Bill McCollum is an investment advisor representative of Wingo Asset Management,
LLC, a Registered Investment Advisor.
City of Shreveport just got a bond rating downgrade. Keep reading if you want to understand what this means.
Most people cannot pay cash for a car, much less, a house. They borrow. Similarly, most municipalities cannot pay for large projects. They, too, borrow. And they do so via the municipal bond market.
Municipal bonds are appealing to both borrowers (issuers) and lenders (investors). For issuers, like Shreveport, they can borrow large sums, larger than what most banks would be willing to lend. Once the bonds are issued, they can be traded publicly by investors.
Individuals, like you and me, can purchase these bonds inside brokerage accounts. The federal government incentivizes us by exempting the interest payments from federal and/or state income taxes. So far, so good.
No one lends money without considering credit risk. Can the borrower make the interest payments and repay the loan at maturity? Credit evaluation requires specialized expertise. That is where rating agencies come in.
Bond issuers pay rating agencies, like Moody’s and S&P, to formally analyze and rate them. Investors rely on these ratings in making investment decisions. Subsequent rating upgrades and downgrades affect the market price of the bond. (Remember, these bonds are publicly traded.)
If you were to apply for a loan having a low credit score, the lender might require a co-signer or other enhancement. Similarly, municipalities with less-than-stellar credit ratings often pay insurance companies to insure their bonds against default. End of class.
Moody’s latest downgrades of Shreveport’s bond ratings – the general obligation and water & sewer bonds are rated differently – are concerning. I encourage everyone to read Moody’s report (or a news summary). Moody’s is publicly questioning Shreveport’s creditworthiness.
Because of this downgrade and the current ratings levels, Shreveport will likely find it harder and more expensive to borrow money in the future. Bonds will have to be rated by rating agencies. Borrowers will demand higher interest rates and/or credit insurance. Credit insurance, if available, will command higher premiums.
As a result, Shreveport could be forced to make budget cuts, delay infrastructure spending, and/or raise taxes, fees, and utility rates. Consider those possibilities against current baselines, such as the city’s population growth trend, police department staffing levels, road conditions, and water quality, to name a few. Now do you understand?