Fitch Ratings completed its recalibration of municipal bond ratings on Friday, raising their marks on more than 2,200 credits, according to its updated scale.
The rating changes affect 1,828 local tax-supported credits, 338 water and sewer credits, 50 higher education credits, and 27 public power credits. Los Angeles, for example, had its general obligation bonds raised to AA-minus with a stable outlook from A-plus with a stable outlook.
The move follows Fitch’s April 5 recalibration of state ratings.
“We did it in two pieces just because there’s sort of a massive amount of data that needs to be adjusted and a massive number of ratings,” said Fitch managing director Amy Laskey. “This should be the end of the process.”
Local GO bonds — and credits dependent on them — with GO ratings from BBB-minus to A were raised two notches. Those with a GO rating of A-plus or higher were raised one notch.
Public power distribution and water and sewer credits were raised using the same formula. Special tax-backed bonds with ratings from AA-plus to BBB-minus were raised one notch. Public higher education credits with ratings from BBB-minus to AA-minus were also raised one notch. Public higher education credits with ratings of AA-minus or higher and all private education credits were not adjusted.
“A lot of the reason for the adjustment had to do with trying to make ratings comparable to other sectors based partly on historical default rates,” Laskey said.
Moody’s Investors Service has also begun to recalibrate its ratings, raising 34 states and Puerto Rico according to its global scale last month. There were anecdotal signs last week that the recalibrations may have had an effect on pricing, but establishing a cause and effect is difficult.
Moody’s announced on March 16 it would recalibrate its scale and thus raise California’s rating. Fitch’s recalibration lifted California to A-minus from BBB and Moody’s raised it three notches to A1. The spread between the state’s 10-year yield and Municipal Market Data triple-A had fallen to 104 basis points on Thursday compared to a 157 basis points spread in early March.
“The California spread tightening is likely a symptom of the recalibration,” said Matt Fabian, managing director at Municipal Market Advisors. Light trading flows in April make it difficult to gauge the recalibrations’ impact, he said.
“Higher ratings make bonds eligible for purchase by a wider group of buyers and as we’ve seen with Build America Bonds, the wider a group of buyers you have, the better prices you’ll get,” Fabian said. “For the issuers with [recalibrated] higher ratings, you’ll very likely see lower yields over time.” Securities that were already highly rated, on the other hand, “may see somewhat higher yields as their own scarcity is diluted,” he said.
Evan Rourke, portfolio manager at Eaton Vance, said the higher ratings would have a greater impact on retail investors than on institutional buyers.
“You would expect that over time as individual investors come into the market — and they tend to be very much more dependent on the rating agencies’ ratings than perhaps the professional institutional investors are — there you may start to see spreads tighten,” Rourke said. “People are looking at it as a readjustment of the whole market so you don’t look at it as a true upgrade in the conditions of the actual credit.”
He said he hadn’t seen a dramatic shift in credit’s spreads, though over time increased liquidity from higher ratings could be priced in. “I don’t think you’re going to pay dramatically more for that bond — incrementally, maybe, because it might be slightly more liquid,” Rourke said.
