Bond Ratings AA+ vs. Aa1: What's the Difference?

AA+ vs. Aa1: An Overview

Credit rating agencies score individuals, companies, and governments based on their ability to pay their debts. Agencies like Standard & Poor's (S&P) Global Ratings and Moody's Investors Services assign these ratings to entities (corporations and governments) that issue debt, such as a bond, through a letter-based scale. A bond's rating is the key indicator of the creditworthiness of the bond issuer, and therefore the degree of risk to the investor that the issuer could default on the debt.

AA+ and Aa1 are assigned by S&P and Moody's respectively. These scores are given to investment-grade products as they are high-quality. They signify that the issuer is financially sound and has adequate revenues and cash reserves to pay its debts. The risk of default for investors or policyholders is low.

AA+

S&P ratings are issued to long-term issuers of credit and insurance companies on a letter-based scale. The first rating is a AAA while the second highest is AA. This is followed by an A-rating. Anything that falls in the A-class is considered to be high quality, which means the debt issuer has a very strong likelihood of meeting its financial obligations.

According to S&P Global Ratings, a corporation with an AA rating is defined as having a "very strong capacity to meet its financial commitments." It deviates just slightly from the highest-rated companies. S&P may add a "+" or a "-" to these letter grades as well to "show relative standing within the rating categories." This means that an AA+ rating is slightly higher than an AA grade.

One important point to note is that S&P uses a different scale for long- and short-term debt. The short-term bond rating system is relatively simple. Short-term bonds that are considered investment quality are rated A-1, A-2, or A-3. B- or C-rated short-term bonds are deemed speculative or worse.

According to material from the Environmental Protection Agency (EPA), S&P rated senior debt by Ameritech Corporation with an AA+ rating—one of the highest ratings corporate debt can have. The United States has an AA+ rating from S&P. This means that the U.S. has a strong standing and that it can meet its obligations. As such, debt issues from the U.S. government are considered high-grade and investment-worthy.

Aa1

Moody's has a system that is slightly similar to that used by S&P. Debt issuers with the highest grades fall into the A-range beginning with Aaa. Aa is the next category followed by A-grade investments. According to Moody's, an Aa-grade investment is "judged to be of high quality and are subject to very low credit risk."

Moody's assigns numerical modifiers to these letter-based ratings. Adding a 1 puts it into the highest position of that range while a 2 indicates a mid-range and a 3 denotes a low-range ranking.

An Aa1 rating is higher than an Aa2 rating. It is also the second-highest score that Moody's can assign to investments and corporations after the Aaa rating. Investments with an Aa1 score are designated with a P-1 classification, which indicates a "superior ability to repay short-term debt obligations.

The senior debt issued by Emerson Electric was given an Aa1 rating by Moody's, according to EPA records. Moody's ranks Austria with an Aa1 rating, which means the federal government is very likely to repay back its debts if it decides to issue bonds.

Special Considerations

S&P and Moody's assign ratings based on certain inherent characteristics (of a debt issue and the issuing company or of a particular country) along with other certain external factors. These include financial strength, which can be determined by analyzing financial statements and the financial ratios that are associated with them. Some of the external considerations include monetary and fiscal policy, interest rates, and an entity's relationship with other key players, such as a parent corporation. Geopolitical concerns also factor in when considering a country's ability to repay its debts.

Ratings Below AA+ and Aa1

Scores that fall below S&P's A grades fall in the following categories:

• BBB: This rating signifies debts are fairly sound. But when economic conditions or any other circumstances change, the debt issuer may have trouble fulfilling its financial obligations.
• BB: These debts are more vulnerable to nonpayment because of problems within the business, the financial landscape, or the economy.
• B: S&P assigns this rating to debt issues that are significantly more vulnerable than a BB rating.
• CCC: If the debt issuer has any problems stemming from business, economic, or financial issues, it won't be able to repay its obligations.
• CC: Anything that is rated with a CC grade has a great risk of default.
• C: Those with this rating are less likely to be repaid.
• D: A D rating is given to any company or debt issue that is in default or any other type of breach.
  

Ratings that fall below Moody's A rating fall in these categories:

• Baa: These ratings denote a moderate level of credit risk. Although speculative, they are commonly referred to as medium-grade investments.
• Ba: The credit risk with these speculative vehicles is significantly higher.
• B: Moody's assigns this rating to debt issues that come with high credit risk and are deemed speculative.
• Caa: Along with high credit risk, this rating is assigned to obligations that are considered to be highly speculative.
• Ca: These issues are likely to be very close to default—if not already. They may have a chance of recovery, though.
• C: This grade is assigned to low-class bonds that are in default. As such, there's very little chance that creditors will be repaid.

How Bond Ratings Work

Bond ratings are the equivalent of a consumer's credit rating for companies and governments that want to borrow money. The rating that a company's bond receives determines the rate of return (RoR) it will pay on its bonds. Each successive step lower in the ratings listed above means a step up in the rate of return and in the degree of risk.

High-quality bonds have lower rates of interest. They are seen as safe-haven investments and are often bought by retirees seeking a steady income stream and by investors seeking to balance riskier investments like stocks with high-quality, low-risk bonds.

Low-quality bonds are often referred to as high-yield bonds. They pay better because they come with a greater risk that the issuer will default on their bond payments. The bond ratings call them non-investment-grade bonds. They're often referred to as junk bonds.