Fitch Ratings will raise its credit rating on nearly every state and most cities under an overhaul of its municipal credit-evaluation system next month.
Saying municipalities’ credit should be judged by the same standards as corporate issuers,
The revision in every case will be an upgrade, implemented on April 5.
Any bond rated A-plus or higher secured by full faith and credit from a state or local government will be upgraded a notch, Fitch said. Any state or local GO bond rated from BBB-minus to A will be raised two notches.
Any state or local GO bond below investment grade will be evaluated individually.
Water, sewer, and public power debt will be upgraded the same way as the GO debt.
Special tax-backed bonds rated from BBB-minus to AA-plus will be upgraded a notch. Public higher education bonds rated BBB-minus to AA-minus will be raised a notch.
This announcement comes just a week after Moody’s Investors Service unveiled a similar plan, to be implemented later in April.
The ratings revamps reflect a dichotomy that has lasted decades: if a credit rating is intended to convey the probability of default, municipalities are held to a higher standard than private corporations.
The cumulative default rate on municipal bonds rated investment grade by Moody’s through 2007 was 0.07%, compared with 2.1% for investment-grade corporate bonds.
Fitch said its recalibration is intended “to ensure a greater degree of comparability across Fitch’s global portfolio of credit ratings.”
Fitch emphasized that the revisions do not communicate an improvement in municipal credit quality. They are an adjustment to the ratings system to “denote a comparable level of credit risk as ratings in other sectors.”
“The aspiration is for Fitch’s ratings to demonstrate broadly comparable levels of default patterns over long periods,” the agency said.
Municipalities have exhibited a “very low default history,” Fitch said. State and local government issuers have “inherent strengths that allow them to maintain fiscal balance,” it said, including taxing power, the ability to enforce revenue collection, expense flexibility, and the right to tap reserves.
Ashton Goodfield, head of municipal trading at DWS Investments, said the recalibration could help muni bonds.
Some institutional investors, such as mutual funds, are restricted from buying bonds below a certain rating. The revisions may put into play some bonds that funds previously could not buy.
In addition, retail investors, the predominant buying force in the municipal market, may not have all been aware that the rating scales were different for municipals and corporates, according to Goodfield. The higher ratings may make them feel more secure.
The higher ratings may also help Build America Bonds compete with corporate bonds, she said, adding that not all the consequences of the recalibration are likely to be positive.
The revisions will bunch a lot of GO debt into the A-or-better class, meaning a wide range of credit quality will be squeezed into each rating, Goodfield said. That will make it harder for retail investors to discern among municipal bonds with different credit qualities and the same rating.
Fitch first said it was considering a recalibration of its ratings scale in July 2008, but its timing was not ideal. The worst economic contraction since the Great Depression forced Fitch to shelve the program to avoid wholesale upgrades at a time of deteriorating credit quality.
