What is ‘AAA’
AAA is the highest possible rating assigned to an issuer’s bonds by credit rating agencies. An AAA-rated bond has an exceptional degree of creditworthiness, because the issue can easily meet its financial commitments. The ratings agencies Standard & Poor’s (S&P) and Fitch Ratings use the AAA to identify bonds with the highest credit quality, while Moody’s uses AAA is the top credit rating.
BREAKING DOWN ‘AAA’
Default is the risk that a bond misses a principal or interest payment. Since AAA-rated bonds are perceived to have the smallest risk of default, these bonds offer investors the lowest yields among bonds with similar maturity dates. The global credit crisis of 2008 resulted in a number of companies, including General Electric, losing the AAA rating. By mid-2009, only four companies in the S&P 500 possessed the coveted AAA rating.
How a High Credit Rating Helps a Business
A high credit rating lowers the cost of borrowing for an issuer, and companies can borrow larger sums of money with a high rating. A low cost of borrowing is a big competitive advantage, because the firm can take advantage of opportunities by easily accessing credit. If, for example, a business has the opportunity to start a new product line or buy a competitor, it can borrow funds to finance the transaction.
Factoring in Secured and Unsecured Bonds
Issuers can sell both secured and unsecured bonds, and the risk of default is different for each type of bond. 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 on the bond. Secured bonds are collateralized with equipment, machinery or real estate, and these bonds may have a higher credit rating than an unsecured bond sold by the same issuer. An unsecured bond, on the other hand, is simply backed by the issuer’s ability to pay, and the credit rating of an unsecured bond relies on the issuer’s source of income.
The Differences Between Revenue and General Obligation (GO) Bonds
Municipal bonds can be issued as revenue bonds or as general obligation bonds; each type of bond relies on a different source of income. Revenue bonds, for example, are paid using fees and other income generated from a specific source, such as a city pool or sporting venue. A general obligation bond is backed by the issuer’s ability to tax; state bonds rely on state income taxes, while local school districts depend on property taxes.