Muniland – Municipal Credit Rating Divergence

Last week we discussed Illinois and Chicagoland credits and how the rating agencies, particularly Moody’s, had downgraded the City of Chicago and Chicago Public Schools (CPS) more severely than had S&P.  We know that the credit rating divergence is partially due to differences in rating methodology, as Moody’s gives more weight to pension and debt liabilities than S&P.  The difference of credit opinions invites the question, are credit ratings divergences commonplace? What we’ve found, quantitatively, is that credit rating divergence is common today, and has been a persistent issue for years.

Please refer to the two charts below. Using the Bank of America Municipal Master Benchmark as a broad representation of the municipal market, we compared month end data from May 2013 and May 2015.  For each time period, we removed any bonds wrapped with municipal insurance and state guarantee programs in order to focus the analysis on the underlying credit quality of the issuers. We then performed a credit rating variance analysis between Moody’s and S&P, and charted the variance (x-axis) versus the average option adjusted spread (OAS) by sector (y-axis). For reference, OAS is an alternative measure of yield. What we see is a wide ratings divergence between sectors in both years analyzed. In some cases, the rating divergence is as much as eight notches, or AAA versus BBB. That is a significant difference in credit quality.  Moreover, in both the maps, we see some cases where Moody’s ratings are higher (left side) and other cases where the S&P ratings are higher (right side).  For example, in the 2015 map, S&P rated tax-backed bonds more favorably than Moody’s by five to seven notches, and Moody’s rated tobacco bonds more favorably than S&P by up to eight notches.  Curiously, this pattern for tax-backed and tobacco bonds does not hold in 2013, and because we limited the time period between our analyses, the impact of maturing bonds falling out of the index is also limited.  Therefore, we can conclude that credit rating divergence is nothing new. As an active bond manager, this kind of analysis adds significant value for our clients because it helps identify possible credit dislocation and buying opportunities.  

Download the 2013 Muni Master NSRO Quadrant Map (125k .PDF)
Download the 2015 Muni Master NSRO Quadrant Map (126k .PDF)

Sources: SNWAM Research, Bloomberg and Bank of America Merrill Lynch