Standard & Poor’s Ratings Services downgraded refunded municipal bonds that were rated AAA in a follow-up to its downgrade notice of the U.S. triple-A outlook to negative from stable.
S&P suggests that in a scenario of economic or political stress a local government could have a higher credit rating than the USA. So could Miami one day have a higher credit rating than the USA? Sounds like a stretch.
Interestingly, S&P said it does not tie ratings on state and local governments to that of the United States and as a result, existing outlooks on their triple-A ratings will not change because of the revision for the federal government.
But this seems inconsistent with the market realty. The entire muni bond industry estimates prices based on various factors. The spread to the US treasury is a main criteria. BondView research So are Pre Refunded muni bonds since they are a key benchmark and are backed by US treasuries. Common sense suggests there will most certainly be a price and yield effect on the benchmark Pre Refunded muni bond since they are priced at a spread to the AAA US tres bond.
If and when the AAA US Tres is downgraded, so will Pre-Re muni bonds backed by US treasuries also known. But thats just the effect on the top of the food chain. We would expect to see a wild ride for all other muni bonds since they are also priced relative to the AAA US treasury bond. But to make matters worse, about 1/2 of all muni bonds are not rated by a major credit rating agency. These unrated muni bonds will be in worse limbo then they are today.
What S&P actually said was that only about 4 percent of state and local issues are rated AAA with a stable outlook by S&P, which said the possibility exists that a state or local government could have a higher rating than their sovereign government “in a scenario of economic or political stress.” But its a stretch to suggest that say swinging Miami, Florida could have a higher credit rating than the US government, long considered the global benchmark for stability.
To see the real effect of interest rate changes on muni bond prices, go to bondview.com, a free resource for muni bond investors.