California Treasurer Bill Lockyer Tuesday wrote to Fitch Ratings that although he is "pleased" with the idea of using a single scale to rate municipal and corporate debt, the rating agency's proposed framework is not "sufficient" in accomplishing the goal of harmonizing ratings.
In the four-page letter, Lockyer wrote he is "disappointed" that most investment-grade general obligation and senior revenue bonds will move up only one or two notches under Fitch's proposal. (Read the letter here)
"It will leave many issuers who never have defaulted - and never will default - saddled with unjustifiably low ratings," Lockyer wrote.
The treasurer has taken a leading role in the criticism of rating agencies, saying municipal issuers had to pay a higher borrowing costs because the agencies rated municipal credits systemically lower than corporate debt with similar rates of default. Under pressure from Lockyer and other politicians, all three rating agencies have taken steps to adjust municipal ratings upward on global scales.
Lockyer's most recent comments came in response to Fitch's exposure draft of its proposed framework. The rating agency will continue to accept public comments through tomorrow on the draft it published July 31.
Lockyer's said Fitch's proposal does not do enough to recognize municipalities' historically low rates of default. Although the default rates of bonds from different sectors might not be identical at each ratings level, Lockyer said he would expect them to be closer than proposed.
Currently, 58% of state and local general obligation debt is rated in the double-A or triple-A categories, compared to 10.1% of corporate debt. Fitch estimates 86% of state and local GO debt will fall into those categories after upgrades under its proposal.
"Of course there will be a greater concentration of higher ratings among GO bonds, just as there will be more A students among those headed to Harvard than those dropping out of high school," Lockyer wrote. "What determines harmonization, instead, is whether bonds with the same ratings represent the same risk, regardless of sector."
The California treasurer also took issue with Fitch's decision to incorporate in its ratings the impact future burdens - such as economic weakness, pension and other post-retirement benefit costs, and infrastructure needs - could have on municipal governments. Although he agrees Fitch makes a "good list of potential budget strains," municipalities have weathered such tough times in the past, Lockyer wrote.
Lockyer suggested Fitch undertake more studies to determine which factors should be considered. He said Fitch "must consider" the ability of almost all municipalities to survive economic downturns in the past "in any evaluation of the future."
"If the goal, as described, is for ratings to indicate the likelihood of default, sound credit analysis must be based on factors that have a direct impact on the possibility an issuer will default," Lockyer wrote. "And those factors must be based on historical evidence, not mere conjecture."
Fitch and others have pointed out that historical evidence does not always predict future performance. Residential mortgage-backed securities, for instance, had low historical default rates and high ratings before the market collapsed.
Lockyer suggested Fitch try to "understand why tax-backed bond defaults are virtually non-existent, that than just posit unproven factors that may theoretically lead to defaults."
"Tax-backed bonds are extremely safe for investors because they incorporate numerous protections that make the payment of debt service mandatory, not optional," he wrote. "When budget times are tough, issuers do not have the option to not pay debt service."