What Is a Credit Rating?
A credit rating is an independent assessment of a borrower's ability and willingness to repay its debt on time. The three major rating agencies, S&P Global, Moody's, and Fitch, assign letter grades to companies, governments, and individual bond issues.
The scales differ slightly by agency, but the logic is the same: AAA (or Aaa at Moody's) marks the strongest credits, grades step down through AA, A, and BBB, and anything below BBB- (Baa3 at Moody's) is considered non-investment grade, commonly called high yield or junk.
How Credit Ratings Are Assigned
Rating agencies analyze both quantitative and qualitative factors: leverage ratios like Debt / EBITDA, interest coverage, cash flow stability, industry dynamics, competitive position, and management's financial policy. Analysts meet with company management and publish reports explaining each rating decision.
Ratings are not static. Agencies place issuers on watch or assign outlooks (positive, stable, negative), and they upgrade or downgrade as fundamentals change. The line between BBB- and BB+ is the most consequential in the market, since crossing it forces many institutional investors who can only hold investment grade paper to sell.
Example
Suppose two companies each want to borrow for 10 years. The A-rated issuer might pay a yield of 5.0 percent, while a BB-rated issuer in the same industry pays 7.5 percent. That 2.5 percentage point gap, or 250 basis points of spread, is the market's price for the extra default risk implied by the lower rating.
On 500 million dollars of debt, the rating difference costs the weaker issuer an extra 12.5 million dollars in interest every year, which shows why management teams actively defend their ratings.
Why It Matters
Credit ratings shape borrowing costs, determine which investors can own a bond, and often trigger covenant or collateral requirements when they change. Downgrades can cascade, raising a company's cost of capital exactly when it is most vulnerable.
In leveraged finance and debt capital markets, bankers model how a proposed deal will affect the issuer's rating before it launches, and credit analysts on the buy side effectively re-do the agencies' work to find mispriced bonds.
