Municipal credit ratings are letter grades that Moody’s, S&P Global, and Fitch assign to cities, counties, school districts, and other local governments to signal how likely each is to repay its debt on time. Those grades set the price of borrowing: a top-tier rating and a middling one can be separated by millions of dollars in interest over the 20- to 30-year life of a bond.1Municipal Securities Rulemaking Board. Municipal Bond Basics Because interest on most municipal bonds is excluded from federal income tax, the securities attract a broad investor base, and ratings are the main tool investors use to sort risk within that market.2Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds
Who Issues Municipal Credit Ratings
Three firms dominate: Moody’s Investors Service, S&P Global Ratings, and Fitch Ratings. All three are registered with the Securities and Exchange Commission as Nationally Recognized Statistical Rating Organizations, a designation created under the Credit Rating Agency Reform Act.3U.S. Securities and Exchange Commission. Learn More About NRSROs Smaller NRSROs, including Kroll Bond Rating Agency, also rate municipal debt, but the three legacy agencies hold the vast majority of outstanding ratings.
The agencies work on an issuer-pays model: the municipality seeking a rating pays for the evaluation, not the investors who rely on it. The SEC has acknowledged the structural tension this creates, since firms have some financial incentive to keep paying clients satisfied.4U.S. Securities and Exchange Commission. Statement on the Removal of References to Credit Ratings The fees themselves are relatively modest. Research on a sample of municipal bonds found median rating fees of roughly 0.1% of the issued amount, meaning a $50 million issue would cost about $50,000 to rate.
The Rating Scale
Each agency uses its own letter system, but all three draw the same fundamental line between investment grade and speculative grade.
Investment Grade
The strongest rating is AAA (S&P and Fitch) or Aaa (Moody’s). From there, the scale steps down through AA/Aa, A, and BBB/Baa. S&P and Fitch use plus and minus signs to refine within each tier (AA+, AA, AA−); Moody’s uses numerical modifiers, with 1 at the top of a tier and 3 at the bottom (Aa1, Aa2, Aa3).5Moody’s Ratings. Moodys Rating Symbols and Definitions The floor for investment grade is BBB− at S&P and Fitch, and Baa3 at Moody’s.
Speculative Grade
Anything below that floor (BB+/Ba1 and lower) falls into speculative grade, sometimes called high-yield or junk. The line matters. Many institutional investors, pension funds, and insurance companies are legally or contractually barred from holding speculative-grade debt, so a downgrade across that boundary shrinks the pool of eligible buyers, not just the price. Less than 2% of all municipal issuers carry speculative-grade ratings, compared with nearly half of corporate borrowers.
Outlooks and Watch Designations
Every letter grade comes with additional context. An outlook (positive, stable, or negative) points to the likely direction of a rating over the next one to two years, though a change is not guaranteed.6KBRA. Rating Outlook and Watch A credit watch is more urgent, signaling a meaningful chance of a rating change within roughly 90 days. Landing on negative watch means something specific has gone wrong and analysts are actively deciding whether to act.
What Rating Agencies Actually Look At
The exact formulas differ by agency, but the core areas of analysis overlap.
Economic Base
Analysts start with the local economy: population trends, employment diversity, median household income, and the breadth of the tax base. A city dependent on one employer or industry carries more risk than one with diversified revenue. Property tax collection rates show whether residents can actually afford the tax burden the municipality relies on.
Financial Performance and Reserves
Agencies want to see budgets balanced with recurring revenue rather than one-time fixes like asset sales or reserve drawdowns. Moody’s has published rating-tier benchmarks that associate its Aaa tier with fund balances above 35% of revenues and its A tier with balances between 15% and 25%. Audited statements prepared under standards from the Governmental Accounting Standards Board give analysts the data they need to verify those figures.7Governmental Accounting Standards Board. Financial Statement Users
Debt, Pensions, and Long-Term Liabilities
Total outstanding debt relative to property values and revenue is a standard measure, and the analysis extends beyond bonds. Unfunded pension obligations and retiree health benefits (often called OPEB) are treated as debt-like. Moody’s combines net tax-supported debt, adjusted pension liabilities, and OPEB into a single ratio measured against the government’s own-source revenue. In its scoring framework, a ratio below 200% corresponds to the strongest credit tier; a ratio above 700% pushes into speculative territory.8Moody’s Ratings. US States and Territories Rating Methodology No single pension funding ratio automatically triggers a downgrade. The 80%-funded rule of thumb is a myth, according to the American Academy of Actuaries; what matters is whether contributions are keeping pace with growing obligations.
Overlapping Debt
A city’s taxpayers don’t just support that city’s bonds. They also support debt from the county, school district, water authority, and other special districts that share the same tax base. Moody’s methodology specifically accounts for this, noting that overlapping debt can push total tax rates high enough to limit a municipality’s practical ability to raise more revenue even when it has legal authority to do so.9Moody’s Ratings. US Cities and Counties Rating Methodology Smaller municipalities sometimes get squeezed here: their own debt looks modest, but the combined burden on local property owners tells a different story.
Management and Governance
Analysts assess whether the municipality uses conservative revenue forecasts, maintains formal reserve and debt policies, and plans capital spending over a long horizon. Institutional stability matters, since agencies want financial discipline that survives changes in elected leadership. Emerging risks like cybersecurity also factor in, because a major breach can disrupt operations and drain reserves.
General Obligation Bonds vs. Revenue Bonds
Not every municipal bond is rated the same way, because not every bond is backed by the same promise.
General obligation bonds are backed by the municipality’s full taxing power. If revenue falls short, the government pledges to raise taxes (usually property taxes) to cover payments. That broad backing generally earns stronger ratings and lower interest rates. GO bonds are typically subject to statutory or constitutional debt limits and, in many states, require voter approval.
Revenue bonds are backed only by income from a specific project or source, such as water utility fees, toll receipts, or hospital charges. Because investors can’t fall back on the general tax base if that revenue stream underperforms, revenue bonds are generally considered less secure than GO bonds and tend to carry slightly higher rates. In exchange, they usually escape debt limits, giving the issuer more flexibility.
Legal protections attached to a specific bond also matter. Some bonds carry statutory liens on their pledged revenue, which give bondholders priority if a municipality enters Chapter 9 bankruptcy. That added security can push a revenue bond’s rating above the issuer’s underlying rating.
How Ratings Translate Into Borrowing Costs
Ratings function much the way a personal credit score does for a mortgage. A better grade attracts a wider pool of investors and lowers the interest rate; each step down narrows the pool and adds yield.
Even small rate differences compound. On a $5 billion borrowing program, a downgrade that adds just a few basis points to the rate can translate to roughly $360 million in additional costs over 30 years. Those payments come out of the same budget that funds schools, roads, and public safety.
Higher rates on future debt are the most visible consequence of a downgrade, but not the only one. Many municipalities have interest rate swap agreements with banks that include termination triggers tied to rating thresholds. If a downgrade crosses one, the counterparty can demand an immediate termination payment. A downgrade does not change the rate on bonds already outstanding; it affects only new debt.
Bond Insurance
Municipalities with weaker ratings can buy bond insurance that guarantees principal and interest if the issuer defaults. An insured bond effectively carries the insurer’s rating rather than the issuer’s, widening the investor pool and lowering the rate. The premium has to be less than the interest saved, so for issuers already in the AA range the math usually doesn’t work.
How Often Do Rated Municipalities Actually Default
Rarely. From 1970 through 2022, the five-year cumulative default rate for all rated municipal issuers was 0.08%, compared with 6.92% for global corporate issuers. Investment-grade municipal bonds defaulted at 0.04% over five years, versus 0.86% for investment-grade corporates.10Fidelity. US Municipal Bond Defaults and Recoveries 1970-2022 Even speculative-grade municipal bonds defaulted at about one-quarter the rate of speculative corporates.
One reason defaults stay rare is that states often step in before a municipality reaches that point. Roughly 20 states run formal oversight or intervention programs for financially distressed local governments. Common triggers include missed debt service, inability to meet payroll, operating deficits, exhausted reserves, and rating downgrades. Intervention ranges from advisory monitoring to full state receivership, in which an appointed manager takes over the municipality’s finances. Michigan’s emergency manager law and Pennsylvania’s Act 47 are among the most established frameworks. For bondholders, state oversight tends to be a positive credit factor because it signals the state won’t let the situation spiral into unmanaged default.
How to Look Up a Municipal Bond’s Rating
Federal securities law requires ongoing disclosure from municipal issuers. Under SEC Rule 15c2-12, an underwriter cannot sell municipal bonds unless the issuer has agreed in writing to file annual financial information and audited statements with the Municipal Securities Rulemaking Board.11eCFR. 17 CFR 240.15c2-12 – Municipal Securities Disclosure Issuers must also report material events, including payment delinquencies, rating changes, bankruptcy filings, and unscheduled draws on reserves, within ten business days.
Those filings flow to the MSRB’s Electronic Municipal Market Access system, known as EMMA, which the SEC has designated as the official public repository for municipal securities data.12Municipal Securities Rulemaking Board. Making Disclosures on EMMA Anyone can search EMMA free of charge for a bond’s official statement, current ratings, trade history, and continuing disclosure filings.13Investor.gov. Using EMMA – Researching Municipal Securities and 529 Plans If you’re weighing a purchase or want to check where your own city stands, EMMA is where to start.