Municipal bonds are rated by independent credit agencies that assign a letter grade reflecting how likely a state or local government is to repay its debt on time. Three agencies dominate the work: Moody’s Investors Service, S&P Global Ratings, and Fitch Ratings. Each reviews the issuer’s local economy, financial performance, debt and pension burden, and quality of management before a committee votes on the final grade. That grade then shapes the interest rate the municipality pays and the risk an investor accepts.
Who Assigns the Ratings
The SEC registers credit rating agencies as Nationally Recognized Statistical Rating Organizations, and ten agencies held that designation as of late 2024.1U.S. Securities and Exchange Commission. Nationally Recognized Statistical Rating Organizations (NRSROs) In the municipal market, Moody’s, S&P, and Fitch together account for more than 95 percent of ratings issued. Most issuers get a grade from at least one of the three, and many buy two.
Ratings are almost always solicited. That means the municipality hires and pays the agency to perform the analysis, with the median fee running roughly 0.1 percent of the amount being issued.2FDIC. Do Municipalities Pay More to Issue Unrated Bonds? The issuer-pays model is worth knowing about as an investor, since the party writing the check has an obvious interest in a favorable grade. Agencies address that conflict by assigning ratings through independent committees rather than letting a single analyst decide.
What the Letter Grades Mean
Each agency uses its own symbols, but the structure is the same. Grades run from the highest credit quality to default, with a hard line separating investment-grade from speculative-grade bonds.
Moody’s Scale
Moody’s grades begin at Aaa for the strongest credits and step down through Aa, A, and Baa, which sits at the bottom of investment grade. Below Baa come the speculative tiers: Ba, B, Caa, Ca, and C, with C generally reserved for bonds already in default.3Moody’s. Moody’s Rating Scale and Definitions From Aa through Caa, Moody’s adds a numeric modifier of 1, 2, or 3 to show position within a letter category. A1 ranks higher than A2, and A3 ranks at the bottom of the A range.
S&P and Fitch Scales
S&P and Fitch both use the AAA-through-D format most investors recognize. AAA signals an extremely strong capacity to meet financial commitments, and BBB- is the lowest investment-grade rating.4S&P Global. Understanding Credit Ratings Below that line, BB+ through C mark increasing speculative risk, and D means the issuer has missed a payment. Both agencies use plus and minus signs to show position within a grade.5Fitch Group. Ratings Definitions
Why the Investment-Grade Line Matters
The split between BBB-/Baa3 and BB+/Ba1 is more than cosmetic. Many pension funds, insurance companies, and money-market funds are barred by their own policies from holding speculative-grade debt. When a bond slips below that threshold, forced selling by institutional holders can push the price down sharply and raise the issuer’s future borrowing costs. Investment-grade municipal bonds have historically defaulted at very low rates, with a Moody’s study covering 1970 through 2005 showing a ten-year cumulative default rate of 0.07 percent for investment-grade munis.6Moody’s. Mapping of Moody’s U.S. Municipal Bond Rating Scale
What Analysts Actually Look At
A rating is not a quick read of the balance sheet. Analysts dig into four areas, and weakness in any one can hold back the final grade.
The Local Economy
The starting point is whether the community generates enough economic activity to support stable tax revenue. Analysts look at property values, unemployment, income levels, and how diversified the employer base is. A city where one military base or manufacturer provides most of the jobs is riskier than a comparable city with a broader mix, because losing that employer can hollow out the tax base.
Financial Performance and Reserves
Agencies work through several years of audited statements to see whether the government runs balanced budgets, builds reserves, and follows the accounting rules set by the Governmental Accounting Standards Board. A municipality that routinely spends more than it collects, or that patches budget gaps with one-time money, draws skepticism. The size of the reserve fund relative to annual spending matters because thin reserves leave no room to absorb a downturn without sudden cuts or tax hikes.
Debt, Pensions, and Retiree Benefits
This is where many credit stories get complicated. Analysts measure total debt against taxable property value and look at what share of the annual budget goes to debt service. Once debt payments climb into the range of 10 to 15 percent of expenditures, the burden starts drawing attention.
Pension and retiree healthcare obligations often weigh as much as the bonds themselves. Under S&P’s methodology, a combined carrying charge of pension and retiree healthcare costs at or above 10 percent of total expenditures is considered elevated and can worsen the debt score. When total debt service plus pension and retiree healthcare costs together approach half of expenditures, S&P limits the overall rating to no higher than single-A.
Governance and Management
The last area is harder to put in numbers. Analysts judge whether the finance staff has the depth to manage cash flow, whether audits come in clean and on time, and whether elected officials have shown they’ll make hard fiscal decisions rather than defer them. A council that repeatedly drains reserves to avoid tax increases sends a very different signal than one that builds long-range plans and sticks to them.
General Obligation vs. Revenue Bonds
Not every municipal bond is backed the same way, and the backing determines which framework the agencies apply.
General Obligation Bonds
General obligation bonds carry the full faith and credit pledge of the issuer, including the legal power to levy taxes. That taxing authority gives bondholders a strong safety net, since the government can raise rates to meet its payments. The rating tracks closely with the overall creditworthiness of the government: economy, finances, debt load, and management all feed in directly.
Revenue Bonds
Revenue bonds work differently. They are repaid from income generated by a specific project or system, such as tolls on a bridge, fees from a water utility, or rent from a housing authority. Bondholders have no claim on general tax revenue. Analysts evaluate these bonds primarily through the debt service coverage ratio, which compares the project’s net revenue to its annual debt payments. A ratio of 1.25x, meaning $1.25 of revenue for every $1.00 of debt payment, is a common minimum. A ratio below 1.0x means the project cannot cover its debt from operations, which is a serious warning regardless of how the broader municipality is doing.
How the Rating Process Works
The process follows a predictable sequence, though its depth scales with the size and complexity of the issuance.
- The municipality or its underwriter contacts the agency and formally requests a rating on a new issuance or a review of outstanding debt.
- The issuer submits several years of audited financial statements, the official offering document, budget projections, and details on the specific bonds.
- The agency assigns an analyst who works through the documents, prepares questions, and meets with local officials — typically the finance director, city manager, and sometimes elected leaders — to discuss fiscal strategy and anything unusual in the numbers.
- A rating committee of senior analysts deliberates. The lead analyst presents the case and the committee votes on the grade. No single person decides.
- The agency communicates the rating to the issuer first, then publishes it. Most ratings are also filed with the MSRB’s EMMA system for public access.
After the initial grade, the agency maintains ongoing surveillance. If the municipality’s finances change significantly between issuances, the agency can upgrade or downgrade the rating at any time.
Outlooks and Credit Watch
A rating itself is a point-in-time view, but agencies also signal where they think the credit is heading.
Rating outlooks come in four forms: stable, positive, negative, and developing. A stable outlook means the agency sees little chance of a change in the medium term, and historically about 90 percent of ratings with a stable outlook stay put over the following year. A negative outlook signals a higher chance of a downgrade, and a positive outlook signals the opposite. Roughly a third of issuers with a negative outlook have been downgraded within 18 months, and a similar share of positive outlooks have led to upgrades in that window.7Moody’s Investors Service. Rating Outlooks A developing outlook means direction depends on an event not yet resolved, such as a merger or lawsuit.
A credit watch is more urgent. Agencies place bonds on watch when a specific event — a sudden revenue shortfall, a governance crisis, a natural disaster — could force a change in the near term. Most watch placements resolve within a year.
Credit Enhancements That Raise the Grade
A municipality does not have to rely entirely on its own credit profile. Several mechanisms can raise the effective rating on a bond and lower the issuer’s interest cost.
A bond insurer, sometimes called a financial guarantor, promises to make principal and interest payments if the issuer cannot. The insured rating reflects the higher of the guarantor’s financial strength and the bond’s underlying rating.8Moody’s. Other Rating Services – Moody’s Rating Symbols and Definitions If a BBB-rated city buys insurance from an AA-rated guarantor, the bond carries an insured rating of AA. Bond insurance was widespread before the 2008 financial crisis; after the major insurers lost their top ratings, the market shrank, though it has partially recovered.
A bank letter of credit works along similar lines. The bank pledges to cover payments if the issuer defaults, and the bond’s rating reflects the bank’s creditworthiness. Some states also run credit enhancement programs that back their local issuers. Moody’s distinguishes between the underlying rating, which is the bond’s standalone credit quality with no outside support, and the enhanced rating, which incorporates state-level programs.
The practical question with any enhanced bond is what happens if the enhancement goes away. If the insurer is downgraded or a letter of credit expires without renewal, the bond reverts to its underlying rating. Check both before buying.
Separately, federal rules require issuers to keep investors informed on an ongoing basis. Under SEC Rule 15c2-12, the issuer must agree to provide annual financial information and audited statements to EMMA, and to file notice within ten business days of significant events such as missed payments, rating changes, or bankruptcy.9eCFR. 17 CFR 240.15c2-12 – Municipal Securities Disclosure Those filings often supply the raw material that moves a rating agency to reassess.
How to Look Up a Bond’s Current Rating
The MSRB’s EMMA site at emma.msrb.org gives free public access to municipal bond data, including current credit ratings.10Municipal Securities Rulemaking Board. EMMA – Current Credit Ratings Search Search by issuer name, CUSIP, or state, and filter by Fitch or S&P rating. On a bond’s security details page, a Ratings tab shows every rating that has been reported for that bond. EMMA also displays recent trade prices, official statements, and continuing disclosure filings, which together make it the best free resource for municipal bond research. Ratings also appear on the agencies’ own sites, though Moody’s and S&P typically require a subscription for full access, and most brokerage platforms show current ratings for bonds held in client accounts.