A lot has changed since what’s commonly referred to as the Dodd-Frank Act was signed into law in 2010, but at least when it comes to a certain type of municipal bond some evidence suggests that one thing hasn’t changed: They’re still rated more harshly than corporate bonds.
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Section 938 of the act requires that any symbol used by a nationally recognized statistical rating organization to denote a credit rating be applied “in a manner that is consistent for all types of securities and money market instruments for which the symbol is used.”
Still, when it comes to choosing between a corporate bond and a taxable muni bond with the same rating, Travis Lower, author of a paper entitled “Beyond the Rating: A Comparative Analysis of A-Rated U.S. Taxable Municipal and U.S. Corporate Bonds,” is quick to say which one he’s most likely to pick.
“I would much rather invest in the muni, both in terms of default rates and in terms of the yield that you’re getting off of those,” said Lower, who is currently pursuing a Doctor of Business Administration degree from Jacksonville University and authored the paper as part of his course work.
But the topic isn’t just an academic matter for Lower, who in addition to being a doctoral student is also chief investment officer for Farm Bureau Insurance of Michigan. Currently, taxable and tax-exempt municipal bonds account for about $1 billion of the Lansing-based insurer’s roughly $4.5 billion in cash and invested assets, Lower said.
“This is a passion of mine,” Lower said of his paper’s topic, adding that his experience as a CIO helped fuel his interest in it. “I’m doing my dissertation on taxable municipals versus corporates, and so this paper was just the start.”
Lower’s November 2024 paper examined the yields of A-rated U.S. taxable municipal bonds and A-rated U.S. corporate bonds issued between 2009 and 2023.
“This study produced compelling evidence of a clear yield advantage given the consistently higher excess yield observed for U.S. Taxable Municipal Bonds across all maturity buckets, especially considering their minimal default rates in recent years,” according to the paper.
The study also suggested “that investors relying solely on credit ratings from rating agencies may erroneously view A-rated U.S. Taxable Municipal Bonds and A-rated U.S. Corporate Bonds as equal in terms of risk and return,” the paper said.
When it came to actual default rates from 2009 through 2023 there were no defaults among the sampling of A-rated taxable municipal bonds analyzed in study. Among the sample of A-rated U.S. corporate bonds, there were 11 defaults over the same period.
While Lower submitted his paper in 2024, his study’s findings are consistent with what he continues to see in practice as an investor today.
“Even today, I’m seeing that – the differences both in yield and in terms of default rates for an …equally rated bond,” he said.
Currently, Lower is working on a study that explores why taxable municipal bonds typically offer more favorable yields than corporate bonds with the same rating.
“There may be some differences in issue size; there may be some differences in information asymmetry – so what kind of information is out there for municipals versus what’s out there for corporate bonds,” he said, adding while an IBM bond is likely to have “tons of” analysts covering it and investors who have experience owning the credit, the same can’t be said for a credit like Potterville Public Schools, a small school district in Michigan.
“There’s just not as many people looking at the individual issuers of these municipal bonds versus corporate bonds,” Lower said. “So there’s fewer potential buyers that we’re seeing on the institutional side.”
When it comes to municipal bonds overall, it appears that they are being rated less harshly in the post-Dodd era than they had been in the pre-Dodd days, “particularly given Moody’s 2010
“We all know that the default rate for munis is considerably lower than that for corporates,” Lipton said. “Much of this relates to general obligation taxing authority and budgetary flexibility.”
Theoretically, “an assigned rating should have the same significance regardless of asset class because it measures the likelihood of non-payment, or the distance from default,” he said.
“That said, nuances exist across asset classes for each rating category, and these nuances do factor into recovery assumptions,” Lipton said.
While recoveries tend to be higher for municipal bonds than corporate bonds, those nuances that exist across asset classes can make things “tricky,” he said. For example, a municipal bond with a “B” rating is likely to have a swifter downward rating migration than a similarly rated corporate security, the analyst said.
“At a ‘B’ rating, a corporation could very well remain a going concern, but the poor operational, political, and financial viability of various ‘B’ rated municipal revenue bonds may already set the stage for rapid credit deterioration and possible default and restructuring,” Lipton said.
Today, rating agencies are more discerning than they were in the past when it comes to assigning public finance ratings “and they continuously revise their sector methodologies to account for evolving circumstances and more relevant assumptions,” Lipton said.
“With this in mind, rating anomalies exist across the rating agency community due to varying methodologies,” he said. “Furthermore, corporate disclosure is far more intense and frequent. The fact that many municipal credits are tied to extended budgetary and economic vagaries does not necessarily result in the best and most timely response to surveillance activity.”
S&P Global and Moody’s Ratings declined to comment for this report.