AAA: Definition as Credit Rating, Criteria, and Types of Bonds

What Is a AAA Credit Rating?

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 a slightly different Aaa to signify a bond’s top-tier credit rating.

Understanding AAA Credit Ratings

Credit ratings are assessments or opinions of the creditworthiness of a business or government. As such, they provide an alert of the likelihood that the subject will live up to their financial obligations by paying their 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. Since they are perceived to have the lowest risk of default, these instruments tend to offer the investors the lowest yields among bonds with similar maturity dates (lower risk equals lower return). The term default refers to a bond issuer failing to fulfill its obligations, namely failing to make semiannual interest payments or repay the principal amount when due.

AAA ratings are given to government debt and companies’ corporate bonds. The global credit crisis of 2008 resulted in a number of companies losing their AAA rating, most notably General Electric (GE). 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. That is, until August 2023 when Fitch downgraded the U.S.'s long-term ratings from AAA to AA+. The agency cited potential issues with financial deterioration over the next three years and rising national debt.

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 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 promise to pay. Therefore, the credit rating of such instruments relies heavily on the issuer’s income sources and business outlook.

Benefits of a AAA Rating

A high credit rating lowers the cost of borrowing for the issuer (or borrower). 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.

The Bottom Line

Credit ratings are assigned to debt issues and bonds by the three major debt-rating agencies: S&P, Moody’s, and Fitch. Their credit ratings have a strong influence on the cost of borrowing for the issuer. The better the credit rating, the lower the cost to borrow.

AAA/Aaa ratings are the highest ratings issued by the credit-rating agencies and likely result in the lowest borrowing costs or yields. Investors seeking a better return should look down the credit-ratings scale for bond issuers with lower ratings and higher yields.