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The Municipal Market Place Just Got More Confusing

As we all know, the governor of our fair Commonwealth and the Pennsylvania senate have yet to pass a budget. Ok, that’s not exactly true anymore. I wrote that line a few weeks ago when I wrote this story. At 1:10 on March 23, 2016 the governor said he won’t block the republican’s budget, ending a nine month stalemate. What still concerns us is the lack of state aid to our 501 individual school districts and what that means to some of our more troubled districts. Each School district, vocational school authority, and community college municipal bond issued has a “State Aid Withholding” feature under the Pa. School Board Act 150 that says that if a school should meet with financial difficulty and cant pay the bond holders, the state school board will withhold their appropriations and deliver them to the trustee bank for the direct benefit of the bondholders. This lack of a budget for the past nine months including state aid withholding has lead Moodys Investor Service to downgrade the “State Aid Enhancement” feature on all Pennsylvania school districts that it rates from an “A-3” rating to a maximum “Baa-1” rating and to place the “Enhancement” features rating on Negative Credit Watch. There are several issues today with respect to ratings on our school districts, and local government issuers that you should know.

1. That downgrade has been widely misunderstood and poorly reported by many. Some stories that weve read don’t mention exactly what was downgraded, and some municipal bond fund managers have been heard to say to a group of financial advisors that, “no school district in Pennsylvania has a Moodys rating higher than Baa-1” and that’s simply bad information. There can be three Moody’s ratings for any individual school district; #1 the rating on the State Aid Enhancement feature, aka State Aid Withholding, aka Pennsylvania School Board Act 150, #2 the underlying rating of the school district which is given based on the long-term credit analysis and worthiness of the school district, and #3 the ratings on a bond insurance policy, if one was purchased by the school district. So a single school district bond issue like Blackhawk, for instance, could be rated by Moodys a ‘A-2’ for AGM insurance, ‘A-3’ for their own credit worthiness, and ‘Baa-1’ for the State Aid Enhancement. Some of our school districts have ratings as high as the highest of Moody’s Aaa, and many have ratings in the ‘Aa’ range. So it is possible to see Moody’s ratings listed as Aa Underlying and Baa-1 Enhanced and A-2 insured. To be perfectly clear, many, if not a great many, of the 501 school districts have higher ratings than Baa-1 or ‘A’ on their own credit worthiness and at least one is rated Aaa.

2. S&P and Moody ratings have never been so split on state and local government entities, and not just between S&P and Moody’s, but between Fitch and Moody’s and KBRA and Moody’s as well. It is not unusual to see Moody’s rate a bond issue as Baa-1, or single ‘A’ and have S&P give the same issuer a AA rating. That’s called a spilt rating. That makes Traders, Financial Advisors, Registered Reps, and Individual Retail Investors make their own judgment calls when buying municipal bonds. In essence you have decide who has it right. Is the bond as safe as a AA credit or as risky as a Baa-1? The need for more homework and research has never been greater.

3. So most of the more “reliable” Municipal Bond Insurance companies have ratings that are also split. Wait. I take that back. They all have split ratings. Moody’s rates AGM as A-2 and S&P has it as AA, while KBRA is AA+. This industry had many bond insurers prior to 2009 when most failed or reorganized, and most, if not all were rated Aaa/AAA. So who do you trust today when buying an insured bond, Moody’s or S&P? Whose analysis has it right?

In the end, you need to trust one of the ratings agencies, if the bond is rated, at least in some measure. You don’t have to trust an insurance rider anymore and shouldn’t, but insurance, however rated, does offer some comfort. You could trust your advisor to pick the right one, or his/her trading department, if he/she has one, but you can do the homework yourself too. Just type www.emma.msrb.org and follow the instructions to research the bond issuer that you’re interested in. Or give me a call.

Investment Advisory Team

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