Credit rating agencies analyze the finances of governments, corporations, and complex debt securities, then publish letter-grade opinions on how likely each borrower is to repay. What credit rating agencies do, in one line, is turn financial analysis into a shorthand grade that investors and regulators use to price risk and decide what to buy. Three firms produce most of the ratings that move global markets: S&P Global Ratings, Moody’s Investors Service, and Fitch Ratings. Eleven firms in total are registered with the SEC as Nationally Recognized Statistical Rating Organizations, but the Big Three dominate.1U.S. Securities and Exchange Commission. Current NRSROs
One thing they do not do: rate you. Consumer credit scores are a separate system run by different companies. If your mortgage gets bundled into a mortgage-backed security, the agencies rate the security, not you.
What They Rate
Rating agencies cover almost every kind of large institutional borrowing.
Sovereign debt. When a national government issues bonds, the agency weighs macroeconomic performance, political stability, institutional strength, and the tax base against the debt load. A sovereign rating often functions as a practical ceiling for other borrowers in the country, because a shaky government usually means elevated risk for the banks and companies operating under it.
Corporate and municipal bonds. Corporate ratings look at financial statements, cash flow, competitive position, and industry outlook. Municipal ratings—covering state and local government debt for roads, schools, and infrastructure—focus on the local tax base, revenue stability, and the legal protections written into the bond structure. Historically, municipal bonds have defaulted far less often than corporate bonds.
Structured finance products. Asset-backed securities, mortgage-backed securities, and collateralized loan obligations pool hundreds or thousands of underlying loans and slice the pool into tranches with different payment priorities. Here the agency assesses the quality of the collateral, the legal structure isolating the assets, and how cash flows through each tranche under stress. Because these products are engineered, the rating leans heavily on modeling assumptions.
How a Rating Gets Assigned
The process starts when an issuer—a company preparing a bond offering, a government agency, or the sponsor of a structured product—formally requests a rating and shares its financial records. Under the dominant “issuer-pays” model, the entity being rated pays for the analysis, and the finished rating is published freely.
A lead analyst pulls together balance sheets, debt ratios, cash flow projections, and any confidential information the issuer provides. The quantitative work sits alongside a qualitative read of management quality, industry dynamics, and the broader economy. For structured products, the analyst also models how cash flows would hold up under stressed scenarios like rising defaults or falling recoveries.
That preliminary work goes before an internal rating committee, which debates the evidence and votes on the final grade. Before publication, the issuer can flag factual errors, though not lobby for a better rating. Once assigned, ratings are monitored continuously. If the issuer’s financial condition, industry, or regulatory environment shifts, the agency can place the rating on watch and eventually upgrade or downgrade it.
Reading the Rating Scales
Every agency compresses its analysis into a letter shorthand. The scales differ in typography but communicate the same idea: how likely the borrower is to default.
S&P and Fitch
Both scales start at AAA and step down through AA, A, BBB, BB, B, CCC, CC, C, and finally D for default.2S&P Global. Understanding Credit Ratings Within each letter category, a plus or minus sign adds detail: AA+ sits just below AAA; AA- sits at the bottom of the AA range.3Fitch Ratings. Rating Definitions
Moody’s
Moody’s uses Aaa at the top, then Aa, A, Baa, Ba, B, Caa, Ca, and C. Instead of plus and minus, it appends 1, 2, or 3 to mark the higher, mid, and lower ends of a category. Aa1 at Moody’s roughly matches AA+ at S&P or Fitch.4Moody’s Investors Service. Moody’s Rating Symbols and Definitions
Investment Grade Versus Speculative Grade
The most consequential line on any of these scales divides investment grade from speculative grade. At S&P and Fitch, BBB- and above is investment grade; BB+ and below is speculative.2S&P Global. Understanding Credit Ratings At Moody’s, the cutoff falls between Baa3 (investment grade) and Ba1 (speculative).4Moody’s Investors Service. Moody’s Rating Symbols and Definitions Speculative debt is often called “high-yield” or “junk.” The higher yields exist to compensate investors for the greater chance of not being paid back.
Outlooks and Watch Lists
Alongside the letter grade sits an outlook—positive, negative, stable, or developing—signaling where the agency thinks the rating is headed over the next year or two. A negative outlook doesn’t guarantee a downgrade; it flags risk factors. When something more immediate is unfolding, like a pending merger or a liquidity crunch, the agency may place the rating on credit watch, indicating a decision could come within weeks.
Why the Grade Matters
A letter grade functions as a key that opens or closes the door to large pools of capital. The effects reach borrowing costs, regulatory compliance, and the tradability of bonds.
Borrowing Costs
A company rated AA can issue bonds at a lower interest rate than one rated BBB, because investors view the higher-rated issuer as safer. For a large issuer floating billions of dollars in debt, a single-notch downgrade can add tens of millions of dollars a year in interest expense. Sovereigns face the same dynamic: a downgrade raises the cost of funding everything from infrastructure to social programs.
Regulatory Gatekeeping
Many institutional investors face legal or regulatory limits on what they can hold. Banks, for example, must demonstrate that their securities meet an “investment grade” standard, meaning the bank has determined the issuer’s capacity to meet its financial commitments is adequate and the risk of default is low.5Board of Governors of the Federal Reserve System. SR 12-15 – Investing in Securities Without Reliance on Nationally Recognized Statistical Rating Organization Ratings Pension funds and insurance companies face similar constraints. Federal regulators have moved away from requiring blind reliance on agency ratings, but in practice those ratings still heavily influence internal creditworthiness determinations.
Fallen Angels and Forced Selling
When a bond drops from the lowest rung of investment grade (BBB- or Baa3) to the top of speculative grade (BB+ or Ba1), the industry calls it a “fallen angel.” Institutional investors barred from holding speculative debt are forced to sell, flooding the market with supply just as demand is drying up. Research from the European Central Bank suggests credit markets often begin repricing the risk before the official downgrade, and that prices frequently recover partially once the forced selling ends.6European Central Bank. Understanding What Happens When Angels Fall
Market Liquidity
Even setting aside any single rating action, the mere existence of a rating makes a bond easier to trade. A standardized assessment gives buyers and sellers a starting point for pricing, even when neither party can conduct a full credit analysis. Unrated bonds tend to trade less often and at wider spreads because the information gap makes investors cautious.
The Issuer-Pays Conflict
The central tension in the ratings business is that the entity being graded is the one writing the check. If an issuer is unhappy with a preliminary rating, it can shop around, which creates pressure on agencies to be generous rather than lose the fee. In structured finance, where a small number of large investment banks generate enormous deal volumes, that pressure is concentrated. Agencies rating structured products have at times also advised on how to structure deals to achieve higher ratings, blurring the line between evaluator and collaborator.
The 2008 financial crisis made the problem impossible to ignore. Agencies had assigned top-tier grades to complex mortgage-backed securities and collateralized debt obligations built on increasingly risky subprime loans. Roughly 90 percent of the residential mortgage-backed securities issued in 2006 and 2007 were later downgraded from investment grade to speculative grade. Securities rated AAA suffered losses no AAA rating should have contemplated. In 2015, S&P agreed to pay $1.375 billion to settle federal and state claims that it had inflated ratings to win business from the banks packaging these securities.
The deeper problem the crisis exposed was that investors, regulators, and the agencies themselves had treated ratings as near-guarantees rather than the opinions they technically are. Ratings carry no legal warranty of accuracy.
Who Oversees the Agencies
For decades, rating agencies operated with little formal oversight. The Credit Rating Agency Reform Act of 2006 established a registration framework for NRSROs and gave the SEC authority to examine their operations. Registered agencies must disclose their methodologies, maintain policies against misuse of nonpublic information, and report conflicts of interest.7Office of the Law Revision Counsel. 15 U.S. Code 78o-7 – Registration of Nationally Recognized Statistical Rating Organizations
The Dodd-Frank Act of 2010 expanded these requirements. Section 932 required that at least half of each agency’s board of directors be independent of the ratings business, with a portion representing the investors who rely on ratings. Agencies also had to disclose the historical performance of their ratings and the assumptions most likely to change a rating if proven wrong.8U.S. Congress. Public Law 111-203 – Dodd-Frank Wall Street Reform and Consumer Protection Act Separately, Dodd-Frank directed federal agencies to scrub their own regulations of any blanket reliance on credit ratings, so that banks and other regulated firms would form their own independent judgments about credit risk.5Board of Governors of the Federal Reserve System. SR 12-15 – Investing in Securities Without Reliance on Nationally Recognized Statistical Rating Organization Ratings
For structured finance, SEC Rule 17g-5 requires a hired rating agency to maintain a password-protected website listing every deal it is in the process of rating. Other registered agencies get free access to the same information and can produce competing ratings.9eCFR. 17 CFR 240.17g-5 – Conflicts of Interest The SEC’s Office of Credit Ratings conducts at least one examination of each NRSRO every year, and its January 2025 staff report documented material deficiencies at several agencies, a reminder that the conflict-of-interest problems the 2006 and 2010 reforms were meant to address are still live.10U.S. Securities and Exchange Commission. 2024 Staff Report on Nationally Recognized Statistical Rating Organizations
What a Rating Is Not
Every agency emphasizes the same point: a credit rating is not a recommendation to buy, sell, or hold. It’s an opinion about default probability, not a judgment about whether the bond is a good investment at its current price. A AAA-rated bond trading at a premium can be a worse deal than a BB-rated bond trading at a deep discount. The rating tells you about the likelihood of getting paid back, nothing more.
Ratings also move on a slower clock than the market. An agency may take months to downgrade a deteriorating issuer while the bond market reprices the risk in days. That lag is by design; agencies aim for rating stability rather than real-time tracking. If you rely on the letter grade alone and ignore what the yield spread is telling you, you’re seeing only part of the picture.