For many years, the United States government was regarded as the gold standard in terms of good credit. It was regarded as one of the safest investments in the world due to its taxing power and sound finances. That picture changed after the recession. Standard & Poor's downgraded the US credit rating from AAA to AA+ in 2011, giving the US a lower credit rating than Canada, Germany, and the United Kingdom at the time. In fact, Microsoft and Johnson & Johnson, both based in the United States, had better credit ratings than the country. Understanding the factors that go into a bond issuer's credit rating can help you understand why this is. Major credit rating agencies like Standard & Poor's (S&P), Moody's, and Fitch assign ratings based on the likelihood of the bond issuer defaults. This likelihood is determined by evaluating an institution's financial health, such as its balance sheet strength and cash position. The following factors are considered in addition to an institution's ability to service its debt with cash left over after expenses are deducted from revenue:
- Earnings increase
- Margin of profit
- Perspectives for the Future
- Regulatory framework
- the cost of taxes
- Trends in the Industry
Downgrade by the government
Because of its rising debt, ongoing budget deficits, and rapidly deteriorating debt-to-GDP ratio, the United States is no longer regarded as providing the same level of long-term security that it did even in the late 1990s. The most significant event in terms of its credit rating occurred in August 2011, when S&P downgraded the United States' debt from AAA to AA+, its second-highest rating. The main reason for S&P's downgrade was the lack of predictability in the US political landscape, which increased the uncertainty of wrangling over issues like the debt ceiling. Note that the downgrade had no effect on the market on its own. The other two agencies kept their high ratings, and S&P even distinguishes between AAA and AA as "extremely strong capacity to meet financial commitments" versus "very strong capacity" to do so. Because Microsoft and Johnson & Johnson both have the highest credit ratings from all three agencies, it can be assumed that these two businesses are less risky than the government as a whole. The United States no longer has the highest credit rating from all three agencies. This advantage is justified by the fact that both companies have significantly lower debt levels than the country as a whole. While corporations cannot monetize or pay off their debt, the United States can do so by printing money and using its taxing authority.The AAA Rating Doesn't Tell the Whole Story
When comparing these corporations' bonds to US Treasury bonds, there are a few things to keep in mind. To begin with, even though these two companies have higher credit ratings than the US government, they continue to offer higher yields because corporate bonds pay a higher interest rate than government bonds. The yield spread is the term for this difference. These companies' spreads are typically lower than the average corporate bond because they are financially strong and thus have a lower risk of default. Tip: While ratings are helpful, they should not be the only factor to consider when selecting a bond. Interest rate and credit risks affect bond performance, regardless of how well-rated the issuer is. This is especially true for longer-term issues. The fact that a bond is rated AAA does not guarantee that the investor will be completely protected from the effects of fluctuating principal. While AAA is the highest rating, bonds with an AA or equivalent rating are extremely safe in terms of default.Questions and Answers (FAQs)
How much does a AAA corporate bond currently pay?
In October 2021, the average yield on a AAA corporate bond with a maturity of at least 20 years was 2.68 percent. Check the data maintained by the Federal Reserve Bank of St. Louis for the most recent information as bond yields are subject to continuous fluctuation in response to broader market conditions.What are the steps to purchasing AAA corporate bonds?
You have three basic options when it comes to investing in AAA corporate bonds, all of which require access to the market via a brokerage account. The first option is to purchase a new "first-issue" bond right as it is being created from the company. The second option is the secondary market, which allows you to buy and sell bonds with other traders. Using a corporate bond fund is the third option.You pay a fund manager to oversee a portfolio of bonds that achieves a particular objective described in the fund's details. Mutual funds or ETFs can be used.