Saturday, March 27, 2010

A Change in Municipal Bond Ratings

This article previously appeared as a new feature at Repercussion- A Retirement Review.

We are far from free of the clutches of the Great Recession.  The hold that the recent economic downturn has had on numerous types of investment portfolios will continue, even if, one the surface, it seems to abated somewhat in the equities markets.  The recent decision by Fitch, a bond ratings company, to revisit their grading strategies of municipal bonds may be simply cloaking the possible maturity wall facing bond investors.

Municipal bonds have historically been rated slightly lower when compared to corporate bond issues.  While the default rate for munis is much lower (0.7% compared to 2.1% default by corporate bonds) these debt securities used for public financing of roads, water, sewer and other public projects have often received a slightly lower rating.  This despite what appears to be a robust fiscal balance which includes increasing tax revenue, the ability to enforce revenue collection, control over expenses gives the municipality better flexibility, and the right of local communities  to tap reserves when needed.

The question is simple: will this change in ratings by Fitch (following a recent change initiated by Moodys), often moving munis up a grading notch provide better transparency or simply complicate the ability for buyers of these bonds to tell the difference?  This is of particular concern for those close to retirement looking to exert more stable control over their accumulated assets, fixing their projected returns and protecting capital.

It is our belief that munis will be approaching the same "bubble status" as mortgage backed securities attained just two years ago.  While Fitch claims to be looking at the long-term ("The aspiration is for Fitch’s ratings to demonstrate broadly comparable levels of default patterns over long periods") they may be looking at more historical data on the sector rather than the possibilities that in the near future, these securities might be facing the same trouble as the rest of the bond market might face in the coming years.

The "Maturity Wall", a point in the future when a great deal of corporate and Treasury bond issues mature and demand for debt might be overwhelmed by too many choices, often at higher prices and lower yields. Seeing that possibility will force investors to flock to munis if they feel as though they are immune.  They may well be in just as much trouble if the projects they are undertaking fall short of funding from the federal government.

More from Dan Seymour writing in BondBuyer

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