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 boast a high degree of creditworthiness, because their issuers are generally easily able meet their financial commitments and they consequently run lower risks of defaulting. Noted ratings 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.
Breaking Down AAA
The term "default" refers to a bond issuer failing to make the principal amount and/or an 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.
The global credit crisis of 2008 resulted in a number of companies losing their AAA rating, most notably, General Electric. By mid-2009, only four companies in the S&P 500 possessed the coveted AAA rating. And as of 2017, only two companies held the AAA rating.
--The highest possible rating that a bond may achieve is AAA, which only bestowed upon those bonds that exhibit the highest levels of creditworthiness.
--This AAA rating is delivered by Fitch Ratings and by Standard & Poor's, while S&P) while Moody's uses the similar "Aaa" lettering to signify a bonds highest credit rating.
--Bonds that receive AAA ratings are viewed as less likely to default, therefore they have no trouble finding investors willing to loan their money to these offerings.
--AAA-rated bonds often give the issuing competitive edges over lower ranked bonded companies, because the former group can use the cash raised for business expansion efforts.
How a High Credit Rating Helps a Business
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 the credit needed 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.
Factoring in Secured and 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 rely heavily on the issuer's income sources.
The Differences Between Revenue and General Obligation (GO) Bonds
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.
[Important: 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.]