LeoGlossary: Investment Grade (Bond Rating)
A bond or other debt security is considered investment grade when a rating agency judges it relatively likely to pay principal and interest on schedule.
The three largest credit rating agencies are:
- Moody’s Investors Service
- Standard and Poor’s (S&P)
- Fitch Ratings
These agencies all have similar rating scales. Investments rated Baa/BBB or higher are considered investment grade.
They are:
- Aaa/AAA - highest rate: lowest risk of default
- Aa/AA - high quality with low risk
- A - upper-medium grade with low risk
- Baa/BBB - medium grade, could have speculative characteristics
Depending on the rating agency, modifiers of 1, 2, and 3, or +/- are added to each rating classification – e.g., Aa1 or BB+ – to indicate whether the security falls into the low or high end of the range.
The rating agencies came under fire for their role in the Great Financial Crisis. Much of this was brought about by the fact that mortgage backed securities were rated as investment grade, meaning they were on par with US Treasuries. When the banks and other financial institutions started to find it difficult to value their holdings due to the lack of liquidity in the markets, the entire system stared to unravel.
This took on epic proportions since these investment grade assets were used as collateral throughout the short term lending and Repo markets.
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