Municipal Bond Forum
Rating agencies and municipal bonds
Q
I just read an article about how employees from the leading credit rating agencies knew about the dangers in subprime mortgages but gave them the seal of approval anyway. I find this distressing. They rate the bonds, and if they can’t be trusted, what good are their ratings?
A
James A. Klotz responds:
We are also distressed by the actions of the rating agencies outlined in the article you forwarded. It is important, however, to keep in mind that these regrettable lapses of judgment were related to the ratings of mortgage-backed securities, not municipal bonds. Rating municipal bonds is a completely different ballgame and, fortunately, considerably more straightforward.
For example: The creditworthiness of a general obligation municipal bond is determined by evaluating an existing tax base, along with the dependability of tax collections in that issuing entity. Revenue bond analysis is centered on calculating the strength of the revenue stream from a particular project or facility, in comparison to the costs associated with operating the facility. It is also the role of the rating agencies to project these factors into the future based on reasonable economic assumptions.
In much the same manner as the ill-fated municipal bond insurers, the rating agencies stumbled when they ventured away from their bread and butter businesses in search of more profitable endeavors.
In the municipal sector, the rating agencies enjoy a more favorable reputation, supported by a track record that dates back to the 1860s.
Although bond ratings provide helpful guidelines for municipal investors, they should not be relied upon as the last word when making a bond purchase.
At FMSbonds, we also own the bonds we sell, which makes it incumbent upon us to understand the security behind the bonds we recommend to our clients. Toward this end, we employ a full-time municipal credit analyst, whose research is made readily available to our trading desk, and bond specialists who are specifically trained in municipal securities.
Please contact us with any questions you may have with regard to any particular issues.
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The responses provided in this forum are meant to address specific questions posed by investors about their municipal bonds and to provide market insight for our general audience. Please note, your investments, objectives, results and experience may differ significantly. Our answers and any potential strategies discussed should not be construed as a solicitation to buy nor sell any security or investment product. All investing entails risk.