Bonds

As Moody’s stops endorsing muni credit ratings in EU, UK, foreign buyers may retreat

Moody’s Investors Service’s recent decision to stop endorsing U.S. public finance credit ratings for use in the European Union and the United Kingdom will trigger market volatility, negatively impact infrastructure needs, and reduce foreign investors’ presence in the muni market, market participants said.

Due to Moody’s decision, EU/UK investors may be forced to sell their muni holdings, and their regulatory capital costs will likely increase, Barclays strategists said in a recent report.

Moody’s made the decision “in light of the extremely limited market demand for the EU/UK endorsement of U.S. Public Finance credit ratings,” the company said in a press release. The changes apply to all debt issued in the muni market.

U.S. public finance investors are mostly based in the United States due to the federal tax-exemption and as such, Moody’s will no longer accept new requests to endorse U.S. public finance credit ratings for use in the EU or the UK, the company said.

The ending of endorsement of muni ratings will be completed by the end of Q1, and at that time, the endorsement status of currently EU/UK endorsed credit ratings will end as well, Moody’s said.

Foreign investors own more than $100 billion of munis, mostly in taxables, Barclays strategists said. Of the $100 billion, EU/UK investors own more than half of it, they said.

“The universe of taxable munis with maturity sizes above $25 million that are rated only by Moody’s is pretty large (more than $17 billion if we account for both municipal and corporate CUSIPs), and it is fair to assume that foreign investors own a sizable chunk of these bonds,” they said.

Moody’s decision will make it harder for foreign investors to invest in munis, said Vikram Rai, head of municipal markets strategy at Wells Fargo.

This decision will accelerate foreign buyers’ reduced presence in the muni market, which will lead to higher volatility and steeper curves, said Vikram Rai, head of municipal markets strategy at Wells Fargo.

One of the biggest triggers of volatility is the “increasingly concentrated nature of the municipal buyer base,” he said.

Retail buyers dominate the muni market, accounting for more than 75% of the buyer base, he said.

But when traditional retail buyers — which include mutual funds, separately managed accounts, exchange-traded funds and tax-exempt money market funds — aren’t buying, Rai said “non-traditional or crossover buyers (banks, insurance firms and foreign investors) to step up and provide back-up demand for municipal paper, which helps stem return volatility.”

Unfortunately, crossover buyers’ footprint has been shrinking, and this decision will lead to even less demand from foreign investors, he noted.

So far there has been “relatively weak pushback from investors,” but “at least some of these investors have recently started pushing back, trying to change Moody’s decision, and we think that more interested parties will join the fray in the near future,” Barclays strategists said.

The long-term impact of Moody’s decision will also lead to fewer avenues to finance infrastructure needs, Rai noted.

“Reduced buyer base in the EU for municipal bonds that would have been helpful to allowing the $4 trillion municipal market to expand” could impede financing infrastructure projects, he said.

Foreign investors like munis due to the diversification and value they add, along with muni projects aligning with environmental, social and governance principles, according to Rai.

Therefore, while foreign investors usually tap the taxable market, they sometimes opt to buy tax-exempt paper when total returns are attractive, he said.

“Foreign investors, who have a huge balance sheet in aggregate, can help grow the municipal buyer base, if needed,” he said. “But Moody’s decision will make it harder for them to invest in U.S. municipals, and therefore the U.S. infrastructure.”

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