What is 'Notching'

Notching is the practice by rating agencies to give different credit ratings to obligations of a single entity or closely related entities. Rating distinctions among obligations are made based on differences on their security or priority of claim. With varying degrees of losses in the event of default, obligations are subject to being notched higher or lower.


Moody's Investors Service ("Moody's) and Standard & Poor's Financial Services ("S&P") are two major credit rating agencies that notch up or notch down instruments within the same corporate family depending on placement in an obligor's capital structure and their level of collateral. The base from which an instrument is notched in either direction is an obligor's senior unsecured debt (base = 0), or the corporate family rating (CFR). Notching also applies to the structural subordination of debt issued by operating subsidiaries or holding companies, according to S&P. As an example, the debt of a holding company of an enterprise could be rated lower than the debt of the subsidiaries, the entities that directly own the enterprise's assets and cash flows.

Moody's Updated Notching Guidance

In 2017, Moody's published an update to its 2007 notching methodology. The guidance indicated as "applicable in most cases" was as follows:

  • Senior Secured Debt: +1 or +2 notches above base
  • Senior Unsecured Debt: 0 (base)
  • Subordinated Debt: -1 or -2
  • Junior Subordinated Debt: -1 or -2
  • Preferred Stock: -2

In a small number of cases, Moody's will notch beyond the -2 to +2 range if: 1) an unbalanced capital structure results in a particular obligation comprising a very small or large proportion of total debt; 2) a legal regime is less predictable; or, 3) there is extra complexity in the legal structure of a corporation.

  1. Senior Debt

    Senior debt is borrowed money that a company must repay first ...
  2. Subordinated Debt

    Subordinated Debt is a loan or security that ranks below other ...
  3. Subordinate Financing

    Subordinate financing is debt financing that is ranked behind ...
  4. Subordination Agreement

    Subordination agreement is a legal agreement which establishes ...
  5. Underlying Debt

    Underlying debt is a municipal bond term that reflects an implicit ...
  6. Moody's Analytics

    Moody’s Analytics offers tools, solutions and best practices ...
Related Articles
  1. Investing

    Chinese Tech Firms Could Be Hurt By Their Finance Arms: Moody's

    The finance arms of China's tech darlings has Moody's a bit concerned about the quality of the credit, particularly when it comes to Baidu.
  2. Investing

    Understand the Security Types of Corporate Bonds

    Any investor should be aware of the different security types regarding corporate bonds as well as the direct correlation to potential recovery rates.
  3. Investing

    What's a Debt Security?

    A debt security is a financial instrument issued by a company (usually a publicly traded corporation) and sold to an investor.
  4. Investing

    Netflix Will Be Cash Flow Positive in 5 Years: Moody's

    Moody's Investors Service upgraded Netflix's credit rating by one notch on Wednesday after predicting that the streaming giant’s growing subscriber base and gradual price increases will help ...
  5. Investing

    Evaluating a Company's Capital Structure

    Learn to use the composition of debt and equity to evaluate balance sheet strength.
  6. Investing

    Ford's Credit Rating Close to Junk After Downgrade

    Ford got its credit rating downgraded by Moody's, putting it one downgrade away from junk status.
  7. Insights

    S&P Cuts US Growth, Increases Chance Of Recession

    S&P Global Ratings cut the U.S. growth forecast and increased the chance of a recession
  8. Investing

    Why You Shouldn't Trust Ratings From Rating Agencies

    When the U.S. debt was downgraded, what does that really mean?
  9. Investing

    Tesla Faces 'Considerable' Credit Risk, Moody's Warns

    The electric car manufacturer’s launch of its first vehicle aimed at the mass market raises "considerable" credit risks, according to Moody’s.
  1. What is the difference between subordinated debt and senior debt?

    Understand the difference between subordinated debt and senior debt. Learn what a company is required to do in case of bankruptcy. Read Answer >>
  2. On which financial statements does a company report its long-term debt?

    A company lists its long-term debt on its balance sheet under liabilities, usually under a subheading for long-term liabilities. Read Answer >>
  3. Why would a company use a form of long-term debt to capitalize operations versus ...

    Learn about the different consequences of using long-term debt versus equity to raise capital for business activity, and ... Read Answer >>
Trading Center