Saturday, May 10, 2014

Issuer rating vs issue rating

Credit agencies rate both specific issues and issuer. These two ratings can be different, one BB rated issuer can issue a BBB rated bond. Now I face the question which ratings needs to be used to price the credit risk and why ?  

Definition of issuer rating from S&P
A Standard & Poor's issuer credit rating is a forward-looking opinion about an obligor's overall creditworthiness in order to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation.

Definition of issue rating from S&P
A Standard & Poor's issue credit rating is a forward-looking opinion about the creditworthiness of an obligor with respect to a specific financial obligation, a specific class of financial obligations, or a specific financial program (including ratings on medium-term note programs and commercial paper programs). It takes into consideration the creditworthiness of guarantors, insurers, or other forms of credit enhancement on the obligation and takes into account the currency in which the obligation is denominated. The opinion reflects Standard & Poor's view of the obligor's capacity and willingness to meet its financial commitments as they come due, and may assess terms, such as collateral security and subordination, which could affect ultimate payment in the event of default. 

In short, an issuer rating generally indicates the likelihood that a company may default with regard to all its financial obligations. An issue rating, however, is based on a blend of default risk and the priority of a creditor's claim in bankruptcy associated with the specific debt being rated. Secured debt has the higher recovery rates than non secured debts in situation of issuer defaults so normally secured debt get higher rating. 

To price credit risk it is better to use the issuer's rating as issuer is default on all its obligations even if it defaults on one of its obligation. Issue specific rating or covenants are more relevant in situation of financial liquidations.  

Normally we have Senior secured , senior unsecured , subordinated secured and subordinated unsecured type of debts. Senior debt refers to debt that is in first-lien position and in event of a default and subsequent liquidation, the senior lender has first priority in getting its investment, followed by subordinated debt and followed by equity holders.Subordinated debt, also known as mezzanine or junior debt is a second-level of debt.

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