What is a Bond Rating
A bond rating performs the isolated function of credit risk evaluation. A bond rating does not constitute a recommendation to invest in a bond and does not take into consideration the risk preference of the investor. While many factors go into the investment decision making process, the bond rating is often the single most important factor affecting the interest cost on bonds.
There are three major rating agencies for municipal bonds: Moody’s Investors Service, Standard Poor’s, and Fitch Ratings. Of the three rating agencies, Standard Poor’s and Moody’s rate over 80% of all municipal and corporate bonds.
In assigning a rating for general obligation bonds the rating agencies assess the following factors:
Management practices of the governing body and administration
The above criteria are also used to analyze revenue bonds and lease obligations although additional credit criteria is considered (e.g. users and user charges for utilities) and the covenants and protections offered by the bond documents are highly important.
Rating agencies use mathematical ratios to compare an issuer to others; however, a rating is not a scientific evaluation and subjective evaluation appears to also play a role in the final rating assigned.
Moody’s investment grade ratings (ratings in the Baa category or higher in contrast to lower rated issues that are considered speculative) are described below.
“Aaa” – Issuers or issues rated Aaa demonstrate the strongest creditworthiness relative to other U.S. municipal or tax-exempt issuers or issues.
“Aa” – Issuers or issues rated Aa demonstrate very strong creditworthiness relative to other U.S. municipal or tax-exempt issuers or issues.
“A” – Issuers or issues rated A present above-average creditworthiness relative to other U.S. municipal or tax-exempt issuers or issues.
“Baa” – Issuers or issues rated Baa represent average creditworthiness relative to other U.S. municipal or tax-exempt issuers or issues.
Bonds in the Aa, A, and Baa are also assigned 1 , 2 or 3 based on the strength of the issue within each category. Accordingly, A1 would be the strongest group of A securities and A3 would be the weakest A securities.
The following table shows the comparable investment grade ratings of the three major rating agencies: