Issuer and Issue Ratings

Sometimes a firm's debt will have __cross-default provisions__, meaning that any non-payment on one bond will trigger a default on all bonds. This is similar to the "tripwire" scenario in consumer debt that you may know about, where not paying one credit card can count as a default on all credit cards.

It's said that when you marry someone, you marry the entire family. That's not a bad mindset to have when investing in a bond. When you go out "dating" in the bond market, looking for that special issue, with just the right features and sufficient maturity, you often have to wonder about the parent company. Just like you will often have a different rating of a person and their family, ratings agencies can often have an __issue rating__, or rating on a specific bond issue, that differs from the __issuer rating__, which is called the corporate family rating (CFR).

No, the cross-default provision doesn't increase the likelihood of default. It simply allows all issues to share the same trigger event.

Correct! Since all issues would be triggered by a single non-payment, then all issues have the same __default risk__, or probability of default. However, all issues may not have the same loss severity. More junior issues will have a much larger loss severity than that of more senior issues. Also, a firm might have subsidiaries with debt that are serviced prior to the debt of the parent firm, making the subsidiary debt safer. For these reasons, it's still appropriate to start with the issuer rating and choose issue ratings that are a "notch" or two above or below the issuer rating. This is called __notching__.

No, this provision doesn't protect a firm at all. There is a likelihood of default that remains.

When a firm has a very high rating the apple doesn't fall far from the tree, so to speak. The issue ratings will likely be the same, or at most one notch away. But for lower rated issuers, it's possible that the specifics of a bond might be several notches in either direction.

Suppose a parent firm had an S&P issuer rating of BBB+, and a subsidiary with debt that received service prior than the senior unsecured debt of the parent company. What do you think is the most likely issue rating for this subsidiary's debt?

No, this is a notch lower than the issuer debt. But consider that the subsidiary enjoys more safety from structural subordination.

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How would you restate the existence of a cross-default provision for a firm's total debt?

No, this rating is six notches above that of the parent company. It's highly unlikely that the subsidiary's debt would be this good.

The issuer rating is typically the rating for its __senior unsecured__ debt. Why do you suppose that is?

No, there are multiple levels of debt higher than this in the seniority ranking.

Exactly! Debt more senior than this is __secured debt__, and is covered by specific assets that can be liquidated in order to pay the debt. So this doesn't speak to the issuer's ability to service debt in general. But senior unsecured debt is the most senior debt that is not backed by specific assets, but rather the general assets and operations of the firm.

No, the majority of debt more junior than this level is paid, and investors expect this.

Yes! That's reasonable. An S&P rating of A- is one notch above BBB+, and the structural subordination of the subsidiary makes this positive difference reasonable. Now, if the parent's issuer rating was AAA, then there's no question that the subsidiary debt would also be AAA. In fact, even a slightly worse issue might still be rated AAA if the parent had that top rating. But if the issuer rating was as low as CCC, then a safer subsidiary issue might have an issue rating of B-, that is two notches up from the issuer.

AAA

A-

BBB

The firm is more likely to default on all issues

All issues carry the same probability of default

No issue is likely to experience default

It's the most senior debt of the issuer

Any debt more senior is backed by specific assets

Anything more junior is unlikely to be paid

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