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A BBB-grade no more: Why California's bond rating is going up

April 6, 2010 |  7:00 am

Investors who own California’s $68 billion in outstanding general obligation bonds went to sleep on Friday with their securities rated a weak BBB by Fitch Ratings.

They woke up on Monday owning bonds rated A-minus by Fitch. That’s still the lowest rating of the 50 states, but as all students know, any grade that begins with A always is preferable to one that begins with B.

It may look like an upgrade of cash-strapped California by Fitch, but officially it wasn’t. Rather, the firm is in the process of recalibrating its ratings on many state and local municipal bonds to reflect “a greater degree of comparability” with other credit ratings, such as those on corporate bonds.

Most of the affected muni debt was bumped up at least one notch. The lowest-rated investment-grade issuers (such as California) got a two-notch bump higher.

The grading change is something that California Treasurer Bill Lockyer and other state and local government officials have been demanding for years. Moody’s Investors Service, which rates California Baa1, plans to make a similar ratings shift later this month, also resulting in a higher credit grade for California.

In a report late last month, here’s what Fitch said about the ratings change:

The recalibration of certain public finance ratings should not be interpreted as an improvement in the credit quality of the securities. Rather, they are adjustments to denote a comparable level of credit risk as ratings in other sectors.

Fitch and Moody’s are bowing to the fact that municipal bond defaults historically have been relatively rare, particularly compared with corporate bond defaults. As Fitch noted in its report, state and local governments have “inherent strengths that allow them to maintain fiscal balance, including the authority to raise taxes and fees.”

In other words, Fitch decided that a BBB rating for a municipality wasn’t fair if the comparison was to a BBB-rated company.

Still, why raise muni bond ratings now, as states, cities, counties and other government entities continue to face enormous fiscal pressures? Fitch said that “while municipal credit risk may be elevated from very low levels in 2008, defaults are expected to be isolated occurrences.”

Anticipating what some readers undoubtedly are thinking: Yes, these are the same credit-rating firms that didn’t foresee the subprime mortgage bond debacle and its aftermath.

-- Tom Petruno

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