The credit agency letter ratings of bond issuers allow investors to quickly compare the safety of different bond investment choices. As the top two possible ratings, there will be little difference in either safety or yield between bonds with AA and AAA ratings. This may be good news for investors, since the number of AAA rated issuers is small and shrinking.
Bond Ratings Ladder
The three main rating agencies of Standard & Poor's, Moody's and Fitch Ratings use very similar letter scales, and the ratings of a bond issuer will be the same or very similar from each. The S&P and Fitch letter grades from best to worst are as follows: AAA, AA, A, BBB, BB, B, CCC, CC, C. The Moody's system has the same steps, but uses small "a's" for the second and third positions. A Moody's Baa rating is the same as a BBB from S&P. The agencies will also use plus and minus symbols to further break down the credit levels. For example, an AA rated company may be an AA plus, AA or AA minus, from best to worst.
AA to AAA Spreads
A September 2013 article in "Forbes" stated that the average yield difference from 1997 through 2012 between corporate AA and AAA rated bonds was 0.23 percent. To put the difference in dollar terms, a $100,000 AA rated bond would pay $230 more in interest each year than would an AAA bond. The spread between the top two credit ratings will increase as you look at longer bond terms. To illustrate: In December 2013, the spread between AA and AAA on two-year muni bonds was 0.05 percent. At 10 years, the spread was up to 0.16 percent and with 20-year terms, the difference was 0.54 percent. The spreads for corporate bonds at 10 and 20 years also shown on the BondsOnline website were very similar to the muni bond yield differentials.
Small Number of AAA Rated Issuers
The AAA credit rating is hard to come by. In the early 1980s, there were about 60 companies with the top rating, according to a 2011 "New York Times" article. By 2000, that number had dropped to 15 and, as of 2013, only four non-financial corporations had an AAA rating. On the international front, in 2013, there were 15 AAA rated countries, and even the U.S. had been dropped to Aa by Moody's in 2011. Out of the 50 U.S. states, nine have the top AAA rating from all three agencies.
With only four issuers, an investor looking for AAA rated corporate bonds may not be able to find what she wants. The AA rating provides a more-than-adequate degree of safety and usually comes with a small increase in yield. With municipal bonds, AAA rated bonds are much easier to find. Many muni bond issuers buy insurance on new bond sales to give the bonds an AAA rating. However, an investor looking for long-term municipal bonds may find that the extra yield from some AA rated bonds may be worth the small drop in credit rating.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.