| DEFINITION: Rating agencies issue credit ratings for bonds of local or state governments. Credit ratings are similar to credit scores — rating agencies assess the ability of an issuer to repay investors and then issue a rating based on that information, such as AAA. |
In the case of municipalities…
Rating agencies assess the creditworthiness of a municipality and assign a credit rating to the bonds they issue. The three major credit rating agencies are Fitch, Moody’s, and S&P Global.
Municipal bond credit ratings are based on two key factors — operating account analysis and economic base. The agency looks at the economic diversity of the tax base, growth in employment opportunities, and economic base trends for population, employment, and personal income.
There are two main types of municipal bonds — general obligation and revenue bonds. The rating agencies use different criteria for rating each of these types of bonds.
General obligation bonds are backed by the issuer’s taxing ability. For these bonds, rating agencies analyze four key aspects — the socioeconomic base, financials, debt, and administrative factors.
Revenue bonds are repaid via revenues from the project — common types of revenue bonds are educational and utility bonds. For revenue bonds, rating agencies focus on legal, economic, financial and administrative areas.
| EXAMPLE: The city of Fort Worth, Texas, issued water and sewer system revenue bonds in 2022. The $38.71 million bond issuance has a Moody’s Aa1 rating — the agency’s second-highest rating, with Aaa being the highest. The Aa1 rating suggests the issuer is high quality and carries very low credit risk. Moody’s Aa1 rating is the equivalent of an AA+ rating by S&P Global or Fitch. |
What’s important here?
Rating agencies are tasked with evaluating credit risk — their ratings aren’t investment recommendations. However, the ratings ascribed by these agencies are one of the key factors that determine interest costs for bonds. Agencies only focus on the creditworthiness of the issuer. Their ratings are based on the likelihood that investors will get their money back.