Understanding Credit Ratings Agencies all the way from AAA to Default

The Grownup's Report Card

Remember the days of elementary school, coming home with a report card to show off to your parents? You probably thought those days were long past. You thought that being an adult meant that higher-ups would stop assigning letter grades, evaluating your performance every few months.

Much to our disappointment, report cards never go away.

You see, virtually every company and every government will have to borrow money at some point. In doing so, the lender - the bank or other entity letting you borrow that money - wants to know the likelihood that your company or government will be able to pay that money back.

That's what a credit rating is.

Who does the Grading?

You might be surprised to know these report cards are handed out by private companies, each using their own secret calculations. In fact, there is no government-standardized formula for credit ratings.

The three dominant credit rating agencies are

• S&P Global Ratings
• Moody's
• Fitch Ratings

Each company keeps its formula for rating businesses or governments a tightly kept secret - you won't be able to game the system by simply moving some money around.

By the way, all three of these ratings agencies have recently downgraded the United States’ credit rating. But we'll come back to that.

Credit Ratings Scale

Like with your old school report cards, credit ratings are broken down into letter grades. But unlike school grades that go from A to F, the ratings agencies use an eccentric system.

If you're being graded by S&P Global Ratings or Fitch, your potential rating will range from the coveted AAA to the disastrous D. And if Moody's Ratings is your scorekeeper, that will be from Aaa to D.

This bundle of letter grades are then split into three distinct categories, and this category split is probably more important than you imagine.

• Investment Grade - Investments with a credit rating in the investment grade category are considered to be safe and reliable. There is very little risk of the debt being unpaid by the debtor.
• Speculative Grade - Investments with a credit rating in the speculative grade category are considered to be high risk. Depending on the company or future economic conditions, there is a substantial chance that the debt will not be repaid.
• Default Grade - Companies or governments that have already missed a repayment on their debt are considered to be in default. This rating indicates that any current and future debt is unlikely to be repaid.

Risk of Fallen Angels

Why is the Investment Grade so critical?

The Investment Grade is critical because that credit rating is required by many pension funds and other major investment firms before adding any company to their repertoire of investments. These financial institutions are not looking for high-risk, high-growth companies. They want to invest in stable growth companies - businesses that are turning out profits year after year.

Credit ratings from AAA to BBB- are categorized as investment grade on the S&P Global and Fitch scale; they range from Aaa to Baa3 on the Moody's scale.

One tier down from Investment Grade is Speculative Grade. Credit ratings of the speculative category are high risk, and the debt is often referred to as "junk." Companies or governments that might not be able to pay back their debts due to potential economic conditions are assigned these lower credit ratings as a signal to potential investors they may not actually see a return on investment.

Credit ratings from BB+ to C are categorized as speculative grade on the S&P Global and Fitch scale; they range from Ba1 to C on the Moody's scale.

And below "junk" is the final credit rating category, Default Grade. A company or government that is already missing payments on its debt is assigned a credit rating of D, warning investors that investments made are unlikely to be paid back.

An entity crossing the threshold from Investment Grade to Speculative Grade is labeled a Fallen Angel, and the effects can be catastrophic.

Perks for Good Performance

Unlike your elementary school report card, the credit rating of a business actually matters. There are tangible benefits to having an Investment Grade credit rating over being labeled Junk.

If your company is assigned a junk credit rating ...

• Cost of Borrowing Skyrockets - The interest rate a company must pay on its debt increases dramatically, typically from around 4.5% to 9% or even more.
• Investment Mandate Cliff - Massive pension and insurance funds are forced to sell Fallen Angel bonds immediately, further crashing the bond's price.
• Collateral Toll - Lower credit ratings trigger clauses requiring the company to post more cash collateral, draining liquidity from the company at a time when they need it most.

Is the United States Credit Rating Junk?

No, not even close.

While it may feel like the United States economy is deteriorating (because it is), the federal government still maintains a strong credit rating. Other countries can lend the United States money and still feel assured that money will be repaid.

However, the United States did recently lose its highly coveted AAA credit rating. This happened in three stages, as each of the three major credit rating agencies lowered their score individually.

• S&P Global - downgraded the United States to the AA+ rating all the way back on August 5th, 2011.
• Fitch Ratings - downgraded the United States to AA+ on August 1st, 2023, in the midst of post-COVID money printing.
• Moody's - downgraded the United States to Aa1 on May 16th, 2025.

( s&p, fitch, moody's )

The United States has a unique, self-imposed problem in that it routinely faces a debt ceiling. When Congress spends more money than Congress allows itself, it must raise the debt ceiling. Except, politicians regularly abuse this quirk with political brinkmanship and repeated debt-limit standoffs. Each time this happens, the federal government is increasingly at risk of not being able to pay off its debts.

The three credit rating agencies finally recognized the deteriorating political climate in the United States and adjusted their models accordingly. The United States no longer has the AAA rating because there is real increased risk that the government may one day not pay back its debt.

Are the Credit Ratings Agencies Corrupt?

It's hard to forget the scene in The Big Short where "Mark Baum" (in real life, Steve Eisman), is arguing with an analyst at the Standard & Poor’s credit rating agency. He wanted to know why the risk assessment of the mortgage-backed securities and collateralized debt obligations that Baum was investing in had not been marked, in his opinion, appropriately.

In this scene the risk assessment analyst admits that S&P was motivated by incentives and fear of losing business. She suggests that if S&P did not give the highest ratings requested by their clients, those banks would simply go to their competitor across the street (Moody's) instead.

This little back-and-forth argument demonstrates the inherent conflict of interest in the credit rating agency business model. The companies and governments being rated by the agencies actually pay the agencies for the service of being rated. There is strong incentive for the agencies to give high ratings so that those customers become repeat business.

The United States Securities and Exchange Commission does technically regulate these agencies, designating them as "Nationally Recognized Statistical Ratings Organizations" (NRSROs). The SEC is supposed to ensure the agencies manage conflicts of interest appropriately. From an outsider's perspective, that regulation does seem to lean conservative.

What the SEC does not do is influence credit ratings themselves. The final score is always left to the opinion of the agencies.

What it means

Credit ratings rarely make it into public discourse, but they can and do have significant impact on day-to-day life. Employees of a company with a junk credit rating are going to feel the stress of improving performance more than a company with a AAA rating.

Not even the United States government is immune to the effects of credit ratings. As America inches closer and closer to economic ruin, its citizens must decide whether being the trade center of the world is important enough to get its spending obligations under control.

In a world were technical jargon and complex concepts rule, it's interesting to note that in the world of finance, sometimes the simplest letters hold the most power.