U.S. Companies Rated AAA, Higher Than U.S. Government Bonds
For years the U.S. government was looked to as the gold standard for good credit. Due to its taxing power and healthy finances, it was considered one of the safest investments in the world. Today, that picture has somewhat changed, and now only two U.S.-based non-financial companies have higher credit ratings than the country itself: Microsoft and Johnson & Johnson.
The map below illustrates nations color-coded by Standard & Poor's credit rating.
To gain a better sense of why this is, it helps to understand the factors that underpin the credit rating of a bond issuer. Ratings are assigned by major credit rating agencies such as Standard & Poor's (S&P), Moody's, and Fitch, and are based on the likelihood that the bond issuer will default. An institution's financial health, such as the strength of its balance sheet and cash position, is assessed to determine this likelihood. In addition to an institution's ability to service its debt via the cash left over after expenses are subtracted from revenue, the following are examined:
- Earnings growth
- Profit margins
- Future outlook
- Regulatory environment
- Tax burden
- Industry trends
The agencies rate each issuer on a letter scale based on these and other criteria. The ratings differ somewhat between the three agencies, but the highest-ranking—AAA for Fitch and S&P, and Aaa for Moody's—indicates that the borrowing entity is extremely unlikely to default on its debts.
Due to its rising debt, continued budget deficits, and sharply deteriorating debt-to-GDP ratio, the U.S. is no longer seen as offering the same degree of long-term safety it did even as recently as the late 1990s. From the perspective of its credit rating, the most important event occurred in August 2011, when S&P downgraded United States debt from AAA to its second-highest rating, AA+. The primary reason S&P cited for its downgrade was the lower degree of predictability in the U.S. political picture, which raised the uncertainty of wrangling associated with issues such as the debt ceiling.
Alone, the downgrade didn't have a meaningful impact on the market. The other two agencies retained their high ratings, and even S&P itself distinguishes the difference between AAA and AA as being an "extremely strong capacity to meet financial commitments" versus a "very strong capacity" to do so.
The fact that the U.S. is no longer afforded the highest ranking by all three agencies, whereas Microsoft and Johnson & Johnson both retain that status, means that the two companies are seen as having lower credit risk than the government. This advantage is justified in the sense that both companies have much better debt profiles than the country as a whole. However, the U.S. can monetize or pay off its debt by printing money and using taxation powers—something that can't be said for corporations.
The AAA Rating Isn’t Everything
When comparing the bonds of these corporations to U.S. Treasuries, it is important to keep a few issues in mind. To begin, even though these two companies are more highly rated than the U.S. government, they also continue to offer higher yields since corporate bonds trade at a higher yield than government bonds. This gap is known as the yield spread. Since these companies are so financially strong, and therefore at lower risk of default, their spreads are typically lower than the average corporate bond.
Ratings, while useful, are by no means the only consideration an investor should have when choosing a bond.
No matter how highly rated the issuer, the performance of its bonds—particularly longer-term issues—is affected by interest rate and credit risks. Just because a bond is rated AAA doesn't mean the investor is completely safe from the effects of fluctuations in their principal. While AAA is the highest rating, bonds rated AA, or the equivalent, are extremely safe in terms of the rarity of default. Even though there are only two companies rated AAA, that doesn't mean that there is not an abundance of bonds just outside of this group that are almost equally as safe.
S&P Global. "Fitch Affirms J&J's Ratings on Consistent Operating, Financial Performance." Accessed April 12, 2020.
SEC. "Form 10-K: Microsoft Corporation." Accessed April 12, 2020.
Moody's. "Moody’s Rating Process." Accessed April 12, 2020.
S&P Global Ratings. "S&P Global Ratings Definitions." Accessed April 12, 2020.
IASG. "S&P Downgrades U.S. Credit Rating." Accessed April 12, 2020.
Committee for a Responsible Federal Budget. "The Deficit Has Never Been This High When the Economy Was This Strong." Accessed April 12, 2020.
Pimco. "Corporate Bonds." Accessed April 12, 2020.