AAA

What Is AAA?

AAA is the highest possible rating that may be assigned to an issuer's bonds by any of the major credit rating agencies. AAA-rated bonds have a high degree of creditworthiness because their issuers are easily able to meet financial commitments and have the lowest risk of default. Rating agencies Standard & Poor's (S&P) and Fitch Ratings use the letters "AAA" to identify bonds with the highest credit quality, while Moody's uses the similar "Aaa" to signify a bond's top-tier credit rating.

Understanding AAA

The term "default" refers to a bond issuer failing to make the principal amount and/or interest payment due to an investor. Since AAA-rated bonds are perceived to have the smallest risk of default, these instruments tend to offer investors the lowest yields among bonds with similar maturity dates.

AAA ratings can also be given to companies. The global credit crisis of 2008 resulted in a number of companies losing their AAA rating, most notably, General Electric. And as of 2020, only two companies held the AAA rating — Microsoft (MSFT) and Johnson & Johnson (JNJ).

Rather than restricting their fixed income exposure to AAA-rated bonds, investors should consider balancing those investments with higher income-producing bonds, such as high-yield corporates.

Types of AAA Bonds

Municipal Bond Types

Municipal bonds can be issued either as revenue bonds or as general obligation bonds — with each type relying on different sources of income. Revenue bonds, for example, are paid using fees and other specific income-generating sources, like city pools and sporting venues. On the other hand, general obligation bonds are backed by the issuer's ability to raise capital through levying taxes. Pointedly: State bonds rely on state income taxes, while local school districts depend on property taxes.

Secured vs. Unsecured Bonds

Issuers can sell both secured and unsecured bonds. Each type of bond carries with it a different risk profile. A secured bond means that a specific asset is pledged as collateral for the bond, and the creditor has a claim on the asset if the issuer defaults. Secured bonds may be collateralized with tangible items such as equipment, machinery, or real estate. Secured collateralized offerings may have a higher credit rating than unsecured bonds sold by the same issuer.

Conversely, unsecured bonds are simply backed by the issuer's promised ability to pay, therefore the credit rating of such instruments relies heavily on the issuer's income sources.

Benefits of a AAA Rating

A high credit rating lowers the cost of borrowing for an issuer. Therefore, it stands to reason that companies with high ratings are better positioned to borrow large sums of money than fixed-income instruments with lesser credit ratings. And a low cost of borrowing affords firms a substantial competitive advantage by letting them easily access credit to grow their businesses.

For example, a business may use the incoming funds from a new bond issue to launch a new product line, set up shop in a new location, or acquire a competitor. All of these initiatives can help a company increase its market share, and thrive over the long haul.