What is AAA (Aaa) Credit Rating?
AAA (Aaa) credit rating refers to the highest rating given by credit rating agencies to bonds or other entities. Bonds rated AAA (Aaa) possess a very high credit value because the issuer can easily fulfill financial commitments, and the default risk is minimal.
Credit rating agencies Standard & Poor's and Fitch Ratings use the letters "AAA" to signify the highest credit-rated bonds, whereas Moody's uses the slightly different "Aaa" to denote the highest credit rating for bonds.
Key Highlights
- The highest rating a bond can achieve is AAA (Aaa), which is only awarded to bonds demonstrating the highest credit value.
- Fitch and Standard & Poor's use AAA to denote the highest rating, while Moody's uses a similar "Aaa" to indicate the highest rating.
- Bonds rated AAA (Aaa) are considered to have the lowest default risk.
- Issuers of AAA (Aaa) rated bonds typically do not face investor shortages. Despite lower yields offered by these bonds, their top credit rating remains highly attractive to large financial institutions or sovereign financial entities.
Understanding AAA (Aaa) Rating
Since bonds rated AAA (Aaa) are deemed the least risky in terms of default, they offer investors the lowest yields among bonds with similar maturity dates (lower risk implies lower returns).
The AAA (Aaa) rating applies to both government and corporate bonds. The 2008 global subprime crisis caused many companies to lose their AAA (Aaa) rating, the most notable being General Electric (GE).
As of May 2023, only two companies have maintained a perfect AAA (Aaa) rating: Microsoft (MSFT) and Johnson & Johnson (JNJ). Apple's rating is split, with Moody's rating it Aaa and Standard & Poor's giving it AA+ (a notch below AAA).
Even the U.S. was downgraded by Standard & Poor's to AA+ in 2011 due to the debt ceiling crisis caused by political disputes, losing its coveted AAA status. Currently, Moody's and Fitch have retained the U.S.'s Aaa and AAA ratings respectively.
Types of AAA (Aaa) Bonds
Municipal Bonds
Municipal bonds can be categorized into revenue bonds and general obligation bonds, each relying on different sources of income.
For instance, revenue bonds are repaid through usage fees and other specific income sources, like city pools and sports arenas. On the other hand, general obligation bonds depend on the issuing authority's ability to raise funds through taxation, such as state debt bonds backed by state income taxes and other revenues.
Secured and Unsecured Bonds
Issuers can issue secured and unsecured bonds, each type having different risk characteristics. Secured bonds are backed by specific assets as collateral, giving creditors the right to claim these assets in case of default. Secured bonds are often collateralized by tangible assets like equipment, machinery, or real estate. Compared to unsecured bonds from the same issuer, secured bonds tend to have higher credit ratings. Conversely, unsecured bonds rely solely on the issuer's promise to pay or creditworthiness, and their ratings largely depend on the issuer's income sources, business prospects, and credit standing.
Advantages of AAA (Aaa) Rating
High credit ratings can reduce the borrowing costs for issuers (or borrowers). Consequently, entities with high ratings can borrow at lower costs compared to those with lower ratings. Lower borrowing costs enable businesses to have more funds to invest in their operations, providing a significant competitive edge. For example, companies can use the funds from new bond issuances to launch new product lines, enter new markets, or acquire competitors, all of which can help increase market share and achieve long-term success.
Why Are Credit Ratings So Important?
The credit ratings assigned to debt issuers significantly influence their borrowing costs in public markets. The higher the credit rating, such as AAA (Aaa), the lower the borrowing costs, and vice versa.
Who Decides the Credit Ratings of Debt Issuers?
There are three main global credit rating agencies: Standard & Poor's (S&P), Moody's, and Fitch. They evaluate the creditworthiness and repayment ability of debt issuers based on factors such as a company's cash flow, the amount of other outstanding debt, and the issuer's business outlook.
Summary
Credit ratings are assessments made by the three major debt rating agencies (S&P, Moody's, and Fitch) on the credibility of debt issuers and bonds. These ratings have a substantial impact on the issuer's borrowing costs; the better the credit rating, the lower the borrowing costs.
For investors, a AAA (Aaa) rating is the highest rating issued by credit rating agencies and typically leads to lower borrowing costs or future yield rates. Investors seeking better returns need to balance between the risks they are willing to take and the returns they seek. They should not limit their fixed-income investments to only AAA-rated bonds but should consider balancing these investments with higher-yielding bonds like high-yield corporate bonds.
