It’s clear that markets aren’t listening to ratings agencies the way they used to.Agencies such as Fitch and Moody’s are planning to make their municipal bond rating system easier, and hike muni bond ratings, in order to bring their muni ratings system into line with their corporate bond system.
Yet some investors aren’t willing to believe that these higher ratings will mean anything:
But investors have warned that the upgrades may not reflect the fiscal problems currently facing a number of municipal bond issuers. Marilyn Cohen, CEO of Los Angeles-based fixed income manager Envision Capital Management, says the recalibrations are “optimistic”.
“There are a number of unfunded pensions liabilities around,” Cohen says. “Many issuers have not taken care of their 2009 budget yet. We may see some real problems there. Take Illinois for example: it has an unfunded liability of $54–55 billion. I hope I’m not around when that hits the fan.”
Illinois will benefit from an upgrade under the new scale, despite having been downgraded by Fitch on March 29 amid concerns over its pension liabilities. Fitch moved Illinois’ general obligation bonds down one notch to A-, but when the new scale is implemented on April 5 the rating will be upgraded to A+.
Politicians had pressured ratings agencies to create an easier rating system for municipal bonds, in the hopes that higher ratings would reduce the perceived risk of muni bonds and thus allow local governments to pay lower interest costs.
Yet the situation above shows how this thinking is flawed. In the end, a credit rating alone is meaningless, it’s just a label for real risk that exists. Bonds ultimately pose risks to those who buy and hold them based on the financial situation of the bonds’ issuers, not based on what Fitch or Moody’s say.
Most fixed income investors were infamously blind to this reality pre-crisis, simply following credit ratings without question. Many are probably still blind, lazily allowing ratings agencies to make their investment decisions for them. But some are now highly sceptical of the ratings given to securities, as shown above, which is a good thing, and is the result of the shock we felt during the crisis.