On Thursday March 25, 2010, Fitch Ratings announced its recalibration of U.S. Public Finance Ratings. A copy of the published research is available on the Fitch Web site. While originally announced in 2008, the plan to release the information was placed it on hold due to the financial crisis and recession.

According to Fitch: Ratings are designed to be forward indicators of risk and that historic default is not the sole determinant. However past performance can be helpful in "considering the distribution of ratings and comparability of ratings across Fitch's rated portfolio." These are not upgrades, but revisions to "denote a comparable level of risk as ratings in other sectors."

Fitch's tax supported and essential service public finance ratings are already more heavily distributed in the upper end of their rating categories (52.7% AA or better vs. 22.5% for corporate ratings), and this change will significantly increase that concentration to the upper end (82%).

The planned implementation will take place April 5 for state ratings and April 30 for the remaining sectors (i.e., tax-supported, water/sewer, public power distribution-only and public higher education). Rating watches will be maintained. Outlooks generally will be maintained, although some may be revised to stable, as a result of movements or recalibrations. During this time, both ratings will be maintained on Fitch's Web site with a note in the rating action commentary.

Rating adjustments will be modest at one to two notches for most. Briefly, adjustments are as follows:

• State and local general obligations and dependent ratings (appropriation backed) will increase two notches for BBB- to A and one notch for A+ or higher. Moral obligation ratings will be reviewed and recalibrated based on the recalibration of the primary or moral obligation provider.
• Water/sewer and public power distribution-only credits will be adjusted upward, similar to general obligations.
• Special tax backed bonds (sales, income, hotel tax, tax increment, special assessment, etc.) will increase one notch for BBB- to AA+. Fitch noted that recent weak performance limited recalibration in this sector.
• Public higher education ratings will go up one notch for BBB- to AA-. No adjustments will be made for AA and higher.
• Below investment grade ratings in these sectors will be recalibrated case by case.

Sectors NOT affected include: public power generating systems, nonprofit healthcare, private higher education, tax exempt housing, airports, ports, toll roads, grant anticipation revenue vehicles (GARVEEs), state revolving funds (SRFs), bond banks, economic development bond funds and other municipal enterprises.

Fitch's action is similar to Moody's, with smaller increases for GO's. Unlike Moody's, however, Fitch will maintain the current short-term rating mapping from long-term ratings, so there will be some positive short-term adjustments, most notable for bond anticipation notes (BANs) and variable rate demand notes (VRDNs). Where the long-term rating can lead to one of two short-term ratings, the recalibrated rating will map to the lower rating.

As before, I think the impact on pricing will be positive: these changes make certain bonds more attractive to retail or other buyers who are limited by ratings, but pricing changes may be small as many institutional investors will not change their internal opinions. I think the effect of the recession on muni's, particularly on the revenue side, has resulted in smaller changes than might have occurred otherwise.

Peter Bianchini
Managing Director, Senior Municipal Strategist
+1 925.386.0262