the BlackRock Advisors Inc. funds, the BlackRock Insured Municipal Term Trust Inc.'s credit quality rating was revised to AAf from AAAf, but the rating was later withdrawn at the firm's request.
Tim Ryan, vice president of State Street, said he was not surprised by the downgrades to the SPDR funds since they are ETFs that track different subsets of the Lehman Managed Money Index, and is not worried about the effects of further downgrades to the monoline insurers.
"This is not a deterioration of the underlying bonds in the portfolio or anything specific to the portfolio that is not going on in the index itself," Ryan explained last week of the downgrades.
"We always felt we would be doing what the index would be doing," he said of the ETFs, which were launched in the fall of 2007. "The portfolio and the index have exposure to bond insurance companies, and as they were downgraded, we weren't surprised of the similar effect to the portfolio itself."
"There may be some bonds because of the downgrades that are probably going to drop out of the index, and to the extent I own some of those, I have a decision to make," Ryan continued. "If we held something in the index that is not there anymore we would likely sell that."
"If this is a big, prolonged credit crisis and there are downgrades across the board, new bonds will get added and other bonds will get taken out of the index, but the credit quality of the ETF will be maintained," he added.
At the same time, he noted that the funds' exposure to insurance is slightly less than the 55% held by the index, so State Street is confident that its product will still be in demand among investors.
"I don't believe that a further downgrade to the monoline bond insurers is really going to detrimentally hurt the ETF because, one, we are underweight bond insurers overall, and two, we are sensitive to looking at underlying ratings wrapped by bond insurers," Ryan said.
He also pointed out that Standard & Poor's lowered the SPDR funds by a half-notch within the double-A category, as opposed to a multi-notch downgrade into a lower rating category altogether.
