Just as a US insurance company and a Japanese bank with the same rating have essentially the same degree of risk. Ratings are forward looking. Although a thorough historical analysis is the starting point, they are based on the outlook for the issuer's financial performance over the intermediate-term future, not just on its past performance. The forward view takes a range of possibilities into account, including recessions and other potential causes of financial stress. Default, loss and notching Probability of default is the likelihood that a debt issuer will fail to make interest or principal payments as they come due or that a preferred stock issuer will fail to make dividend payments when they are due.
Ratings apply only to payment defaults.
Ratings to do not attempt to estimate the probability of covenant defaults. Ratings also take into account the extent of potential loss on issues that goes into default. Losses vary according to the priority of the issue in default. As the chart indicates, senior types of debt lose much less value than subordinated types, and secured debt loses less than unsecured. For companies with an investment grade corporate rating, secured debt is rated one subgrade higher than unsecured debt, and subordinated debt is rated one subgrade lower.