Notwithstanding the mortgage-backed securities fiasco that nearly destroyed the capital markets, AAA-rated bonds are pretty much the safest things on the market. Reserved for those issuers with the cleanest balance sheets, AAA ratings are rare, with only a handful of companies qualifying for that distinction.
The reward for the prestigious designation is generally a lower borrowing cost (interest rate) than lesser-rated businesses, but a higher cost than the U.S. government pays. But like everyone else, the longer the company needs to borrow money for, the higher the rates it will need to pay. This table shows a snapshot of the relationship between bond rating, time to maturity, and best-available interest rates:
|
Term |
U.S. Treasury |
AAA-Rated Corporate |
AA-Rated Corporate |
A-Rated Corporate |
|---|---|---|---|---|
|
1-3 Years |
1.0% |
2.0% |
3.0% |
6.1% |
|
3-5 Years |
1.7% |
2.2% |
3.5% |
6.8% |
|
5-7 Years |
2.4% |
2.9% |
4.6% |
7.4% |
|
7-10 Years |
2.9% |
3.4% |
5.5% |
7.6% |
|
10-20 Years |
3.7% |
4.2% |
5.9% |
7.8% |
|
20+ Years |
3.9% |
4.7% |
5.9% |
7.8% |
Data from ScotTrade bond center, as of July 6 market close.
Of course, rates will change over time. Key factors driving those changes include things like expected inflation, the rates that the U.S. government can get on its debt, and how risk-seeking or risk-averse market participants become in general.
Who's in the AAA club?
These days, only four nonfinancial companies hold that coveted AAA rating: Automatic Data Processing
With extremely solid balance sheets, earnings high enough to cover their interest payments many times over, and generally stable cash flows, they truly are the cream of the corporate crop.
Who's fallen out?
That said, there's no guarantee that a company will keep its AAA rating once it earns it. General Electric
While the AAA club is a tough one to join and stay in, the lowered borrowing cost can be substantial, especially with longer-term borrowing. With interest rates generally so low today, that may not seem like much of a big deal. But if inflation kicks up, the credit markets once again lock out all but the strongest borrowers, or quality spreads increase substantially, that advantage could grow substantially.
