Rating agencies assess the creditworthiness of an issuer and assign a credit rating to the bonds they issue. The four major credit rating agencies are S&P Global, Moody’s Investors Service, Fitch Ratings, and Kroll Bond Rating Agency.
Municipal bond credit ratings are based on multiple factors, depending on the credit type of the bond issuance. Factors may include economic base, the strength of the revenue source backing the bonds, management, among others.
For tax-based financings such as general obligation bonds, the rating agency may look at the following factors:
- Economic diversity of the tax base
- Growth in employment opportunities
- Economic base trends for population
- Employment rates
- Personal income
For revenue-based financings like revenue bonds, the rating agency review may include:
- Analyzing feasibility reports
- Executing comparisons of the estimated economics of the project versus other similar active projects
- Management of the project once in service
As time goes by, the probability of the investor getting back their investment can change (for example, if a major fire destroys an office building), thus rating agencies periodically review their ratings on bonds and if needed, change the rating accordingly.
Example:
The issuer sold water and sewer system revenue bonds in 2022. The bond issuance has a Moody’s Aa1 rating — the rating agency’s second-highest rating.
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.A lease can be for any term, but a lease must have a term over a definite period of time with a particular starting and ending date.
What’s important here?
Rating agencies are tasked with evaluating the credit risk of bond financings. However, the ratings ascribed by these agencies are one of the key factors that determine interest costs for bonds. Agencies focus on multiple factors when evaluating the creditworthiness of the issuer. Their ratings give investors a sense of the likelihood that they will get their money back.
