Skip to main content
Credit Ratings

Rating Scales Explained

Pomegra Learn

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 / FitchMoody'sApproximate 1Y Default Probability
AAAAaa<0.1%
AAAa0.05–0.15%
AA0.1–0.25%
BBBBaa0.2–0.5%
BBBa1–2%
BB2–4%
CCCCaa4–10%
C–DCa, Cover 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​

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.