Corporate Issuer Credit Ratings

The major credit-rating agencies, Moody’s, Standard & Poor’s (S&P), and Fitch Ratings (“Fitch”), play an essential role in the credit markets. For a majority of bonds, at least two of the agencies provide ratings.

Credit rating agencies use similar symbol-based ratings to assess the risk of default. There are symbols for investment grade and non-investment grade (“junk” or “high-yield” bonds), including low-grade (or speculative-grade) and default.

Issuer Ratings versus Issue Ratings

When assessing corporate debt, rating agencies typically provide both an issuer rating (corporate family rating, CFR) and an issue rating (corporate credit rating, CCR).

The issuer’s credit rating addresses the issuer’s overall creditworthiness and usually applies to senior unsecured debt.

Issue rating refers to specific financial obligations and considers ranking in the capital structure such as secured or subordinated. However, cross-default provisions, which refer to events of default such as nonpayment of interest on one bond triggering default on all outstanding debt, may often suggest the same default probability for all issues.

Notching

A rating adjustment methodology known as “notching” may assign different credit ratings based on the priority of claims. Thus, with varying degrees of losses in the event of default, obligations are subject to being notched higher or lower.

Rating agencies consider structural subordination, which can arise when a corporation with a holding company structure has debt at both its parent holding company and operating subsidiaries. Debt at the subsidiary level could be serviced before funds are passed (“upstreamed”) to the holding company. Based on such payment priorities, rating agencies often adopt a notching. This process allows credit ratings on issues to be moved up or down from the issuer rating.

Question

Which of the following rating methodologies only apply to subordinated debt?

1. Notching.
2. Issue rating.
3. Issuer rating.

Solution

The correct answer is C.

The issuer’s credit rating addresses the issuer’s overall creditworthiness and usually applies to senior unsecured debt.

A is incorrect. Issue rating ranks all other types of debts.

B is incorrect. Notching is a rating adjustment methodology that assigns different credit ratings based on the priority of claim.