Alert April 28, 2010

Fitch and Moody's Recalibrate Ratings

Moody’s Investors Service recently raised the credit ratings of 34 states and Puerto Rico, marking the first stage in a massive ratings adjustment expected to affect tens of thousands of outstanding municipal securities.  Earlier this month, Fitch Ratings implemented similar changes in its rating methodology, resulting in a ratings increase for over 38,000 municipal securities.  Both agencies have been careful not to characterize the higher ratings as upgrades, but instead refer to them as “recalibrations.”

The diagnostic changes implemented by the two rating agencies were designed to more closely emulate the criteria used in the private sector, which focus more on payment histories and default probability than on “distance to distress” models.  California and Puerto Rico were the most notable beneficiaries of Moody’s recalibrations, each rising three rating grades – from Baa1 to A1 for California and from Baa3 to A3 for Puerto Rico.

Market observers expect the Fitch and Moody’s recalibrations to stimulate the municipal securities market, especially the market for short-term securities, by attracting additional investors looking for more secure investments.   An increase in the volume of long-term tax-exempt securities may still take time, however, if issuers use their higher credit ratings to access the Build America Bonds (“BABs”) market instead.  BABs are taxable bonds that have been available to municipal issues since 2009.  An increase in the issuance of BABs tends to depress the market for long-term tax-exempt municipal bonds.