Treasurer Lemoine Urges Rating Agencies to Apply the Same Ratings Scale to State and Corporate Bonds
March 4, 2008
(AUGUSTA)- State Treasurer David G. Lemoine announced today that he has joined state treasurers from across the nation in petitioning the three major credit rating agencies, (Moody’s, Standard & Poor’s and Fitch), for more equitable and transparent creditworthiness standards. Treasurers from California, Connecticut, Idaho, Iowa, Maine, Nevada, New Jersey, New Mexico, Oregon and Washington are asking that municipal (government) bonds be rated on the same scale as corporate bonds.
“It has become apparent in recent months that there are serious flaws in the U.S. government-sanctioned rating system that is the foundation of the worldwide fixed income market,” said Lemoine. “I look forward to working with other state treasurers to push for a simpler and fairer government-bond ratings system” he added
Credit rating agencies now hold state governments to an artificially higher standard than the ratings scale imposed upon corporate issuers. Most states, including Maine, would carry AAA credits if evaluated on the corporate scale. Maine is nonetheless rated Aa3 by Moody’s, and AA by both Fitch and S&P. Municipal bonds rated Baa from Moody’s have had a miniscule default rate of 0.13%, while corporate bonds rated Aaa by Moody’s now have a historical default rate four times as high, or 0.52%. Municipal ratings are compared to corporate ratings in a lot of markets and ratings impact their transaction terms. An efficient, transparent and integrated capital market requires an integrated ratings scale.
“The current dual-rating system inflates the perceived risk of state-issued bonds, adds a false sense of volatility and often imposes an artificial need for bond insurance,” said Lemoine. These factors inflate the borrowing costs paid by state taxpayers. The cost of issuing Maine’s General Obligation bonds last June would likely have been reduced by $75,620 had Maine been rated on a common scale with corporate bonds.
The true security of state-issue bonds is that a state is not going to go out of business during the life of its bond issue. In addition, in Maine, the State Treasurer is constitutionally obligated to take any state revenues needed to make debt service payments. “There is essentially zero risk that the State will not pay all its general obligation debt service obligations on time, and our credit ratings should reflect that fact,” said Lemoine. Maine’s general obligation debt service costs in Fiscal Year 2008 will be $100,927,960, (2.97% of revenues) out of an annual budget that exceeds $3.0 billion.
Rating agencies have been under intense criticism because they failed to adequately reflect the credit risk of collateralized debt obligations (CDOs) and structured investment vehicles (SIVs). Many CDOs and SIVs were rated AAA on the corporate scale and have since become insolvent or are at risk of insolvency. In addition, bond insurance companies are facing ratings downgrades because the rating agencies failed to appreciate the risk of investment loss being insured against. Questions about the financial strength of bond insurers have shaken confidence in all bonds, and this instability, caused by the underlying ratings failures of the CDOs, SIVs and bond insurers, is now spreading to municipal bonds. Treasurer Lemoine is among those taking the lead in seeking structural solutions through a clearer ratings scale for government bonds.