Rating Scales Explained

Credit rating scales assign letter grades that stack hierarchically from AAA (safest) to D (in default). Within major grade buckets (AAA, AA, A, BBB, BB, B, CCC, CC, C, D), agencies use plus/minus modifiers (S&P, Fitch) or numerical notches (Moody's) to create finer distinctions, producing granular rankings that help investors compare credit risk across thousands of bonds.

Key takeaways

• S&P and Fitch use letter grades with plus (+) and minus (−) modifiers: AAA, AA+, AA, AA−, A+, A, A−, BBB+, BBB, BBB−, and so on down to D.
• Moody's uses letter grades (Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C) with numerical subdivisions: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, and so forth.
• The rating scale divides into investment-grade (AAA through BBB− / Baa3) and speculative-grade or high-yield (BB+ / Ba1 and lower).
• Each notch down represents a material increase in default probability; moving from A to BBB (one major bucket) typically adds 0.5–1.5 basis points of yield premium per annum.
• Scales are not linear; the gap between AAA and AA is qualitatively different (sovereign/fortress balance sheet) than the gap between B and CCC (imminent distress signals).

The S&P/Fitch scale with modifiers

Standard & Poor's and Fitch both use ten primary grades: AAA, AA, A, BBB, BB, B, CCC, CC, C, D. Within each primary grade, plus and minus modifiers split it into three tiers. This creates a 30-notch ordinal scale:

Upper tier (safest credits)

• AAA: Prime. Issuer has exceptional capacity to meet financial commitments.
• AA+: High-grade, upper end.
• AA: High-grade.
• AA−: High-grade, lower end.
• A+: Upper-medium grade.
• A: Medium grade.
• A−: Lower-medium grade.

Middle tier (solid, stable credits)

• BBB+: Lower-medium grade, upper end. Highest of investment grade.
• BBB: Lower-medium grade. Adequate capacity; more susceptible to economic change.
• BBB−: Lower-medium grade, lower end. Lowest of investment grade. Highest yield in IG.

Lower tier (speculative-grade / high-yield)

• BB+: Speculative. Less vulnerable in near term but exposed to adverse economic conditions.
• BB: Speculative.
• BB−: Speculative, lower end. Highest yield in below-IG.
• B+: Very speculative; vulnerable to economic pressure.
• B: Very speculative.
• B−: Very speculative, lower end.
• CCC+: Currently vulnerable; dependent on favorable conditions.
• CCC: Currently vulnerable.
• CCC−: Currently vulnerable, lower end; default is plausible.
• CC: Extremely vulnerable; default is imminent.
• C: Bankruptcy petition or similar event has occurred.
• D: In payment default.

Each notch represents a distinct increment in perceived credit risk. An A rated bond is not just slightly safer than a BBB; moving from A to BBB typically increases one-year default probability from under 0.1% to 0.2–0.3%. The yield difference is usually 50–100 basis points for corporate bonds of equal maturity.

Moody's scale with numerical modifiers

Moody's employs a parallel but distinct notational system. The major grades are Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C. Within each grade, Moody's applies numerical modifiers 1, 2, 3 (occasionally more for special cases) to create finer subdivisions:

Upper tier (safest)

• Aaa: Prime. Highest safety.
• Aa1, Aa2, Aa3: Upper-medium grade, subdivided.
• A1, A2, A3: Upper-medium grade, subdivided.

Middle tier

• Baa1, Baa2, Baa3: Lower-medium grade, subdivided.

Lower tier (speculative)

• Ba1, Ba2, Ba3: Speculative, subdivided.
• B1, B2, B3: Very speculative, subdivided.
• Caa1, Caa2, Caa3: Highly vulnerable, subdivided.
• Ca: Imminent default.
• C: Default or near-default.

Moody's ratings can include modifiers like (hyb) for hybrid securities (convertible bonds, perpetual preferreds) that blur debt and equity. This notational flexibility allows Moody's to handle complex instruments.

Equivalence across agencies

When a bond is rated by multiple agencies, the mapping is straightforward:

S&P / Fitch	Moody's	Approximate 1Y Default Probability
AAA	Aaa	<0.1%
AA	Aa	0.05–0.15%
A	A	0.1–0.25%
BBB	Baa	0.2–0.5%
BB	Ba	1–2%
B	B	2–4%
CCC	Caa	4–10%
C–D	Ca, C	over 10%

These are historical medians; actual default rates vary by year and sector. During the 2008–2009 financial crisis, default rates spiked across all categories. During the 2010–2021 expansion, they fell to historic lows.

Investment-grade vs speculative-grade boundary

The boundary between BBB− (S&P/Fitch) / Baa3 (Moody's) and BB+ / Ba1 is crucial. Bonds on the investment-grade side are often called "investment-grade" or "IG". Bonds below this threshold are called "below-investment-grade," "speculative-grade," "junk bonds," or "high-yield" (abbreviated HY).

This boundary matters for several reasons:

1. Regulatory constraints: Insurance companies, pension funds, and many mutual funds are mandated to hold ≥80% or ≥90% of portfolios in IG. A downgrade from BBB− to BB− can force automatic selling by index-tracking funds, depressing price.

2. Index inclusion: Major bond indices (Bloomberg Aggregate, U.S. Corporate) include only IG bonds. A bond dropped from the Aggregate Index due to downgrade can see selling from hundreds of index funds simultaneously.

3. Cost of capital: The yield spread between BBB− and BB+ is typically 100–200 basis points for similarly-matured corporate bonds. An issuer approaching the boundary faces materially higher refinancing costs if downgraded.

4. Investor psychology: The IG/junk divide is a psychological cliff. Many conservative investors have explicit policy forbidding junk bonds, making the boundary a price support for IG and a headwind for speculative bonds.

The notch-by-notch progression

From AAA to D, each step down represents an increment in assumed default risk, but not a linear one. The steps are most significant when moving through the investment-grade tiers. Moving from AAA to AA is a noticeable weakening but both are still "safe." Moving from BBB− to BB+ is a catastrophic cliff: one is IG (index-eligible, mortgage-backed, conservative), the other is speculative (higher-yielding, riskier, more volatile).

Within speculative grades, the notches matter less for typical portfolio construction (many HY funds treat all BB+ through B as a lump category) but are crucial for credit analysts and relative value traders. A BB− bond yielding 5% may be expensive relative to a B bond yielding 6% if both face similar fundamental risks.

Special notations and regional variations

Beyond the standard scale, rating agencies use notations for:

• NR (Not Rated): Issuer has not sought a rating or agency has withdrawn rating.
• WR (Withdrawn Rating): Agency ceased coverage.
• SD (Selective Default): S&P notation for a default on one obligation while others remain current (e.g., a company paying some bondholders but not others).
• In default (D): Moody's uses "C" for default or near-default and may include suspended securities.

Rating agencies also maintain separate scales for short-term debt (commercial paper, short-term bank loans), where the grades differ (S&P: A-1, A-2, A-3, B, C, D). These are not comparable to long-term scales.

Time-to-default assumption

The rating is implicitly tied to a time horizon. S&P and Moody's default probability tables typically show one-year, five-year, and cumulative probabilities. A bond rated BBB might have a 0.5% one-year default probability but a 2–3% cumulative default probability over ten years (reflected in longer-maturity bonds trading at a higher yield).

A bond near maturity (under one year remaining) has lower credit risk than the rating suggests, because the borrower only has to survive months, not years. Conversely, a 30-year bond's credit risk is much higher than a 2-year bond with the same rating, given the extended time horizon for things to go wrong.

How spreads respond to rating changes

Bond market spreads (yield premium above risk-free rate) correspond to the rating scale. Historically, an AAA corporate trades 50–100 basis points above a same-maturity Treasury. A BBB corporate might trade 150–250 basis points wide. A BB bond might trade 400–600 basis points wide. A CCC bond, if it trades at all, might offer 800–1500 basis points.

These spreads widen and narrow with credit cycles, issuer-specific news, and overall risk appetite. A downgrade typically widens spreads (the bond yields more, hence its price falls) until the yield premium reaches equilibrium with the new perceived risk.

Flowchart

Related concepts

• What Are Credit Ratings?
• The Investment-Grade vs Junk Line

Next

The boundary between investment grade and junk bonds—BBB− vs BB+, or Baa3 vs Ba1—is not just a notational distinction but a market cliff with profound consequences for prices, index inclusion, and portfolio mechanics. The next article explores this divide in detail.