Much of the debt issued by governmental entities is rated by private, independent bond rating companies. The bond ratings assigned by these companies reflect the degree of risk associated with the bonds. There are three major companies which rate municipal debt issues in the United States:
Each of the rating companies has a rating scale which reflects the degree of risk associated with a bond. High-end ratings reflect the lowest-risk issues; typically these bonds can be issued at lower interest rates.
The rating companies use very similar criteria in determining municipal bond ratings. Each identifies essentially the same four principal credit factors which figure into the rating of long- term bonds:
Although bonds do not legally require a rating, issuers are compelled by circumstances to have most of their large debt issues rated. Investors use the bond ratings to analyze the degree of risk associated with purchasing various public securities. High ratings reflect a low risk of non- payment on principal and interest by the issuer, whereas low ratings reflect a higher risk of non- payment.
There is a clear inverse relationship between bond ratings and the interest rates at which bonds are issued: the higher the bond rating, the lower the interest rate for the bond due to the decreasing risk of default. All long-term bonds rated below the fourth category are judged to be below investment grade (speculative grade) and are often referred to as "junk" bonds.
Bonds are classified into two types for the purpose of the rating process - short and long-term debt. To qualify as short-term debt, issues cannot have maturity schedules of greater than four years. Many bonds with maturity schedules of less than four years and all bonds with maturity schedules of more than four years are considered long-term debt. Standard Poor's and Moody's rate commercial paper on a separate scale from other short-term notes.
Tables 1 and 2 describe the ratings for investment grade and non-investment grade bonds.
| RATING | EXPLANATION |
|---|---|
| Moody's Aaa, S&P's AAA, and Fitch AAA | These ratings are the highest grade a bond can be assigned; Triple-A bonds have a relatively small degree of risk because payment is secured by a stable revenue source |
| Moody's Aa, S&P's AA, and Fitch AA | These ratings are similar to that of triple A, but differ only in that the revenue sources for double-A rated bonds are slightly less secure than the revenue sources of triple-A bonds |
| Moody's A, S&P's A, and Fitch A | Considered upper-medium grade, but revenue sources are relatively susceptible to fluctuations in relevant economic conditions |
| Moody's Baa, S&P's BBB, and Fitch BBB | Medium-grade obligations that are adequately protected and secured, but nonetheless may be unreliable if relevant economic conditions have long- run adverse effects on revenue source |
Source: Public Finance Department, Moody's Investor Service, An Issuer's Guide to the Rating Process, New York, NY, 1993 (information pamphlet); Standard and Poor's Corporation, Municipal Finance Criteria, New York, NY, 1994 (information pamphlet); Fitch Investor Service, Fitch Ratings, New York, NY, 1994 (information pamphlet).
| RATING | EXPLANATION |
|---|---|
| Moody's Ba, S&P's BB, and Fitch BB | Lower-medium-grade obligations that are presently adequately protected and secured, but represent long-term risk whether relevant economic conditions are favorable or not |
| Moody's B, S&P's B, and Fitch B | These bonds are presently adequately protected and secured and represent risk regardless of economic conditions. In addition, it is likely that future relevant economic conditions will be unfavorable, thus intensifying the probability of default |
| Moody's Caa, S&P's CCC, and Fitch CCC | Besides future risks typical of bonds in the previous category, these are presently not adequately protected and secured, as present relevant economic conditions pose a threat to revenue source |
| Moody's Ca, S&P's CC, and Fitch CC | High degree of present and future risk; Greater chance of default by issuer; Debt issued in same conditions which produced CCC rating of a prior issue; Given CC rating because of additional insecurity of being issued after CCC bonds |
| Moody's C, S&P's C, and Fitch C | For S&P's and Fitch, debt issued at same conditions which produced a CCC-rating in a previous issue is given a C rating because of additional insecurity of being issued after CCC-bonds; For Moody's, these are "the lowest rated class of bonds, and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing" |
| S&P's CI | Reserved for income bonds on which no interest is being paid. |
| S&P's D and Fitch DDD, DD, and D | Assigned these ratings when payment is due and issuer defaults. |
| S&P's and Fitch | Plus (+) or minus (-): Indicate relative standing within the major categories from AA to CCC |
| Moody's "1" | Used to distinguish best bonds in each of five categories, Aa, A, Baa, Ba, and B |
Source: Public Finance Department, Moody's Investor Service, An Issuer's Guide to the Rating Process, New York, NY, 1993 (information pamphlet); Standard and Poor's Corporation, Municipal Finance Criteria, New York, NY, 1994 (information pamphlet); Fitch Investor Service, Fitch Ratings, New York, NY, 1994 (information pamphlet).
Moody's rates short-term notes on the Moody's Investment Grade (MIG) scale. Short-term notes issued with variable interest rates are rated by Moody's on the Variable Moody's Investment Grade (VMIG) scale. Notes must have a demand "put" feature to qualify for VMIG designation. The criteria associated with these two scales are identical.
Standard Poor's assigns two ratings to any long- or short-term issue containing as part of its provision a variable rate demand feature. The second rating represents the demand feature. Fitch does not make a distinction as it rates all short-term issues, including commercial paper, on the same scale. Moody's and Standard Poor's rate commercial paper, short-term obligations with a 365 days or less maturity, on a different scale than short-term debt.
Tables 3 and 4 display the rating categories for short-term debt, short-term notes, and commercial paper.
| RATING | EXPLANATION |
|---|---|
| MIG 1/VMIG 1 | Superior financial backing; Issuer has access to wide variety of financial protection in the event primary revenue source is weakened |
| MIG 2/VMIG 2 | Financial backing is strong, but issuer does not have access to as wide a variety of protection mechanisms as notes in higher category |
| MIG 3/VMIG 3 | Financial backing is still strong but protection mechanisms have the possibility of failure |
| MIG 4/VMIG 4 | Adequate protection, but specific risk exists with this issue |
| SG | Inadequate protection of short-term issue |
Source: Public Finance Department, Moody's Investor Service, An Issuer's Guide to the Rating Process, New York, NY, 1993 (information pamphlet).
| RATING | EXPLANATION |
|---|---|
| SP-1 and F-1 | Strong financial backing; Will be given a SP-1+ or F-1+ rating if financial backing is undeniably strong |
| SP-2 and F-2 | Issuer has satisfactory, but not outstanding, capacity to pay principal and interest |
| SP-3 | Issuer has only speculative capacity to pay principal and interest. |
| F-3 | Issuer has merely adequate capacity to pay principal and interest, and changes in relevant conditions could easily cause these issues to be of speculative quality |
| F-S | Capacity of issuer to pay principal and interest is speculative |
| D | Fitch assigns this rating to issues which are in actual or imminent payment default |
Source: Standard and Poor's Corporation, Municipal Finance Criteria, New York, NY, 1994 (information pamphlet); Fitch Investor Service, Fitch Ratings, New York, NY, 1994 (information pamphlet).
| Back To Topics | To Previous Section: Debt Structure | To Next Section: Bond Insurance |