Introduction
Rating scales are the standardized vocabulary that the Big Three rating agencies use to communicate credit quality, and understanding the scales (along with the distinction between issuer ratings and issue ratings) is essential for any DCM banker covering rated debt. The three agencies use parallel scales that map to the same underlying credit-quality concept but with different notation conventions: S&P and Fitch use letter-based scales (AAA, AA, A, BBB, etc.); Moody's uses lowercase variants with numerical modifiers (Aaa, Aa1, Aa2, Aa3, etc.). Beyond the scales themselves, the distinction between rating an issuer (the entity's overall credit quality) and rating an individual issue (a specific bond's credit quality after accounting for security, subordination, and structural features) is one of the most-misunderstood concepts in fixed income.
This article walks through rating scales and the issuer-versus-issue distinction in detail. It covers the parallel notation systems used by the three agencies, the broad rating categories and the within-category modifiers, the IG/HY boundary at BBB-/Baa3, the short-term rating scales used for commercial paper and similar instruments, and the structural distinction between issuer credit ratings (ICRs) and issue-specific ratings. The framing is from the IBD DCM banker's seat, with the rating agencies as principal counterparties and credit research as the primary user of detailed rating analytics.
The Parallel Rating Scales
The three major agencies use functionally identical scales with different notation conventions.
Long-Term Rating Scales
| S&P / Fitch | Moody's | Credit Quality | IG / HY |
|---|---|---|---|
| AAA | Aaa | Highest credit quality; minimal default risk | Investment Grade |
| AA+, AA, AA- | Aa1, Aa2, Aa3 | Very high credit quality; very low default risk | Investment Grade |
| A+, A, A- | A1, A2, A3 | Upper-medium credit quality; low default risk | Investment Grade |
| BBB+, BBB, BBB- | Baa1, Baa2, Baa3 | Medium credit quality; moderate default risk | Investment Grade |
| BB+, BB, BB- | Ba1, Ba2, Ba3 | Speculative; significant default risk | High Yield |
| B+, B, B- | B1, B2, B3 | Highly speculative; high default risk | High Yield |
| CCC+, CCC, CCC- | Caa1, Caa2, Caa3 | Substantial default risk | High Yield |
| CC, C | Ca, C | Very high default risk; some securities in default | High Yield |
| D | (No D equivalent) | In default (S&P/Fitch) | Default |
The IG/HY Boundary
The single most important threshold in the rating scale is the boundary between investment grade and high yield, which sits at BBB-/Baa3 (lowest IG) and BB+/Ba1 (highest HY). The structural significance of this single-notch boundary was covered in the crossover credits article. A downgrade across this boundary triggers index migration, forced selling from IG-only mandates, and material spread widening; an upgrade triggers structural buying from IG mandates and meaningful spread tightening.
Within-Category Modifiers
Each broad rating category has three notches. S&P and Fitch use plus and minus modifiers (AA+, AA, AA-); Moody's uses numerical modifiers (Aa1, Aa2, Aa3). The conventions are equivalent:
- "+" or "1" denotes the upper third of the broad category
- (no modifier) or "2" denotes the middle third
- "-" or "3" denotes the lower third
A bond rated "A+" by S&P is functionally equivalent to one rated "A1" by Moody's; both indicate the upper third of the A rating category.
- Rating Notch
A single increment within a rating scale, representing one position up or down on the credit quality continuum. Each broad rating category (AA, A, BBB, BB, B, CCC) contains three notches at S&P and Fitch (+, middle, -) and at Moody's (1, 2, 3). A "one-notch upgrade" at S&P moves a bond from BBB- to BBB; a "one-notch downgrade" moves it from BBB to BBB-. Single-notch movements within a broad category produce small spread effects (typically 5-15 basis points), while multi-notch movements or movements that cross broader-category boundaries (particularly the IG/HY boundary at BBB-/BB+) produce substantially larger spread effects. Rating actions are typically discussed in notch terms ("a one-notch upgrade," "a two-notch downgrade") to convey the magnitude precisely.
Short-Term Rating Scales
Beyond the long-term scales, the agencies publish short-term ratings used primarily for commercial paper and other instruments with maturities of one year or less.
S&P Short-Term Scale
| Rating | Description |
|---|---|
| A-1+ | Strongest capacity to meet financial commitments |
| A-1 | Strong capacity to meet financial commitments |
| A-2 | Satisfactory capacity to meet financial commitments |
| A-3 | Adequate capacity to meet financial commitments |
| B | Significant speculative characteristics |
| C | Vulnerable to non-payment |
| D | In default |
Moody's Short-Term Scale
| Rating | Description |
|---|---|
| P-1 (Prime-1) | Superior ability to repay short-term debt |
| P-2 (Prime-2) | Strong ability to repay short-term debt |
| P-3 (Prime-3) | Acceptable ability to repay short-term debt |
| NP (Not Prime) | Below the Prime category |
Fitch Short-Term Scale
Fitch uses F1+, F1, F2, F3, B, C, RD, D, paralleling the S&P structure with slightly different notation.
Mapping Long-Term to Short-Term
There is a general but not strict mapping between long-term and short-term ratings:
- Long-term AAA to AA-/Aa3 typically maps to short-term A-1+ / P-1
- Long-term A+/A1 to A-/A3 typically maps to A-1 / P-1 or A-1 / P-2
- Long-term BBB+/Baa1 to BBB-/Baa3 typically maps to A-2 / P-2 or A-3 / P-3
- Long-term below BBB- typically maps to non-prime / B or below
Issuer Ratings vs Issue Ratings
The distinction between issuer ratings and issue ratings is one of the most important and most frequently confused concepts in credit ratings.
- Issuer Credit Rating (ICR)
A rating agency's assessment of an issuing entity's overall ability to meet its financial obligations, independent of any specific bond. The ICR (also called the issuer rating, or corporate family rating at Moody's) anchors the ratings of the issuer's individual bonds, which are then notched above or below it for security and subordination. A senior secured bond may rate above the ICR while a subordinated bond rates below it; the ICR itself reflects the entity, not any one instrument.
Issuer Credit Rating (ICR)
The issuer credit rating (also called "long-term issuer rating" or "corporate family rating" at Moody's) reflects the overall credit quality of the issuing entity. The ICR represents the rating agency's view of the issuer's general likelihood of meeting financial obligations, abstracted from any specific bond's structural features.
Issue Rating
The issue rating reflects the credit quality of a specific bond, accounting for the bond's structural features that may make it more or less likely to be repaid than the issuer overall. Specific factors that drive issue ratings to differ from the ICR:
- 1.Security: Senior secured bonds (with a security interest in collateral) are typically rated one to three notches higher than senior unsecured bonds from the same issuer
- 2.Subordination: Senior subordinated bonds are typically rated one to two notches lower than senior unsecured; deeply subordinated debt is rated multiple notches lower
- 3.Hybrid features: Bonds with deferral, conversion, or extension features may be rated lower than senior debt to reflect the deferred-cash-flow risk
- 4.Guarantee structures: Bonds with parent or subsidiary guarantees may be rated differently based on the guarantor's specific credit profile
- 5.Covenant strength: Stronger covenant packages can produce higher issue ratings; weaker covenants can produce lower ratings
Worked Example
Consider a single-A rated corporate issuer with three outstanding bond tranches:
| Bond | Structure | Issue Rating |
|---|---|---|
| First-lien senior secured | Backed by all-asset security | A+ (one notch above ICR) |
| Senior unsecured | Standard structure | A (matches ICR) |
| Senior subordinated | Subordinated to senior unsecured | A- to BBB+ (one to two notches below ICR) |
The same issuer's ICR is A; the issue ratings range from A+ down to BBB+ depending on each bond's specific structural features.
Outlooks and Watches
Beyond the headline rating, the agencies provide forward-looking signals through outlook designations and credit watch placements.
Outlooks
Outlooks indicate the agency's view of likely rating direction over the next 12-24 months:
- Positive: Rating may be raised in the medium term
- Stable: Rating likely to remain unchanged in the medium term
- Negative: Rating may be lowered in the medium term
- Developing (occasional): Direction depends on specific events or outcomes
Credit Watches
Credit watches indicate higher-likelihood, shorter-timeframe rating actions, typically in response to specific events:
- Watch Positive (S&P) / Review for Upgrade (Moody's): Rating may be raised soon, typically within 90 days
- Watch Negative (S&P) / Review for Downgrade (Moody's): Rating may be lowered soon, typically within 90 days
Practical Implications
Outlook and watch placements have material market implications. A move from "stable" to "negative outlook" typically triggers spread widening of 10-25 basis points on IG corporates as IG-focused investors begin reducing exposure. A formal "credit watch negative" placement can trigger 20-50 basis points of additional widening. The market reactions reflect the increased probability of formal rating action.
The rating scales and issuer-versus-issue rating distinction are foundational concepts in credit ratings and a recurring topic in DCM and credit-research interviews. The next article walks through the rating process from mandate to publication, focusing on how DCM bankers manage the process for new issuers and new transactions.
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