You may have heard of the term notching and wonder what it means. You will understand more about this term, by reading this article through to the end. In this article, we will be talking about notching as it relates to credit rating. This is quite because companies at one time or the other may have the need to borrow. When this need arises, it is the credit ratings by credit rating agencies use to gauge the company’s ability to meet its debt payment and other duties that will determine if the company can get the credit or not.
What is Notching?
Notching is when credit rating agencies, offer varying credit ratings to the obligations or debts of a single issuing entity or closed related entities. Here, a credit rating agency bumps up or down the credit rating on an issuer’s specific debts. Now, these agencies make rating distinctions among obligations that are based on differences in their security or priority claim. When varying degrees of losses occurs as a result of a default, obligations are then subject to being notched higher or lower. This may be thus seen as: while a particular company may have an overall credit rating of ‘AA’, its rating on its junior debt may be ‘A’.
Credit rating agencies, check the company’s ability to meet its debts payments and other obligations. On the other hand, a company may also issue several types of debts like (Secured Vs. Unsecured). Owing to this, the credit rating on those debts. May be different from the issuing company’s overall credit rating. This is due to the unique risks of the debt.
The angle from which an instrument is notched. In either direction is an obligator’s senior unsecured debt (base = 0), or the corporate family rating (CFR). Notching also comes into play in the structural subordination of debt. Issued by holding companies as stated by S&P. Now, this can be seen in the case of the debt of a company of an enterprise, which could be lower than the debt of the subsidiaries. The entities that directly own the enterprise’s assets and cash flows.
Therefore owing to certain types of debts, for example. Subordinated debts are seen as being riskier than senior debts. The rating on junior debts can be notched lower. Thus, those debts from the issuer that are senior. And secured by collateral may get notched higher.