Credit Ratings Explained: What AAA, BBB and Junk Mean, and How Agencies Decide

What a credit rating is

A credit rating is an independent agency’s opinion of how likely a borrower is to pay interest and repay its debt in full and on time. Agencies rate borrowers, such as a company or a country, and individual debts, such as a particular bond. Investors use ratings to compare the risk of very different borrowers on one scale, fund managers use them to set limits on what they may buy, and borrowers with better ratings can usually borrow more cheaply. Three firms dominate: S&P Global Ratings, Moody’s and Fitch. In most cases the borrower pays the agency for the rating, a model known as issuer-pays that has long been criticised as a conflict of interest.

The rating scales side by side

S&P and Fitch use the same letters, and Moody’s uses its own, but the scales line up closely:

• AAA (Moody’s Aaa): the highest rating, for an extremely strong capacity to pay.
• AA (Aa): very strong.
• A (A): strong, but somewhat more exposed to changes in conditions.
• BBB (Baa): adequate; the lowest tier of investment grade.
• BB (Ba) and B (B): speculative grade, more vulnerable to bad conditions; this is the high-yield or junk range.
• CCC (Caa) down to C: substantial risk, with default a real possibility.
• D: in default. S&P also uses SD and Fitch RD for a selective or restricted default; Moody’s lowest rating is C.

Within each category, S&P and Fitch add a plus or minus, and Moody’s adds 1, 2 or 3. The line between investment grade and junk therefore runs between BBB− (Baa3), the lowest investment-grade rating, and BB+ (Ba1), the highest junk rating. Agencies also publish an outlook, positive, negative, stable or developing, which signals the likely direction of a rating over the next six months to two years, and they place ratings on watch or review when a specific event, such as a takeover, could change them soon.

Short-term ratings, and what ‘A1/P1’ means

Debt that matures within about a year, such as commercial paper, has its own scales. S&P uses A-1+, A-1, A-2 and A-3 for the investment-grade tiers, Moody’s uses P-1, P-2 and P-3, for obligations with an original maturity of 13 months or less, and Fitch uses F1+, F1, F2 and F3. ‘A1/P1’ paper is rated in the top short-term tier by both S&P and Moody’s, and it is the kind of short-term debt that conservative money market funds mostly buy. As an example of the two scales together, S&P rates the United States AA+ for the long term and A-1+ for the short term.

How agencies decide

Ratings are set by a committee of analysts rather than by one person. For a company, the committee weighs business risk, such as the industry, the company’s competitive position and how stable its earnings are, against financial risk, such as how much it owes compared with the cash it generates, how easily it covers its interest and how much cash it can reach. For a country, it looks at the strength of institutions, the size and growth of the economy, its debts to the rest of the world, its budget and its monetary flexibility. In the United States, rating agencies whose ratings are used in regulation must register with the SEC as nationally recognised statistical rating organisations; eleven were registered in 2026. The three largest held about 93% of all outstanding ratings at the end of 2024.

What ratings say about default risk

Ratings are relative rankings of default risk, and history shows the ranking broadly works. In S&P’s 2025 global default study, covering 1981 to 2025, the average five-year cumulative default rate was 0.41% for companies rated A− and 2.31% for those rated BBB−, roughly one in 43, and the rates rise steeply through the junk categories, reaching their highest levels at CCC and below. That is why lower-rated bonds pay higher yields: investors demand extra income, known as a credit spread, for the extra chance of not being repaid in full. Movements across the investment-grade line matter most. A company cut from investment grade to junk becomes a ‘fallen angel’, and because many funds are only allowed to hold investment-grade debt, its bonds can fall sharply as they are forced to sell. A company moving the other way is a ‘rising star’.

A rating answers one question only: how likely is this borrower to pay? It says nothing about whether the bond is good value at today’s price.

Countries’ ratings in 2026

Governments are rated too, and their ratings act as a reference point for everything else issued in their country. The United States is rated AA+ by S&P, since 2011, and by Fitch, since 2023, and Aa1 by Moody’s, which removed its last top rating on 16 May 2025; S&P and Fitch affirmed their ratings in 2026. France was cut to A+ by Fitch in September 2025 and by S&P in October 2025, while Moody’s rates it Aa3 with a negative outlook. A downgrade of a large government rarely means it is likely to default; it signals that its debts and deficits leave less room to absorb shocks.

Where ratings have gone wrong

Ratings are opinions, and they can be badly wrong. Before the 2008 financial crisis, agencies gave top ratings to large numbers of securities backed by risky mortgages. The US Financial Crisis Inquiry Commission found that Moody’s alone rated nearly 45,000 mortgage-related securities AAA between 2000 and 2007, and that 83% of the mortgage securities it rated AAA in 2006 were later downgraded. The Dodd-Frank Act of 2010 created an SEC office to oversee rating agencies and removed many references to ratings from federal rules, and S&P and Moody’s later paid $1.375 billion and $864 million respectively to settle claims over their pre-crisis ratings. Ratings also tend to move after the market has already reacted, so a bond’s price can fall well before its rating does.

How investors can use ratings

• As a starting point for comparing yields: a bond paying far more than others with the same rating is telling you the market sees extra risk.
• To understand a bond fund: its factsheet usually shows the average credit quality and how much it holds below investment grade.
• To set a floor: many investors hold only investment-grade bonds in the safe part of a portfolio, and take credit risk, if at all, in a separate, diversified high-yield fund.
• Not as a guarantee: ratings lag, they can be wrong, and they say nothing about interest rate risk, which affects even AAA bonds.

This article is general education about how credit ratings work, not a recommendation to buy or sell any bond. Ratings quoted were those published by the agencies as of October 2026 and can change at any time.

This article is educational and general in nature. It isn’t personalized investment, tax, or legal advice — always weigh your own circumstances, or talk to a licensed professional, before making financial decisions.

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