Credit Ratings
An opinion on the likelihood of repayment, expressed on a letter scale, produced by firms paid by the issuers they rate.
MadStockAlerts Research · Updated August 29, 2026
What to take away
- Ratings are opinions about default likelihood, not about price or value.
- The investment-grade boundary carries mechanical consequences beyond the opinion.
- The issuer generally pays for the rating, which is a structural conflict.
- Ratings lag: downgrades usually follow the market rather than lead it.
- The scales of the major agencies are similar and not identical.
MAD Academy Training Video · 0:46
An Opinion, Paid For by the Issuer
Ratings are useful, standardised and structurally conflicted, and the line between investment grade and high yield moves real money.
This lesson is part of a Stock Alerts + Tools plan.
The scale
| Category | Typical notation | Meaning |
|---|---|---|
| Highest grade | AAA / Aaa | Extremely strong capacity to repay |
| High grade | AA / Aa | Very strong |
| Upper medium | A | Strong, with some sensitivity to conditions |
| Lower medium | BBB / Baa | Adequate. The lowest investment-grade tier |
| Speculative | BB / Ba and below | Below investment grade, commonly called high yield |
| Default | D | In default |
The line between the fourth and fifth rows is the one with consequences beyond the opinion itself. Many institutional mandates permit only investment-grade holdings, so a downgrade across that boundary forces selling by holders who have no view on the credit at all.
A bond downgraded from investment grade to speculative is conventionally called a fallen angel, and the forced selling around the transition is a mechanical flow rather than a judgement about the issuer.
What a rating is and is not
- It is an opinion about the likelihood of timely repayment, and in some cases about expected recovery.
- It is not a statement about whether a bond is attractively priced.
- It is not a prediction about the bond's market value, which moves with rates as well as with credit.
- It is not a guarantee, and rated issuers default.
- It is not comparable across asset classes as precisely as the shared letters suggest.
The last item was the central failure of the structured credit ratings before the 2008 crisis. Instruments carrying the same letters as sovereign and corporate debt had entirely different risk characteristics, and the shared notation implied a comparability that did not exist.
The conflict, and what addresses it
Under the prevailing model, the issuer of a security pays the agency to rate it. The conflict is obvious: the party being assessed is the customer, and it can approach another agency if it dislikes the outcome.
Regulatory reforms after the financial crisis introduced disclosure requirements, restrictions on the interaction between analysts and sales, and reduced the extent to which regulations themselves reference ratings. The conflict has been managed rather than removed.
The practical response is to treat a rating as one input rather than as a conclusion, and to read the spread alongside it. Where the market prices a bond well outside its rating category, the market is disagreeing with the rating.
The lag
Ratings are revised deliberately and infrequently, because they are intended to be stable through a cycle rather than to track sentiment. The consequence is that they lag.
- Spreads generally widen before a downgrade, sometimes by many months.
- Equity markets frequently reprice a deteriorating credit before an agency acts.
- Watch and outlook designations are the intermediate signals, and they precede action.
- By the time a downgrade is announced, much of it is usually in the price.
The lag is a design choice rather than a defect: a rating that moved with the market would provide no information the market did not already have. It does mean that ratings are a poor early warning and a reasonable description of a settled view.
The notches, and what moves between them
Each letter category is subdivided, and the subdivisions matter because mandates, indices and pricing all reference specific levels rather than broad categories.
| Signal | What it indicates |
|---|---|
| Outlook: positive, stable or negative | A view over a one to two year horizon; not an imminent action |
| Credit watch | A review under way, usually resolved within months |
| A one-notch downgrade within a category | Routine, and usually already reflected in spreads |
| A downgrade across the investment-grade boundary | Mechanical selling by mandate-constrained holders |
| Multiple notches at once | Unusual, and generally reflects a specific event |
The fourth row is where the consequence exceeds the information. A single notch that happens to cross the boundary forces selling that a notch in either direction elsewhere in the scale would not.
This is also why issuers manage their ratings around that boundary specifically, and why a company approaching it will frequently take visible action to defend it.