A Triple-A (AAA) bond rating is the highest rating bond agencies award to an investment considered to have a low risk of default, thereby making it the most creditworthy.
What Is a Triple-A (AAA) Bond Rating?
AAA bonds are considered the absolute safest by the three primary bond rating agencies: Fitch, Moody's, and Standard & Poor's. Grades go as low as "D" for Fitch and Standard & Poor's. The lowest rating Moody's grants is "C."
Bonds are similar to a loan. An entity issues a bond, which an investor buys with the expectation of being paid back in the future—plus interest.
By granting the AAA rating, bond rating agencies signal they have as much faith as possible in these entities to honor the terms of the bond. In other words, they believe there is a very high chance you will get your money back.
How Triple-A (AAA) Bond Ratings Work
Bond rating agencies look at many different metrics to determine how safe a bond is as an investment. These include the strength of the issuer's balance sheet, the likelihood of sufficient earnings and cash flows to cover the promised interest and principal repayments, and the collateral available to seize in the event the bond defaults before or at its maturity date.
It is extraordinarily difficult to achieve an AAA rating. As of Aug. 16, 2020, only two U.S. companies have AAA ratings: Johnson & Johnson and Microsoft have maintained their ratings.
The global credit crisis of 2008 caused companies such as General Electric (GE) to lose their AAA rating.
Alternatives to Triple-A (AAA) Bonds
AAA bonds belong to a broader category of bonds known as "investment-grade" bonds. Investment-grade bonds include any bond that is rated at or above BBB- (on the S&P and Fitch scale) or Baa3 (on the Moody's scale). This has important regulatory implications. For example, a bank trust department or pension fund may favor investment-grade bonds over lower-grade bonds because of the strong desire to maintain a steady balance.
The grading system can break down slightly when comparing investment-grade corporate bonds to government bonds like Treasury Bills and Treasury Notes—also known as "Treasuries." Even though a company like Microsoft may be able to issue AAA bonds, U.S. Treasuries are generally considered the safest bonds. That's because they carry the full weight of the U.S. government behind them.
Not all government bonds are as safe as Treasuries. Municipal bonds (munis) are issued by lower-level government bodies. They can be issued by state authorities, cities, or agencies like a school district.
Municipal bonds can also be issued by U.S. territories like Puerto Rico. Since these bonds aren't issued by the federal government, they aren't backed by the federal government. The relative safety of municipal bond investments varies by the entity issuing them.
The Opposite of Triple-A (AAA) Bonds
With lower risk comes fewer rewards. Due to their rock-solid status, AAA-rated bonds offer the lowest yields. What you gain in peace of mind, you lose in income.
On the other end of the spectrum are junk bonds, which have low ratings and high yields. They're also known as high-yield bonds. The companies that issue these kinds of bonds get poor ratings because credit agencies determine they are in danger of defaulting (or have defaulted in the past).
If they do default, bondholders may not get paid. To entice investors, these companies need to offer higher yields. Some investors then decide it's worth the risk of investing in a junk bond to seek the higher returns offered.
- Triple-A (AAA) rated bonds are those deemed least likely to default.
- In return for this safety, the bonds return the lowest interest rate.
- Bond-rating agencies take into account a company's balance sheet and many other factors.
- Government Treasury bonds are historically considered the safest bonds.