Impact of Moody's Upgrade of Muni Bonds

AccruedInterest has a good post on the expected impact of Moody's change of municipal bond ratings:

Investors should care for two reasons. First it appears that most municipal bonds will soon be upgraded by Moody's. It is not currently clear what the timing of the ratings revisions will be, but Moody's has previously published a guide to "mapping" municipal credits to the Global Scale. For direct obligations of States, anything rated A1 or higher on the muni scale would be Aaa on the Global Scale. That means every state would be Aaa except Louisiana. For other general obligations, including cities and counties, anything rated Aa3 or better would be upgraded to Aaa. A general obligation bond rated Baa3 would be upgraded to Aa3. Even riskier credits like hospitals would enjoy at least a 1-2 notch upgrade, according to Moody's mapping.

There is still a lot of uncertainty over this whole re-rating strategy undertaken by the rating agencies. Even if almost all states are rated AAA, would the market require a weaker state like California to pay a higher yield? Or would the differences dissapear?

I'm In any case, although the final outcome is uncertain, this will significantly reduce the muni bond insurance market size. If the market simply relies on the rating (i.e. doesn't price different states, cities, etc differently even though they have the same rating), the bond insurance market is pretty much reduced to the weaker municipalities, public-private partnerships, and other issuers who don't have strong taxing power.

I'm not too familiar with bond ratings so I'm not sure what the impact will be on foreign "municipalities" ratings (Europe, Japan, developing countries, etc.) I don't know what scale is used for the global entities and whether changes will be made there as well.

If the muni bond insurance market is significantly reduced, bond insurers pretty much have to make a living off structured products or foreign "muni" bond insurance. This is one of the big reasons I am not a huge fan of the current strategy being pursued by MBIA, Ambac, and others, to create a new insurer primarily to insure muni bonds (i.e. get a AAA rating to generate new muni bond business.) Given all the uncertainty in the muni bond market, it might take a long time before we know what is insurable and appreciated by the bond buyers.


1 Response to Impact of Moody's Upgrade of Muni Bonds

June 23, 2008 at 4:56 PM

I really don't see how this influences the decision to start a new sub for the monolines. If the muni market does decline significantly in volume a dedicated muni insurer could upstream capital that cannot be profitably employed to it's parent. Nothing will be lost over not starting the new sub and keeping the capital at the holding in the first place. If the muni market remains strong (personally I expect it to for reasons I outlined some time ago in a post) there is much better opportunity for profitable new business with the new sub. Am I missing something?

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