How to Understand Municipal Bond Ratings

Study and Compare Investments Carefully

Municipal bond ratings give a stated value to thousands of municipal bond issues. Though there are three independent major ratings reviewers, there are many good brokerage firm bond analysts who write important credit and sector analysis that the interested bond investor should read. Moody's Investment Service, Fitch, and Standard and Poor are the three major rating agencies.

Things You'll Need

• Internet access

Instructions

1. Know that municipal bond rating agencies, with some variation, rate top quality investments as AAA and lesser quality investments down to C or default. Remember that any rating is of that moment and can be changed at a later date due to changes in the condition or quality of the bond issuer's ability to pay.

2. Trade municipal bonds as high quality credit instruments. Municipal bonds have low default rates and large taxing capabilities to replenish cash flows. Municipals are a safer credit than the asset class of corporate bonds and rank just below treasuries of the United States government.

3. Understand the difference between revenue bonds, like water and sewer issues, that rely only on the revenues of the project to repay interest and principal payments on debt. General obligation bonds contain the full faith and credit of the issuing municipality. Some bonds contain both credit features and are called double barrel municipal bonds. These bonds share at least the same rating as the higher rated general obligation debt.

4. Know that municipal investment grade ratings are BAA-1 or higher. Below that rate municipal bonds are considered speculative. Municipal ratings are relative. A double-A (AA) rated housing bond by Moody's is NOT a superior credit to the A rated state of California. Ratings within a type of municipal credit are relative. State taxing power and thus the state's ability to pay far exceeds the ability of a water project to pay under stress.

5. Look at broad trends in governance, growth and state population trends to anticipate changes in municipal bond ratings. States with high growth rates (California) will need to devote more to capital projects than states with stable population characteristics (Vermont). Thus the need to issue more municipal bonds will begin to impair the credit worthiness of the state and the pressure to review the municipal rating for possible downgrading will increase.

Tips & Warnings

• Municipal bond funds can be used to create diversified portfolios with excellent portfolio managers.

• Be cautious in buying hospital and housing bonds. They are often subject to downward rating changes depending on the regulatory climate in the state.

Resources

• Daily Discussion of Municipal Bond Activities
• Large Collection of Municipal Bond Reports
• Source of Municipal Bond Reporting