Our Thoughts on Municipal Credit Ratings

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For our clients who own municipal bonds, credit issues have been much in the news recently. There have been a number of news items about the credit stresses afflicting many of our states and their municipal subdivisions. A time-honored starting point for municipal credit analysis has been to look at credit ratings published by “nationally-recognized statistical rating organizations (NRSROs),” mainly Moody’s, Standard & Poor’s, and Fitch, but these companies have themselves come under heavy criticism for their failures in appraising collateralized debt obligations and securities backed by sub-prime and low-documented or no-documented mortgages. Perhaps a few words are in order regarding our opinion of the NRSROs and the use we make of their published credit opinions.

At SNW Asset Management, we view credit as the paramount consideration when purchasing municipal securities for our clients. While we feel that the rating agencies have generally done a good job in appraising municipal credits – they got into trouble primarily by venturing away from the types of credit they knew well and understood — SNW Asset Management has always performed independent reviews of every credit we buy, irrespective of their published credit ratings. We reserve the right to disagree with the rating agencies, and we have deemed a number of credits over-rated and others under-rated. For this reason, we urge our clients who own municipal bonds to treat credit ratings as we do — with respect, but not with unthinking respect.

Some of our clients may receive news of rating changes up or down, and where downgrades occur may become concerned. There are four basic reasons why ratings may change: (1) the NRSROs may change their underlying opinion of a credit; (2) they may change their opinion of the insurer of an insured credit; (3) they may change or withdraw ratings when an issue is pre-refunded with U.S. government securities; or (4) they may change their basic rating model of the entire class of municipal credits, such has occurred recently with the publication of new “global ratings” designed to rate municipal and corporate credits on a common basis. The global ratings are a response to criticism that municipal credits rated at given levels were sounder credits and defaulted far less frequently than comparably-rated corporate credits. Moody’s and Fitch have already begun publishing the new global ratings, which have resulted in numerous upgrades for municipal credits, and S & P is expected to follow shortly. Our opinion is that investors should not lose sight of the credit basics. The financial stresses on municipalities are very real, and even as the nation’s economy shows definite signs of the onset of economic recovery, the financial health of our governmental units will improve only with a lag. It may take two years or more for municipal financials to regain the level of vigor they last enjoyed in fiscal year 2007-08. Our advice is therefore to stick to the credit basics like we do, focus on underlying credit quality and ignore insurance, and above all not make too much of changes in published credit ratings, whether for good or for ill. They represent just one useful indicator of credit health. We think our own detailed review of municipalities’ periodic financial statements is far more important.