MuniLand – Underestimating Portfolio Risk If You’re Only Using Credit Rating Agency Score

The largest players in the municipal credit rating space are Standard and Poor’s and Moody’s.  These two firms have different approaches to scoring general obligation debt.  The major difference are the weights applied to debt/pensions and economic conditions.  Moody’s prescribes a 20% and 30% weight, respectively, to the aforementioned factors, while S&P applies a 10% and 40% weight, respectively.  Moody’s gives debt management more importance than S&P.  This rating methodology was a change by Moody’s which was implemented well over a year ago and we are beginning to see the impacts.  Bloomberg reports that YTD S&P has rated some 86% of the newly issued fixed rate municipal debt while Moody’s has rated about 74%.  S&P’s lead over of Moody’s is growing, in our view, because the S&P ratings methodology systematically scores credits higher than Moody’s.  Municipal GO issuers are taking notice of this trend because the issuer pays for their credit rating and ratings partially drive the cost of financing.  If financing costs are lower with higher credit ratings it makes sense that issuers would “shop around” for the best rating.  The implication of the trend could have a material impact on credit selection and portfolio management if credit ratings are the only major criteria used for picking securities.  SNW Asset Management’s credit evaluation process is based on independent analysis, which leads to our own internal rating.  Credit ratings alone are not sufficient to make an investment decision.  Managing total portfolio risk allows SNWAM to create portfolios with better risk-adjusted returns than could be achieved by simply building a collection of highly rated bonds.