California, the world’s ninth-biggest economy by output, pays more to borrow from investors than John Deere Capital Corp., Idaho Power Co. and Caterpillar Inc., which have the same or lower credit ratings.
Two years after Moody’s Investors Service and Fitch Ratings changed standards to put municipal credits on the same footing as corporates, California and Illinois are among states that still pay more for debt than similarly or lower-rated corporations, according to data compiled by Bloomberg. Yet Moody’s says companies default at 86 times the municipal rate.
“Taxpayers continue to get a raw deal,” said Tom Dresslar, spokesman for California Treasurer Bill Lockyer, who pressed for the rating changes. “Not much has changed.”
In 2010, Moody’s and Fitch revised their government ratings to a standard used for corporations: default risk. Previously, municipal grades were based on separate market criteria that created a different scale and kept the marks lower. The old method looked at “the intrinsic ability and willingness of an entity to pay its debt service,” according to a Moody’s report.
State and municipal officials, including Lockyer, said higher ratings would cut borrowing costs as investors accepted lower yields on debt perceived to be less risky. With a AAA rating rather than A, California would save $5 billion over the 30-year life of some $61 billion of bonds approved by voters, Lockyer said in a 2008 report.
Fitch recalibrated 38,000 municipal ratings in April 2010 while Moody’s shifted scales on 70,000 bonds. California climbed three steps to A1, fifth highest, based on Moody’s new method, from Baa1, the third-lowest investment grade. Even as interest rates have fallen to the lowest levels since the 1960s, the relative costs for municipal issuers compared with corporate borrowers have remained higher.
“I don’t see recalibration leading to lower yields” when comparing company to state and local-government debt, said Susan Courtney, who helps oversee $2 billion of municipal bonds as a Prudential Fixed Income managing director in Newark, New Jersey.
“Most traders and portfolio managers still price bonds as if there had been no recalibration,” said Richard Larkin, senior vice president and director of credit analysis with Herbert J. Sims & Co. in Iselin, New Jersey. “I don’t think it’s made that much difference.”
California, though one of the lowest-rated states, has never defaulted and its annual revenue tops Deere Capital, Idaho Power and Caterpillar combined. While it borrowed this month at 73 basis points over a Bloomberg Fair Value index of AAA municipal securities, the smallest difference since December 2008, the state still hasn’t beat lower-graded corporations.
When California and A2 rated Idaho Power both sold 30-year debt this month, the utility’s bonds priced 6 basis points lower than California’s, compared with similar-maturity Treasuries, according to data compiled by Bloomberg. The Boise company provides electricity for southern Idaho and eastern Oregon.
The state is rated one step higher at A1 and offers tax- exempt securities to provide an incentive to investors to accept a lower yield. That advantage can be whittled down when earlier call dates are included for long-term debt, as they give issuers the option to pay off their bonds earlier than scheduled.
Beaten by Deere
Deere Capital borrowed April 12 at rates 6 basis points, or 0.06 percentage point, lower than California got the same week for three-year debt, relative to Treasuries maturing in 2015, according to data compiled by Bloomberg. The Reno, Nevada-based company finances equipment purchases for the largest maker of farm equipment and is rated A2 by Moody’s. Neither of the issues can be paid off early.
In a March sale, a California State Public Works bond rated A2 and maturing in 2017 priced 47 basis points higher than a similar deal a few days later from Caterpillar, compared with five-year Treasuries, according to data compiled by Bloomberg. The Peoria, Illinois-based company is the world’s biggest maker of construction and mining equipment.
“It is an unfair system for taxpayers,” said Dresslar, the California treasurer’s spokesman.
Moody’s and Fitch adopted new methodologies as states such as Illinois coped with revenue depressed by the longest U.S. recession since the 1930s. Since then, more municipal issuers have been given a negative outlook and had their ratings lowered while defaults have risen.
Many state and local governments haven’t gone far enough in improving disclosure to attract more investors, said George Strickland, who helps oversee $14 billion of fixed-income assets as a Thornburg Investment Management Inc. managing director. He contrasts the year it can take to get current municipal fiscal data with quarterly filings by publicly traded companies.
“Even though they’re a little better credit quality, the municipal-bond market is a less-trafficked market,” Strickland said from Santa Fe, New Mexico. “You get better liquidity in the corporate market. With municipal bonds, you have to peel back a lot more layers to figure out what is going on.”
Companies such as Prudential often do their own research and compile their own evaluations, said Courtney, who leads her group’s municipal-bond team.
“We took recalibration with a grain of salt, and didn’t recalibrate all of our ratings,” Courtney said.
Defaults by governments remain fewer than those by corporate borrowers. Only 0.13 percent of municipal bonds rated by Moody’s fell into that category from 1970 to 2011, compared with more than 11 percent of corporate bonds.
Michigan and Lowe’s
In Michigan, the state paid the same relative rate on 10- year taxable Aa2 rated debt offered April 4, compared with Treasuries, as home-improvement retailer Lowe’s Cos. when it sold bonds with a similar maturity about two weeks later. Moody’s scores the Mooresville, North Carolina-based company’s credit four steps lower at A3.
Caleb Buhs, spokesman for Michigan Treasurer Andy Dillon, didn’t immediately respond to a voice-mail message seeking comment on the state’s costs.
Illinois, which like all states has the ability to impose taxes to raise revenue and whose bondholders have a first claim on the money, also hasn’t received lower yields.
The A2 rated state sold taxable bonds Jan. 11 with a yield about 132 basis points more than debt issued by Central Hudson Gas & Electric Corp. two months later, relative to 30-year Treasuries. The Poughkeepsie, New York-based company serves about 300,000 electric customers between New York’s northern suburbs and Albany, the state capital. It is rated lower, at A3, and its securities mature five years later.
Kelly Kraft, a spokeswoman for Illinois Governor Pat Quinn, a Democrat, declined to comment.
“Recalibration hasn’t turned out to be everything everyone thought it would be,” said Larkin, of Sims & Co.
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