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Investors Pretty Much Ignore Credit Ratings in MuniLand

It looks like municipal bond investors have just stopped trusting credit ratings agencies.

Pennsylvania and Nevada both get a credit rating of Aa1-negative from Moody's. But while Pennsylvania pays just 0.2 percentage points above the broader muni market rate, Nevada is paying 0.8 above the average.

So Nevada is paying a 300 percent higher borrowing spread than Pennsylvania.

It would seem that investors now believe that ratings have become totally unglued from reality.

Namely, ratings don't reflect — in any rational way — the marketplace on a price/yield basis.

When ratings agencies — which are intended to monitor these issuers on an ongoing basis — are summarily ignored by the markets, it should be a warning sign to the agencies that their models are breaking down.

If credit rating agencies don't find a way to address the current disconnects, we can expect to see even greater gaps grow between similarly rated products. Interestingly, this could create arbitrage opportunities for regulated entities—like mutual funds and insurance companies—to seek out extra-yield while still buying highly rated debt.