The Contradiction of Fewer Credit Ratings.

• Author: Marlowe, Justin
• Position: PERSPECTIVE

It's often said that municipal bonds are like snowflakes--from a distance, they all look the same, but up close, no two are alike. They're backed by many different revenue streams and governed by an enormous variety of fiscal policies, management practices, and legal parameters.

That's why municipal credit ratings are so important. They distill that variation into a simple, intuitive measure of the likelihood that bond investors will be repaid. They bring some comparability and structure to a market that's often fragmented, idiosyncratic, and opaque.

Given those market features, it's odd that the number of state and local bond ratings has fallen steadily since the Great Recession. Fewer of today's bonds are rated by two or three of the major ratings agencies, and a growing number aren't rated at all. Moreover, and somewhat paradoxically, the credit ratings agencies themselves are more important than ever. This contradiction of fewer ratings but greater reliance on the ratings agencies has big implications for state and local public finance.

How widespread is the retreat from muni bond ratings? According to a recent analysis from Municipal Market Advisors, the average number of ratings per dollar of borrowed money dropped from 2.13 in 2012 to 1.80 in 2021. In other words, compared to a decade ago, today's bonds are far less likely to have two ratings.

This pullback is especially apparent in one of the most important corners of the market: general obligation (GO) bonds sold through negotiated underwriting. Exhibit 1 illustrates that trend for the more than 22,000 negotiated GOs sold from 2011 through 2021. It shows the annual share of these bonds with a given number of credit ratings in 2011, and that same figure for 2021, and further breaks those data down by small (bank qualified) issuers compared to large (non-bank qualified) issuers. The sparklines show the trend in these annual percentages from 2011 through 2021, with red dots showing the highest and lowest points in those trends.

The data suggest there's considerably less credit rating-based information in this part of the market today than at any point in the past ten years. We see that the past two or three years have brought the lowest annual percentages of bonds with two or three ratings of any moment in the past ten years. The opposite is also true, as the last two or three years have also seen the highest annual percentages of bonds with one rating or no rating. Moreover, the...