Credit Rating Scales: From AAA to D

Key Takeaways

• S&P and Fitch use the same letters, AAA down to D, while Moody's uses a parallel scale from Aaa down to C, so the three ladders map onto each other rung for rung.
• The single most important line on any scale is the split between investment grade (BBB-/Baa3 and above) and high yield, also called speculative grade or junk (BB+/Ba1 and below).
• Ratings measure relative default risk, not the odds of price loss, and they are opinions that can be, and often are, downgraded or upgraded over time.
• A one-notch downgrade that crosses the investment-grade line can move a bond's price sharply because many institutions are barred from holding speculative-grade debt.

What It Is

A credit rating scale is the ranked set of symbols an agency uses to express its opinion of a borrower's creditworthiness. Each symbol corresponds to a broad band of default risk, from "extremely strong capacity to meet financial commitments" at the top to "already in default" at the bottom.

Two facts make the scales usable. First, the agencies line up: an S&P AA is meant to signal roughly the same risk as a Moody's Aa2 or a Fitch AA. Second, most bands are subdivided. S&P and Fitch add a plus or minus (AA+, AA, AA-), and Moody's adds a number 1, 2, or 3 (Aa1, Aa2, Aa3). Each of these finer steps is called a notch.

The Intuition

Think of the scale as a risk thermometer read from the lender's side. At the top, AAA/Aaa issuers are borrowers whose default is almost unthinkable over the near term, so lenders accept a low interest rate. As you move down the ladder, the risk of missed payments rises, and lenders demand more yield to compensate. By the time you reach the C and D bands, the agency is saying default is imminent or has already happened.

Two rungs matter most. One is the investment-grade boundary, the accepted dividing line for whether pensions, insurers, and many funds are even allowed to buy the bond. The other is D itself, which simply records that a payment was missed.

How It Works

Reading across the three scales, the rungs line up like this:

• Investment grade: AAA / Aaa, AA / Aa, A / A, BBB / Baa.
• High yield (speculative): BB / Ba, B / B, CCC / Caa, CC / Ca, C / C.
• Default: D on the S&P and Fitch scales; Fitch also uses RD for a restricted default. Moody's has no separate D and treats its lowest grades as capturing default.

The dividing line sits between BBB- and BB+ on the S&P and Fitch scales, and between Baa3 and Ba1 for Moody's. Anything at BBB-/Baa3 or higher is investment grade; anything at BB+/Ba1 or lower is high yield. Analysts often speak in notches: moving from A- to BBB+ is one notch down, still comfortably investment grade, while BBB- to BB+ is one notch that crosses the whole market in two.

Worked Example

Suppose a broad investment-grade corporate bond index yields 5.0% and a high-yield index yields 7.5%. The gap between them, the credit spread, is:

• 7.5% - 5.0% = 2.5 percentage points, or 250 basis points.

On a $10,000 position held for one year, that spread is worth an extra 10,000 x 2.5% = $250 of income for stepping down from investment grade into high yield.

But the lower rating exists because default risk is higher. Suppose 3% of the high-yield issuers default over the year and lenders recover 40 cents on the dollar. The expected loss is:

• 3% x (1 - 0.40) = 3% x 0.60 = 1.8%, or 10,000 x 1.8% = $180.

Net, the high-yield bet adds 250 - 180 = $70 of expected return for the extra risk and volatility. The example shows why a rating downgrade is never just a label: each rung down the scale is priced.

Common Mistakes

1. Reading a rating as a buy or sell signal. A rating grades default risk only. A cheap CCC bond can still be a fine investment, and a AAA bond can still lose value when interest rates rise.
2. Ignoring the plus, minus, and number modifiers. BBB+ and BBB- sit two notches apart, and BBB- is the last stop before high yield. The letter alone hides that.
3. Assuming ratings are fixed. Ratings are opinions that migrate. An issuer downgraded from BBB- to BB+ becomes a "fallen angel" and can be force-sold by funds that may hold only investment grade.
4. Mixing up the two scales. A Moody's Baa3 is investment grade; someone who reads it as equivalent to S&P's B has mis-ranked the bond by many notches.
5. Confusing default risk with recovery. Two bonds can share a rating yet pay back very different amounts if one defaults, because seniority and collateral drive recovery.

Frequently Asked Questions

Q: What do credit rating scales actually measure? Credit rating scales measure the relative likelihood that a borrower will fail to make its debt payments on time and in full. They rank default risk, not the odds of a bond's price falling and not a recommendation to buy or sell.

Q: How do the S&P, Moody's, and Fitch credit rating scales line up? S&P and Fitch share the same letters, AAA to D. Moody's runs Aaa to C. Rung for rung they map onto each other: an S&P AA equals a Moody's Aa2 and a Fitch AA, and each band is subdivided by a plus/minus for S&P and Fitch or a 1, 2, or 3 for Moody's.

Q: Where does investment grade end and high yield begin? The line falls between BBB- and BB+ on the S&P and Fitch scales, and between Baa3 and Ba1 for Moody's. BBB-/Baa3 and above is investment grade; BB+/Ba1 and below is high yield, also called speculative grade or junk.

Q: What does a D rating mean? On the S&P and Fitch scales, D means the issuer has already defaulted, missing a required payment or filing for bankruptcy. Fitch also uses RD for a restricted default, where only some obligations are in default while others are still being paid.

Q: Are credit ratings guarantees of safety? No. Ratings are informed opinions, not guarantees. Even top-rated issuers occasionally default, and ratings change as an issuer's finances change, which is exactly why the scales exist rather than a simple safe-or-unsafe label.

Sources

1. S&P Global Ratings. "Understanding Credit Ratings." https://www.spglobal.com/ratings/en/about/understanding-credit-ratings
2. Investopedia. "Bond Rating." https://www.investopedia.com/terms/b/bondrating.asp
3. Investopedia. "Investment Grade." https://www.investopedia.com/terms/i/investmentgrade.asp
4. Investopedia. "High-Yield Bond." https://www.investopedia.com/terms/h/high_yield_bond.asp

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.