Implementation of a unified global rating scale for both municipal and corporate bonds is unlikely to have a significant market impact, municipal bond investors say.
"The market is pretty efficient at this point," said Ken Harris, a partner at Westcore Funds. "I'm not sure new ratings makes that much of a difference."
California Treasurer Bill Lockyer has challenged the current system of bond ratings in which municipal bonds and corporate bonds are evaluated on different scales by credit agencies. Lockyer has been pushing for a single, unified scale for all fixed-income assets called the global scale rating.
Besides saving municipalities financing costs, Lockyer has maintained bond investors would benefit from increased clarity in a single methodology for evaluating the likelihood of default in bond issues.
"Rating municipal bonds by the same standard as bonds in other sectors of the fixed-income market would provide investors with more useful information and enable the market to function more efficiently," Lockyer said in an open letter to Moody's Investors Service available on the California treasurer's Web site.
Lockyer has received a number of endorsements to the global-scale rating proposal from banks such as Citi, Morgan Stanley, and Merrill Lynch & Co. But many investors remain cool to the idea.
"Issuers that are single-A right now that would be triple-A might see a small benefit," Harris said. "It's probably a lot less than Lockyer thinks it is."
While the current system arguably penalizes municipalities, that can work to the benefit of investors. "For totally selfish reasons, we like to buy lower-rated bonds other people ignore because they're lower rated," Harris said.
Perhaps alone among investors contacted, Hugh McGuirk, a portfolio manager with T. Rowe Price & Co., came out forcefully against putting municipalities and corporations on the same scale.
The problem with a ratings change, McGuirk said, was that because municipal default rates are so low, a single scale could result in ratings inflation.
"I'm having a hard time equating the fiscal health of a state like California with a state like Maryland," McGuirk said. Both states would likely be rated triple-A on a global scale. "There's a difference between the two that would be lost. They're clearly not of the same risk profile."
McGuirk thinks that a number of municipalities could be significantly less conservative in their financing and still maintain a triple-A.
"Municipalities are very aware of their bond rating. The threat of a downgrade is a strong disincentive system," he said. "A change to the ratings system may result in less fiscal discipline."
Not everyone agrees.
"Not every municipality would be rated triple-A," said Chuck Grob, an analyst with Invesco Worldwide Fixed Income. "I don't think state legislatures pay that much attention to their credit ratings."
"The lowest-grade munis have a better default rate than top-rated corporate bonds, and that's just not right," he added.
While endorsing global scale ratings in theory, Grob backed the recent position of the National Federation of Municipal Analysts that called for a cooling of rhetoric in the fight over ratings.
"With the NFMA, they were concerned with the speed of the conversion, that it might happen too abruptly," Grob said.
Even as large mutual funds like T. Rowe Price and Invesco take opposing views, private investors weigh the ratings more heavily.
"I don't think most individual investors understand the difference between the two scales," said Keith Newcomb, who counsels private clients out of his Nashville office. "It's something I have to spend time educating customers on. Individuals don't have the resources or inclination to study the underlying finances, they rely on the ratings scale."
He agreed both with Grob, that the current system of separate corporate and municipal scales is misleading, and with McGuirk, that fixed-income investors would lose valuable information by moving away from the less forgiving gradations of the municipal scale. "I'd like to have one scale - and for that one scale to be more granular," Newcomb said.
Any change to the ratings would have to be phased in over a period of five years to give the market, and particularly smaller investors, time to react, he added.
Bill Walsh, president of Hennion & Walsh Inc., a firm catering to individual investors located in Parsippany, N.J., said he's not sure what difference a ratings change would make to bond buyers.
"On the state side, it may lower their costs. On the retail side, I don't think it makes much of a difference," he said. "Most munis will get a better rating, but I don't know if the savings or extra income will be enough to matter.".
For Walsh, the ratings system is cosmetic. Regardless of the scale or scheme by which a bond is officially rated, the underlying financials and risk of default for any fixed-income vehicle remains the same.
"In theory, a single scale is an OK idea, but in reality I question whether it will work," Walsh said. "The market is very fair. You still have to pay attention to the issue, not just the rating."