SAN FRANCISCO – Rating agencies continue to treat municipal issuers unfairly even though federal law required that practice to stop, said former California Treasurer Bill Lockyer. Lockyer, who was treasurer from 2007 until term limits spurred his retirement from office earlier this year, made the comments during a luncheon question-and-answer session Thursday at The Bond Buyer’s California Public Finance Conference.
Asked whether California’s general obligation bond ratings, which remain on the low end of states’ ratings despite upgrades since the recession ended, are an accurate reflection of the credit, Lockyer, now an attorney at the firm Brown Rudnick, said he believes the rating agencies are failing to adhere to the requirements of the Dodd-Frank Act. “It’s just not fair,” Lockyer said of the fact that municipal bonds continue to be rated lower than corporate bonds despite data showing that similarly-rated munis default far less often than corporates. On June 15 a Dodd-Frank Act rule went into effect that requires rating agencies to adopt procedures designed so credit ratings weigh default risk "in a manner that is consistent" for all rated obligors and securities; studies published by Moody's Investors Service and Standard & Poor's have shown that the default rates of munis 10 years after being rated BBB are lower than the default rates of corporates 10 years after being rated AAA. Lockyer said the agencies have not adjusted and that the Securities and Exchange Commission is failing to enforce the rule, resulting in higher borrowing costs for municipal issuers. “The SEC is asleep on this issue, and they ought to be ashamed of themselves,” Lockyer said.
Both Fitch Ratings and Moody’s Investors Service formally recalibrated public finance ratings in 2010, elevating many municipal ratings. Standard & Poor’s, though it never conducted a full-scale recalibration, has also reviewed criteria in municipal bonds sectors,
Despite that, many market participants continue to believe that the ratings exaggerate the risk of default.
Requests for a response from the major rating agencies were not answered in time for this report.
During 2014 examinations, the SEC said last year that its staff observed improvements in rating agency record keeping, monitoring and culture, but said improvements were still needed in the management of conflicts of interest, document retention, and policies and procedures for determining or reviewing ratings. Lockyer was joined in the Q-and-A by another former treasurer, Kathleen Brown, who served from 1991-1995. In addition to discussing California’s infrastructure investment needs and the ability of the treasurer to drive positive change in the state, the pair discussed the landscape since the final effectiveness of the SEC’s municipal advisor rule last year.
The rule codifies Dodd-Frank’s requirement that firms giving bond-related advice to muni issuers owe their clients a fiduciary duty, and both former treasurers said they had some reservations about it. “It troubles me,” said Brown, who spent 12 years as an investment banker at Goldman Sachs after she was treasurer. “Regulating and coming after the issue this way makes it not very fun to do what I used to do.” Lockyer said the SEC’s concern for smaller issuers seemed appropriate to him, but added that he didn’t understand why the same rules had to be applied to larger, more sophisticated issuers.
