AAA Credit Rating Explained: Definition, Criteria, and Bond Types

What Is a AAA Credit Rating?

The AAA credit rating is the highest rating possible for bonds and indicates a bond issuer's noteworthy creditworthiness and financial strength. It communicates to investors a minimal risk of default. Leading agencies such as Standard & Poor’s (S&P) and Fitch Ratings issue the AAA rating. Moody’s issues its Aaa rating under the same circumstances. These ratings can change with changes in financial conditions. Both S&P and Fitch have downgraded the credit rating of the United States due to the agencies' views of the nation's financial stability and the government's questionable policy decisions.

Exploring the Benefits and Implications of AAA Credit Ratings

Credit ratings are assessments or opinions of the creditworthiness of a business or government. They indicate how likely the subject is to meet financial obligations and pay bills. Investors can use these ratings to decide whether countries and bond offerings are safe investments. These ratings are assigned by credit rating agencies, notably S&P, Moody's, and Fitch.

AAA and Aaa ratings are considered to be investment grade. Because they are seen as low-risk for default, these bonds offer investors lower yields compared to others with similar maturity dates. Default means a bond issuer fails to make interest payments or repay the principal on time.

AAA ratings are given to government debt and companies’ corporate bonds. The 2008 credit crisis caused many companies, including General Electric (GE), to lose their AAA ratings. As of August 2023, only two companies held the AAA rating outright: Microsoft (MSFT) and Johnson & Johnson (JNJ). Apple (AAPL) is split, with an Aaa rating by Moody’s and an AA+ (one notch below AAA) from S&P.

Even the United States suffered a ratings cut by S&P, to AA+ in 2011—losing its vaunted AAA status due to political infighting over raising the debt ceiling. Moody’s and Fitch maintained the U.S. at Aaa and AAA ratings, respectively. Fitch downgraded the U.S. rating from AAA to AA+ in August 2023. The agency cited potential issues with financial deterioration over the next three years and rising national debt.

Examining Different Types of AAA-Rated Bonds

Municipal

Municipal bonds can be issued as either revenue bonds or 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. State bonds rely on state income taxes, while local school districts depend on property taxes.

Secured and Unsecured

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 might be backed by assets like 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 promise to pay. Therefore, the credit rating of such instruments relies heavily on the issuer’s income sources and business outlook.

Advantages of Holding a AAA Credit Rating

A high credit rating reduces borrowing costs for issuers. 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 a 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.

Conclusion: The Impact of AAA Ratings on Borrowing Costs

AAA/Aaa ratings are the highest ratings issued by the credit-rating agencies for bonds by S&P, Moody’s, and Fitch. They indicate the lowest risk of default and the highest degree of creditworthiness and can mean lower borrowing costs (and, unfortunately, yields). Conservative investors look to AAA ratings despite their lower return potential as compared to issues with lower ratings and higher yields. The AAA rating can change if economic factors or financial conditions affect the financial stability, safety, and outlook of a company or organization. For instance, the credit rating of the U.S. government was dropped in 2011 and 2023 due to its policy decision-making and financial position.