Notching
Capital MarketsRating an individual instrument above or below the issuer rating to reflect where it ranks and what security it has.
Also written: issue level rating, instrument rating
The issuer or corporate rating is about the borrower and answers whether it will default. An instrument rating is about a specific claim and answers what a holder of that claim would recover if it did. The two are related but not the same, so agencies notch the instrument up or down from the issuer rating.
Secured debt with a first claim on the assets is typically rated a notch or more above the issuer rating. Subordinated debt is notched down, and so is debt that is structurally subordinated because it sits at a holding company above the entities that own the assets and generate the cash.
The practical use is in reading a term sheet. When somebody says a deal is rated B plus, the useful question is whether that is the corporate rating or the rating on the tranche being sold, because in a layered structure those two numbers can be two or three notches apart.
Worked example
A borrower carries a B corporate rating. Its senior secured term loan might be rated B plus on the strength of its collateral, while unsecured notes issued by a holding company above the operating group are rated CCC plus.
Same company, same default probability, three different letters, because recovery differs by claim.