Investment grade

A dividing line in the rating scales published by the credit rating agencies, of which Standard and Poor's, Moody's and Fitch are the largest. A rating is an opinion on the likelihood that a borrower pays interest and principal as promised, expressed on a letter scale, and the boundary between the top band and the one below it separates investment grade from what is variously called high yield, speculative grade or junk. The scales are not identical across agencies but map onto one another closely.

Ratings are assigned by committee from financial ratios, the borrower's sector and competitive position, the structure of the debt itself and, for a company, the rating of the sovereign it operates under, which usually acts as a ceiling. They are reviewed rather than fixed, and an agency signals a likely change by placing a borrower on outlook or on watch before moving the rating. Agencies frequently disagree about the same issuer, which produces split ratings and, at the boundary, genuine ambiguity about which side of it a borrower sits on.

The reason the boundary matters more than one notch of credit quality should is mandate. Many pension funds, insurers and index tracking funds are permitted to hold only investment grade paper, so a borrower downgraded across the line, known as a fallen angel, faces forced selling by holders who are no longer allowed to own it. That is a flow effect rather than a change in the borrower, and it is why the yield gap widens sharply at the boundary rather than smoothly along the scale.