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What is an AAA Rating?

2017-05-05T06:09:55+00:00

The term 'AAA Rating' is included in the Corporate Finance edition of the Financial Dictionary. It's available on mazon in Kindle or Paperback version. See more details here.

AAA Rating refers to the maximum potential credit rating that a credit ratings bureau can award to an issuing entity’s bonds. Such a credit rating represents a superb level of creditworthiness. It means that the issuing entity is easily capable of meeting its various financial obligations. The three major ratings agencies of Moody’s, Standard & Poor’s, and Fitch Ratings all utilize the AAA as their top credit rating which designates those bonds and issuers which have the highest possible level of credit quality.

It is not possible to completely eliminate the potential risk of a credit default from a bond issuer. Yet those entities which possess AAA rated bonds are believed to have the least possible chance of defaulting on their interest payments or principal repayments. Because of this, such bonds provide their investors with the smallest possible yields of any bonds that possess the same dates of maturity.

Thanks to the Global Financial Crisis of 2008, many companies and countries lost their coveted AAA rating. In fact, by the middle of 2009, there were only four remaining firms out of the entire list of S&P 500 companies that still held their treasured AAA rated credit. The story was the same with the gold standard credit rated nations of the world as well.

Before the Great Recession, a number of nations enjoyed the highly coveted AAA credit rating from all three of the big three ratings agencies. Once the dust had settled, only the following nine nations still held it including Australia, Canada, Denmark, Germany, Luxembourg, Norway, Singapore, Sweden, and Switzerland. Countries that had lost it included Austria, Finland, France, the United Kingdom, and the United States. The U.S. still had the AAA rated credit from Moody’s and Fitch, while the United Kingdom still held it from Standard & Poor’s (who even removed it from negative watch).

High credit ratings like the AAA rating provide significant benefits to a company or nation which carries them. It allows the issuer to borrow at a reduced interest rate and ultimate cost. These companies and countries are also able to borrow greater amounts of money when they possess the highest ratings. Lower costs of borrowing allow for nations and corporations to access opportunities through cheap and easy credit. A company might be able to buy out a competitor as it is able to cheaply borrow the money for the transaction costs of the relevant merger and acquisition.

Where companies are concerned, it is possible for them to enjoy the highest AAA rating on bonds which they issue as secured while having a lower credit rating on those which are unsecured. This is simply because secured bonds provide a particular asset that has been put up as collateral in case the issuer defaults on the interest or principal payments of the bond in question. The creditor has the right to seize the asset if the issuer ends up defaulting. Such bonds could carry the collateral of real estate, machinery, or other forms of equipment. Conversely, unsecured bonds only carry the backing of the issuer’s capability of repaying the obligation. This is why the credit ratings for unsecured forms of bonds only rely on the income source of the issuer in question.

Since the Global Financial Crisis destroyed the highest creditworthiness of many a long-standing AAA rated nation, neither the world’s largest debtor nor creditor nations possess the all-important AAA rating. For example, S&P argues that it will only deliver the AAA rating in the cases where an “extremely strong capacity to meet financial commitments” exists.

The euro zone was long a shining example of many nations which possessed unanimous AAA rated credit. After the Great Recession and Sovereign Debt Crisis ravaged Europe, only the two nations of Luxembourg and Germany still retain this three ratings agency unanimous AAA status.

The term 'AAA Rating' is included in the Corporate Finance edition of the Financial Dictionary. You can get your copy on mazon in Kindle or Paperback version. See more details here.