WASHINGTON Janney Capital Markets is concerned that Standard & Poor's ratings for some local governments may be too high and out of step with current credit conditions.
"The potential for a discrepancy between Moody's [Investors Service] and S&P's ratings increased after S&P's new local government criteria was released ... and so did the potential for ratings shopping," Janney muni analyst Tom Kozlik wrote in a report Monday. "We also have found that changes in the content of S&P's local government rating reports often leave out significant information we believe is necessary for investors."
But Jeff Previdi, S&P managing director overseeing local governments in the East and Midwest, said the rating agency doesn't think its ratings are too high. In addition to implementing the new criteria, there has been an "improving economic environment for local governments," he said. For example, rising home prices help local governments that rely heavily on property tax revenues.
Previdi said the purpose of the new criteria was to make local government ratings more comparable to other sectors. The criteria change factored in the fact that local governments performed well even during the recession.
Janney is not the first group to be critical of S&P's ratings. A December report from Nuveen Asset Management said that S&Ps upgrades of tax-backed municipal credits increased dramatically during the Great Recession, "though given the economic conditions of the time the increases cannot be explained by improving credit conditions." While the rating agency had a brief period of slowed upgrade activity in 2011, it "appears poised to resume a torrid pace of upgrades," Nuveen said.
Since 2006, Moody's and S&P's upgrade-to-downgrade ratios have been diverging a trend that Janney refers to as the "Great Municipal Bond Rating Dislocation." Upgrades to U.S. municipal market credits have far outpaced downgrades at S&P, but Moody's has downgraded more credits than they have upgraded. However, in 2010, Moody's instituted a criteria change that led to a wave of upgrades, an action S&P did not follow.
S&P published new criteria for local government ratings in September. At that time, the rating agency expected that applying the criteria would result in upgrades to 30% of local governments it rates and downgrades to only 10%.
The prediction that the new criteria would lead to more local government upgrades than downgrades has come true, with 533 upgrades and 39 downgrades occurring in the sector during the first quarter of 2014 as a result of the new criteria.
Given that the country is dealing with the aftermath of the worst financial crisis since the Great Depression and many local governments continue to struggle with balancing their budgets, Kozlik wrote that he believes that Moody's upgrades-to-downgrades ratios make more sense. "Janney retains a "cautious" credit outlook on the local government sector, in fact," he wrote.
Since S&P updated its criteria, it is more common for issuers to have ratings from S&P that are multiple notches higher than their ratings from Moody's. "This leads us to believe that ratings shopping will continue, perhaps at an even faster pace than before," Kozlik wrote.
Janney looked at just over 200 local governments that sold debt on a competitive or negotiated basis in June 2014. Fifty of those governments published an S&P rating and did not have a Moody's rating. Another 11 issuers only published S&P ratings but also had relatively recent outstanding Moody's ratings, though they were at least one notch lower than the S&P rating. An additional 16 issuers only published S&P ratings and had outdated Moody's ratings, the report said. Previdi noted that some of the lower Moody's ratings that were mentioned in the Janney report were older than the S&P's ratings.
Janney's report recommends that investors not rely on ratings alone when making investment decisions. It also suggests that if investors own bonds that appear to only have S&P ratings, they should review the credits and see if they also have Moody's ratings.
Naomi Jagoda is a reporter for the Bond Buyer.
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