Leveraged Finance Methodologies and Criteria

Elena Stock
Director, European Leveraged Finance
September 2016

Contents
1

Corporate Rating Methodology

Differentiating Factors Between B+ and Below Rated Credits

Recovery Analysis and Notching of Debt Instruments

Junior Debt: Holdco PIKs and Shareholder Loans

Distressed Debt Exchanges (DDE) and Defaults

Corporate Rating Methodology

Key Corporate Rating Methodologies and Criteria

Corporate Rating Methodology (Master Criteria)
Recovery Ratings and Notching Criteria for Non-Financial Corporates
Country-Specific Treatment of Recovery Ratings
Junior Debt
Parent-Subsidiary Linkage
Hybrid Securities
Debt Factoring
Sovereign Ceiling
Operating Leases
Pensions

Key Corporate Rating Methodologies and Criteria

Reflection of quantitative and qualitative factors encompassing business and financial risks of issuers and their individual debt
issues
Issuer Default Rating (IDR) as assessment of issuers relative vulnerability to default on financial obligations, comparable across
industry and countries
Instrument Ratings denote additional information on priority of payment and likely recovery in the event of default
Forward looking and cash flow based assessment of commercial and financial risk
Analysis carried out within the framework of:
Industry profile: operating environment and country risk (exchange and ccy transfer risks)
Company profile: market position, level of dominance, geographic and product concentration, customer & supplier
concentration, size, scale
Management strategy and corporate governance
Financial profile: cash flow focus, financial flexbility, liquidity, contingent liabilities

Cash Flow Based Analysis (1/3)

Revenues

Operating Expenditures

Depreciation & Amortisation

Long-term Rentals

Operating EBITDAR

Net Cash Interest Paid

Cash Tax Paid

Net Dividends to/from Minorities / Preferred Dividends Paid

Long-term Rentals

+/=

Other Changes before FFO

Funds from Operations

Source: Fitch

Cash Flow Based Analysis (2/3)

Funds from Operations

+/=

+/-

Working Capital
Cash Flow from Operations
Non-Operating / Non-Recurring Cash Flow

Capital Expenditure

Ordinary Dividends Paid

Free Cash Flow

+/-

Net Acquisitions

+/-

Net Change in Equity

+/-

Net Change in Debt

Total Change in Cash

Source: Fitch

Cash Flow Based Analysis (3/3)

Ratio

Definition

FFO Adjusted Leverage

Gross Debt + Lease Adjustment Equity Credit for Hybrids + Preferred Stock______
FFO + Gross Interest Paid Interest Received + Preferred Dividends + Rental Payments

FFO Interest Cover

FFO + Gross Interest Paid Interest Received + Preferred Dividends

Gross Interest Paid + Preferred Dividends

FFO Fixed Charge Cover

FFO + Gross Interest Paid Interest Received + Preferred Dividends + Rental Payments
Gross Interest Paid + Preferred Dividends + Rental Payments

Source: Fitch

Purpose of Navigator
Improved transparency for key rating drivers
Visually communicate an issuers strengths and weaknesses

Provides granularity and cross-border comparability

Not a new methodology, not a scoring model
Global initiative across Fitchs Corporates Group

Navigator for each major corporate sector

Generic navigator for issuers not covered by sector navigators
An interactive web-based navigator is available on
www.fitchratings.com

Source: Fitch

Structure of Navigator
Navigators define nine key factors for each sector
Five out of the nine key factors are common across sectors:
Operating Environment
Management & Corporate Governance
Profitability
Financial Structure
Financial Flexibility

The remaining four are sector specific

Each key factor is itself divided into a number of sub-factors
Each sub-factor is defined for all rating categories (AA, A, BBB, BB, B and CCC).
For each sub-factor, the user of the Navigator selects the statement / description that best applies to the
individual credit. The related rating category appears automatically.

Once all sub-factors for a key driver have been selected, the user defines a three-notch range and a relative
statement of importance (Higher, Moderate, Lower) for the key factor.

Source: Fitch

Ratings Navigator Example Oil & Gas

Source: Fitch

10

Ratings Navigator Non-Food Retail

Source: Fitch

11

Ratings Navigator Generic

Source: Fitch

12

Differentiating Factors Between B+ and Below Rated Credits

13

Differentiating Factors Between B+ and Below Rated Credits

Financial metrics alone do not determine rating outcomes
Combination of company-specific and sector-specific considerations
Most 'B+' and below credits typically exhibit weak free cash flow profiles due to high leverage or uncertain business model
performance through economic cycles
Key drivers of rating outcomes (with relative importance depending on rating level)
Sustainability of business model
Execution risk in strategy
(Free) cash flow profile
Financial policy and governance
Deleveraging profile and refinancing risk
Liquidity position
Fitch rates to its own independent forecasts. Pre-set guidance on specific qualitative and quantitative benchmarks indicate
positive or negative rating actions if credits outperform or underperform Fitch's Rating Case

14

Key Considerations for B+ and Below

Considerations

B+

B-

CCC

Business model

Robust

Sustainable

Intact

Compromised

Execution risk in
strategy

Limited

Moderate

Meaningful

High

Free cash flow

Consistently positive

Neutral to positive

Volatile

Constantly negative

Leverage profile

Clear deleveraging path

Deleveraging capacity

High but sustainable

Unsustainable

Financial policy

Committed

Some commitment to
deleveraging

Aggressive

Uncommitted

Refinancing risk

Limited

Manageable

High

Excessive

Liquidity

Comfortable

Satisfactory

Limited

Poor/partly funded

Source: Fitch

15

Factors Behind Rating Migration in Low NIG

Considerations

B+ to B

B to B-

B- to CCC

Business Model

Execution Risk in Strategy

Free Cash Flow

Leverage Profile

Financial Policy

Refinancing Risk

Liquidity

Source: Fitch

high

medium

low
16

Example 1: Picard Bondco SA (B/Stable)

Considerations

B+

B-

Trend

Business model

Robust

Sustainable

Intact

Stable

Execution risk
in strategy

Limited

Moderate

Meaningful

Stable

Free cash flow

Consistently positive

Neutral to positive

Volatile

Stable

Clear deleveraging
path

Deleveraging capacity

High but sustainable

Stable

Committed

Some commitment to
deleveraging

Aggressive

Stable

Limited

Manageable

High

Stable

Comfortable

Satisfactory

Limited

Stable

Leverage profile
Governance/financial
policy
Refinancing risk
Liquidity
Conclusion

B/Stable

Source: Fitch

17

Example 2: Financiere IKKS SAS (B-/Stable)

Considerations

B+

B-

Trend

Business model

Robust

Sustainable

Intact

Stable

Execution risk
in strategy

Limited

Moderate

Meaningful

Stable

Free cash flow

Consistently positive

Neutral to positive

Volatile

Stable

Clear deleveraging
path

Deleveraging capacity

High but sustainable

Negative

Committed

Some commitment to
deleveraging

Aggressive

Stable

Limited

Manageable

High

Stable

Comfortable

Satisfactory

Limited

Positive

Leverage profile
Governance/financial
policy
Refinancing risk
Liquidity
Conclusion

B/Stable

Source: Fitch

18

Example 3: Novartex SAS (Vivarte; CCC/-)*

Considerations

B-

CCC

Trend

Business model

Sustainable

Intact

Compromised

Stable

Execution risk
in strategy

Moderate

Meaningful

High

Stable

Free cash flow

Neutral to positive

Volatile

Constantly negative

Positive

Leverage profile

Deleveraging capacity

High but sustainable

Unsustainable

Stable

Financial policy

Some commitment to
deleveraging

Aggressive

Uncommitted

Stable

Refinancing risk

Manageable

High

Excessive

Stable

Liquidity

Satisfactory

Limited

Poor/partly funded

Negative

Conclusion

CCC

* Fitch further downgraded Novartex SAS to CC from CCC on 29 July 2016

Source: Fitch

19

Recovery Analysis and Notching of Debt Instruments

20

Recovery Rating Methodology: Links to the Issuer Default Rating (IDR)

IDR
Bespoke
(B+ and below)

Up to 3 notches up or down from IDR

Generic
(BB+ to BB-;
transitional area)

Up to 2 notches up but capped at BBB-;

up to 2 notches down

Generic
(AAA to BBB-;
Investment Grade

Up to 2 notches up;
up to 2 notches down

-3

-2

-1

+1

+2

+3

21

Bespoke Approach: IDR of B+ and Below

Three-Step Approach to Bespoke Recovery Analysis

Recovery Ratings Scale

1. Estimate the Enterprise Value (EV)

RR

Recovery (%)

Notching from the IDR

RR1

91-100

+3 (usually secured only)

RR2

71-90

+2 (usually maximum for

unsecured)

RR3

51-70

+1

RR4

31-50

+0

RR5

11-30

-1

RR6

0-10

-2 to -3

2. Estimate the creditor mass

3. Distribute the value by waterfall right of payment

Source: Fitch

22

Step 1: Estimating Enterprise Value (EV) Going Concern Approach

Assumes that the company can be restructured as a going concern
Most common approach is a cash flow multiple approach, whereby Fitch analysts
Typically use EBITDA as a proxy for cash flow
Establish an appropriate level of post-restructuring cash flow
Apply a multiple reflecting the specific companys position within a sector
Traded asset valuation: Analysts could also use a sector-specific valuation approach e.g. using value of oil & gas reserves, price
per kilowatt of generation capacity, etc.
Discounted Cash Flow: If sufficient information is available, analysts might consider using conventional DCF techniques, but this
may be of limited value if the issuer is far from default, i.e. still performing

23

Step 1: Estimating Enterprise Value (EV) Going Concern Approach (Cont.)

Part 1: Establishing post-restructuring cash flow
What would be the most likely cause of a distress/default event? At what EBITDA level will default occur (we typically consider the
minimum amount of cash a company must generate to cover basic costs such as interest and maintenance capex)
What will the company look like assuming a degree of corrective action post-default/distress?

Company A EBITDA (EURm)

100
90
80

Distressed
EBITDA

70
60
50
40
30

Post-restructuring
EBITDA

Source: Fitch

24

Step 1: Estimating Enterprise Value (EV) Going Concern Approach (Cont.)

Part 1: Establishing post-restructuring cash flow
Once a reasonable level of post-restructuring EBITDA has been determined, all else being equal it should not change
Instead, the discount applied to the actual EBITDA will change over time, based on the performance of the company
The following elements can lead to a reassessment of the post-restructuring EBITDA level, from period to period
Acquisition, i.e. an inorganic increase in size of business
Step-change in companys condition, e.g. increased profitability following new plant opening

Company A EBITDA (EURm)

100
90
80
70

60
50
40
30

15%
discount

20%
discount

7%
discount
Post-restructuring
EBITDA

Source: Fitch

25

Step 1: Estimating Enterprise Value (EV) Going Concern Approach (Cont.)

Part 2: Multiple Selection and Application
Sector multiples can be observed from performing or distressed market transactions
In all cases, multiples are subject to a prudence principle limiting multiples when market valuations are at historical peaks, but
also avoiding the absolute trough of a severely depressed or disrupted market
Stylised Valuation Multiples Over the Cycle (EBITDAx)
EV/EBITDA

Fitch Distressed Multiple

10
8
6
4
2
0
Source: Fitch

26

Step 1: Estimating Enterprise Value (EV) Going Concern Approach (Cont.)

Part 2: Multiple Selection and Application
Once a suitable range of multiples for the sector has been determined, analysts must select a specific multiple for the company
being rated
The company is positioned in its sector based on consideration of
Competitive advantage/position
Asset quality/diversification
Growth prospects
Profitability
Regulation
Etc.
The multiple is considered compared to sector peers to ensure consistency

27

Step 1: Estimating Enterprise Value (EV) Going Concern Approach (Cont.)

Part 2: Multiple Selection and Application Median US/EMEA by Sector
Fitch Median Recovery Multiple
Industry

US

EMEA

Aerospace & Defence

6.5

Auto & Related

Fitch Median Recovery Multiple

Industry

US

EMEA

5.0

Food, Beverage & Tobacco

6.5

5.0

5.7

4.5

Gaming, Leisure & Entertainment

7.0

5.0

Broadcasting & Media

5.5

5.5

General Retail

5.5

5.0

Building & Materials

5.0

5.0

Healthcare

7.0

5.5

Business Services

5.7

5.0

Industrial/Manufacturing

5.5

5.0

Cable

5.5

5.5

Lodging & Restaurants

7.5

5.0

Chemicals

6.0

4.5

Packaging & Containers

5.6

4.8

Consumer Products

6.0

5.0

Technology

5.6

5.5

Energy (Oil & Gas)

6.0

4.5

Telecommunications (incl Cable)

6.0

5.0

4.8

Transportation

5.3

5.0

Food & Drug Retail

Source: Fitch

28

Step 1: Estimating Enterprise Value (EV) Balance Sheet Liquidation

A balance sheet liquidation approach may be more appropriate if:
The company generates negative cashflow/EBITDA for non-cyclical reasons and a restructuring appears unlikely
If multiples are particularly low, liquidation may maximise recoveries for lenders
The approach involves discounting the book value of balance sheet assets and summing the results
Account receivables, inventory, cash, fixed assets
Where available, market valuations of readily tradable assets (e.g. real estate) can form a base
Discount rates for each asset can be customised, e.g.
A/R according to quality of customers, historical bad debts
Inventory according to type and marketability
PP&E according to over-capacity issues in the sector, general state of investment, etc.
Cash assumed to be exhausted

29

Step 2: Estimating the Creditor Mass

Include all drawn debt according to seniority/priority
Include all undrawn but committed facilities assumes that revolving lines are drawn to support the business as it deteriorates
e.g. to replace trade payables as supplier credit shrinks
Letter of credit commitments assumed fully drawn to the extent permissible. Any debt (or contingent liability) supported by
letter of credit commitments (issued under the revolver) is implicitly included under the assumption of a full draw on the revolver
Some flexibility regarding treatment of undrawn facilities if rationale supports it
Committed capex lines are only available to fund capex (suggest drawing at 50%)
Committed acquisition lines are only available to fund acquisitions (suggest excluding undrawn portions)
Specific treatment of
Priority administrative claims 10% deduction from total distressed EV
Pensions Use the IFRS valuation as a starting point, seniority can vary by jurisdiction, see European Pensions Impact on
Corporate Recovery Ratings dated August 2011
Securitization/Factoring Treated as debt regardless of the accounting treatment, unless receivables are in a ring-fenced
structure and relate to a discontinued line of business. For specific approach, see Debt Factoring dated 6 February 2013

30

Step 3: Distribution of Value

The resulting EV from step 1 is distributed among the claims identified in step 2 according to a waterfall of priority
Value goes to satisfy the most senior claims first, with junior claims receiving only the surplus value thereafter
RRs subject to the soft country cap, detailed in country-specific treatment of recovery ratings, 28 April 2016, reflecting
The general ethos of the legal environment
Broad recovery expectations on the jurisdiction applying laws consistently and reliably
Countries are grouped based on creditor friendliness. The issues by issuers in countries in

Group A will be rated up to RR1

Group B will be rated up to RR2
Group C will be rated up to RR3
Group D will be rated up to RR4

31

Soft Country Cap/Jurisdictional Framework

Country groupings

Impact on
recovery ratings

Expected recovery ratinga

Includes

Jurisdictions that generally

The legal and political
RR1RR6 (recoveries given
UK, USA, Germany,
support the priority of claims on
environment provides no cap to
default range from outstanding
Netherlands, Australia, Japan
bankruptcy and display other
RRs. The most senior liabilities
to weak
features that are deemed to be
generally have sequentially
generally creditor-friendly,
higher ratings than junior
including generally reliable
obligations
enforceability

Jurisdictions where insolvency

and bankruptcy procedures
place less emphasis on the
priority of claims, and display
other features that are deemed
to be generally more debtorfriendly

Caps of RR2 for the most

senior obligations, potential
compression of some senior
and junior obligation ratings
reflecting the impact of
negotiated settlements

RR2-RR6 (recoveries given

default range from superior to
weak)

Austria, France, Italy, Spain,

Ireland, Belgium, Sweden, Hong
Kong

Recoveries for RR1:91-100%, RR2: 71-90%, RR3:51-70%, RR4:31-50%, RR5: 11-30% RR6: 0-10%
Source: Fitch

32

Soft Country Cap/Jurisdictional Framework (Cont.)

Country groupings

Impact on
recovery ratings

Expected recovery ratinga

Includes

RR3RR6 (recoveries given

default range from good to
weak)

Poland, Greece, Luxembourg,

China, Brazil

Jurisdictions where the letter of Caps of RR3 for the most

the law is balanced against
senior obligations, potential
governance indicators,
compression of some senior
suggesting that enforceability of
and junior obligation ratings
claims may be variable, for
reflecting the impact of
example, where enforceability
negotiated settlement
has yet to develop a
demonstrable track record

Jurisdictions where the law is

Caps of RR4 appropriate for
RR4RR6 (recoveries given
not supportive of creditor
the most senior obligations, and
default range from average to
rights, and/or where significant
little if any distinction made
weak)
volatility in the application of
between obligations based
legal enforceability of any claim
upon formal collateral. Most
materially limits the practical
junior obligations, nonetheless,
chances of recovery, or greatly
likely to still receive RR5 or
increases the volatility of
RR6 ratings
recovery prospects

Russia, Argentina, Turkey,

Ukraine, Saudi Arabia, UAE

Recoveries for RR1:91-100%, RR2: 71-90%, RR3:51-70%, RR4:31-50%, RR5: 11-30% RR6: 0-10%
Source: Fitch

33

Example of Going Concern Approach: Picard

Business profile

French frozen food manufacturer and retailer

Center of Main Interest (COMI) in France
Resilient like-for-like performance despite competition and challenging domestic consumer spending environment
Asset-light business model
EBITDA of EUR186m
Picard Bondco SAS (rated group): IDR of B

34

Example of Going Concern Approach: Picard (Cont.)

Step 1: Estimating the Distressed Enterprise Value (DEV)
Establishing the level of EBITDA upon which to base the valuation

Point of
distress

EUR 120m

Corrective
action
estimate

EUR 10m

Postrestructuring
EBITDA

Discount to
LTM EBITDA

About 30%
EUR 130m

35

Example of Going Concern Approach: Picard (Cont.)

Selecting the Distressed Multiple

Market
valuations

Transaction
multiples

Picards
relative
position

Distressed
multiple

Median market multiple is about 9x EV/EBITDA for non-distressed European food companies

In Europe, the median transaction multiple is 10x.

In the distressed food retail universe, the average historical multiple has been 5.5x

From an operational point of view, Picard performs better and has a stronger brand in its home
market than other European food retail companies

6.0x (versus 5.5x median for food retail peers)

36

Example of Going Concern Approach: Picard (Cont.)

Calculating the DEV

Postrestructuring
EBITDA

Distressed
multiple

6.0x

Admin
claims

10%

Distressed
EV

EUR130m

EUR704m

37

Example of Going Concern Approach: Picard (Cont.)

Step 2: Estimating the Creditor Mass
Capital structure includes senior secured RCF ranking pari passu with senior secured notes (FRN and fixed rate).
Senior notes are subordinated in the waterfall
Debt facilities/notes

Debt currently drawn (EURm)

Debt drawn at defaulta (EURm)

30

Senior secured notes

822

822

Senior secured debt

822

852

Senior notes

428

428

1,250

1,280

RCF

Total debt

Fitch assumption
Source: Fitch
a

38

Example of Going Concern Approach: Picard (Cont.)

Step 3: Distributing the Distressed EV through the Capital Structure
Amount
outstanding

Amount
recovered

Amount
remaining

Recovered
(%)

Recovery
rating

Notching
from IDR

30

25

82

RR2

+2 (BB-)

Senior secured notes

822

679

82

RR2

+2 (BB-)

Senior notes

428

428

RR6

-2 (CCC+)

(EURm)
Revolving credit facility

Cap at RR2 due to French jurisdiction resulting

in maximum +2 notching from the IDR

Source: Fitch

39

Example of Liquidation Approach: Voyage

Business profile

Independent provider of care services for people with acute learning disabilities in the UK (COMI)
The group owns a significant property portfolio
Fitch believes that creditors are likely to maximise recoveries in a liquidation scenario
Revenue of GBP203m, EBITDA of GBP44m
Voyage Bidco Limited (rated group): IDR of B

40

Example of Liquidation Approach: Voyage (Cont.)

Step 1: Estimating the Distressed Enterprise Value (EV)
Valuing the assets in distress
Market valuation of Voyages properties (GBP414m)
Typically, 50% discount rate applied to PP&E
However, Voyages properties are convertible into residential homes without significant refurbishment required
Unlikely to lose as much as 50% of value in distressed sale scenario
30% discount rate applied instead
Limited account receivables (GBP15m)
No inventory
Cash balance exhausted
Calculating the Distressed EV
GBP301m 10% (admin claims) = GBP271m

41

Example of Liquidation Approach: Voyage (Cont.)

Step 2: Estimating the Creditor Mass
Contractual considerations impacting the waterfall: RCF ranks super senior on enforcement proceeds.
Second lien notes are subordinated to senior secured notes
Debt facilities/notes

Amount currently drawn (GBPm)

Amount drawn at defaulta (GBPm)

Super senior RCF

45

Super senior secured debt

45

Senior secured notes

222

222

Senior secured debt

222

267

50

50

272

317

Second lien notes

Total debt

Fitch assumption
Source: Fitch
a

42

Example of Liquidation Approach: Voyage (Cont.)

Step 3: Distributing the Distressed EV through the Capital Structure
(GBPm)
Super senior RCF
Senior secured notes
Second lien notes

Amount
outstanding

Amount
recovered

Amount
remaining

Recovered
(%)

Recovery
rating

Notching
from IDR

45

45

100

RR1

+3 (BB)

222

222

100

RR1

+3 (BB)

50

46

RR6

-2 (CCC+)

Source: Fitch

43

Recovery Estimates for BB- and Above IDR

General Comments
The relatively long time before a potential default makes it difficult to compute sufficiently accurate recovery ratings at
investment grade (BBB- IDR and above) or high speculative grade (BB IDR category)
As a result, a generic approach is followed at these levels based on the nature of the underlying instrument
Instrument

Investment grade IDR

High spec. grade IDR (BB category)

Secured debt

Generally 1 notch uplift (2 notches for

specific sectors)

Up to 2 notches but capped at BBB-

Generally equal to IDR (average recoveries)

If low levels of senior secured debt, may be notched up

(1 notch)

Generic sector uplift of 1 notch for REITs and

network-based regulated utilities

If material presence of senior secured debta, may be notched

down (1 or 2 notches)

Unsecured debt

Generally 1 notch down adjustment

Subordinated debt

Presence of optional deferral feature may lead to 2

notch down adjustment

If material presence of senior secured debta, may be notched

down (1 or 2 notches)

Prior-ranking debt of 2x-2.5x EBITDA indicates high likelihood of subordination and lower recoveries for unsecured debt
Source: Fitch
a

44

Junior Debt: Holdco PIKs and Shareholder Loans

45

HoldCo PIKs and Shareholder Loans

46

Key Analytical Considerations

Should the instrument be considered debt of the Restricted Group? Does it increase the risk of default of the RG?
If so, we include the instrument in the RGs debt figures and adjust leverage and coverage ratios accordingly
Key components supporting exclusion
Structural subordination (ring-fencing) and contractual subordination (via inter-creditor agreement)
No cash interest payments (i.e. PIK for life)
Maturity date beyond the more senior instruments at the Restricted Group
Absence of security and guarantees from the Restricted Group
Absence of financial covenants
Absence of Event of Default
Inability to accelerate/enforce independently
Inability to transfer the instrument to non-shareholders
Small quantum in relation to overall debt (< 25-30% of total debt)
Decision process follows a pragmatic/case-by-case approach, taking the various features of the instrument into account

47

Summary Decision Tree

Holdco PIK and Shareholder Loan: Step 2

PIKs and Shareholder Loans are treated differently depending

on their collocation within the Group

Holdco PIK

Presence of Event of
Default Provisions?

For PIKs and Shareholder Loans at Opco level (i.e. inside the
Restricted Group) we apply the Treatment and Notching of
Hybrids in Non-financial Corporate and REIT Credit Analysis
For PIKs and Shareholder Loans outside the Opco level (i.e.
outside the Restricted Group) we apply the Treatment of
Junior Debt Corporate Debt in Europe European HoldCo
PIK and Shareholder Loans (dated 8 November 2013),
utilising the decision tree on the right of this slide

No

Non-Debt

Yes

Cross-default with the

Restricted Group with
immediate enforcement
rights

Yes

Debt

No

Maturity After the Debt at

the Restricted Group
Level?

No

If Maturity of the PIK Note is Less than

9 to 12 Months and Would Otherwise
have Been Treated as Equity, Rating
Watch Negative (RWN)

Yes

PIK for Life?

Yes

Non-Debt

No

Share Pledge Over

Restricted Group
(and/or other Guarantee
Over Restricted Group?

No

Non-Debt

Yes

Individual Enforcement/
Acceleration Rightsa and
Change of Control
provision at Restricted
Group Level?

No

Non-Debt

Yes

Interest Paid in Cash Only

if Does not Create a
Default at Restricted
Group level?

No

Debt

Yes

Size of PIK: <30% of Total

Debt; Restrictions on
Transferability?

Yes

Non-Debt

No

Debt
a

I.e. no individual enforcement right: if the PIK can only be accelerated in the event of HoldCo PIKs insolvency or if enforcement can only be exercised once all debt at the
Restricted Group level is repaid (provided that all debt at the Restricted Group level is not due and payable because of a Change of Control-type event)
Source: Fitch

48

Distressed Debt Exchanges (DDE) and Defaults

49

Ratings Definitions
Key Rating Issues in Restructurings
What constitutes a default or a restricted default?
Default (D): Bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure
Restricted default (RD): Uncured payment default on a bond, loan or other material financial obligation but no bankruptcy
Selective payment default on a specific class or currency of debt
Uncured expiry of any applicable grace period
Extension of multiple waivers or forbearance periods
Execution of a DDE on one or more material financial obligations
C: Exceptionally High Levels of Credit Risk: Default is imminent or inevitable, or the issuer is in standstill

50

DDE for Bonds and Loans

Key Rating Issues in Restructurings
What constitutes a distressed debt exchange (DDE)?
For Bonds
A DDE imposes a material reduction in terms compared to the original ones (e.g. one or a combination of the following):
Reduction in principal, interest or fees
Extension of maturity date
Change from cash-pay into PIK
Swapping debt for equity, hybrids or other instruments
Cash tender for less than par if acceptance is conditioned on a minimum aggregate amount being tendered or if
combined with a consent solicitation to amend restrictive covenants
Exchange offers or cash tenders that are accepted only if the tendering bondholder also consents to indenture
amendments that materially impair the position of holders that do not tender
AND is conducted to avoid bankruptcy/similar insolvency or a traditional payment default

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DDE for Bonds and Loans (Cont.)

For Loans
A material reduction in terms, by itself, is not sufficient for an amendment to a RCF or a term loan to be a DDE
This is because loans are more flexible than bonds and the frequency with which loans are amended makes it difficult to have a
categorical determination of a DDE for a loan
Therefore, while Fitchs DDE criteria may be applied to bank loan restructurings in a similar fashion to bond DDEs, it will also be
necessary to consider the issuers solvency, liquidity, and access to additional funding
Are Amend and Extend transactions treated as DDEs?
Unlikely, unless (e.g. one or a combination of the following)
Issuer has declared intention to file for bankruptcy if the A&E is not accepted
Reduction in terms coupled with a concurrent DDE bond exchange
Introduction of PIK interest
A debt for equity exchange
Significant reduction in terms coupled with an obvious/material deterioration in credit quality
Are below-par debt buybacks treated as DDEs?
Unlikely, unless the issuer threatens bankruptcy absent the exchange or Fitch believes the issuer cannot survive without the
exchange

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Rating Implications Pre Execution

On the announcement of a prospective debt exchange offer that Fitch determines to be a DDE, the IDR will likely be lowered to
C, indicating imminent default
In situations where the completion of the DDE is subject to uncertainty, a RWN classification may be used as an alternative to
lowering the IDR to C
For example, because of a minimum acceptance threshold may not be reached. Eg 75% threshold of a certain creditor class in the
UK schemes of arrangement cannot be achieved
A DDE proposal may target one or more debt issues within an issuers capital structure and certain debt issues are unaffected

In such cases, to reflect the likelihood of the impending default, the above mechanism of lowering the IDR to C will probably
take place but unaffected instrument ratings may stay at their existing rating levels and may be placed on Rating Watch
A Rating Watch Negative or Positive for the unaffected issues may reflect the potential ratings following the DDE, depending on
analytical visibility of the outcome at the time of this rating action

These unaffected instrument ratings may temporarily stretch the recovery uplifts beyond normal Recovery Ratings criteria,
but in order to not create ratings volatility, these instrument ratings can stay at the same rating level for up to 90 days
If the DDE is not executed within 90 days, Fitch will review the execution and timing of the DDE and the likelihood of the
unaffected instrument ratings maintaining their creditworthiness
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Rating Implications On Execution

On completion of the exchange, the IDR will be lowered to RD to record the default event
But unaffected instrument ratings will not change unless their creditworthiness changed as a result of the post-execution profile

54

Rating Implications Post Execution

Once sufficient information is available, the RD rating will be re-rated to reflect the appropriate IDR for the issuers postexchange capital structure, risk profile and prospects in accordance with relevant Fitch criteria
At the same time as the new IDR is assigned, all related issue ratings may be adjusted, including those that were not part of the
exchange, to ensure that all ratings are consistent with applicable notching guidelines in the relevant criteria
As these criteria will apply to a broad range of situations across a variety of sectors, it is difficult to define precisely the length of
time that the IDR will remain at RD before the new post-exchange IDR is assigned
However, it may occur contemporaneously (ie, the IDR is downgraded to RD and then upgraded to its new post-exchange level
on the same day and in a single Rating Action Commentary)

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Observations on Defaults
Key Considerations of Restructured Capital
For over-levered companies undergoing restructuring, Fitch has observed various approaches
Excess debt simply PIKd or PIYC
Excess debt converted to equity or written off
Excess debt converted to more deeply subordinated, PIK instruments
If debt converted to a more subordinated PIK instrument, then Fitch will treat this as debt, unless it can be
Treated as equity under our junior corporate debt/Holdco PIK loans considerations

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Disclaimer

Fitch Ratings credit ratings rely on factual information received from issuers and other sources.
Fitch Ratings cannot ensure that all such information will be accurate and complete. Further, ratings are inherently forward-looking, embody assumptions
and predictions that by their nature cannot be verified as facts, and can be affected by future events or conditions that were not anticipated at the time a
rating was issued or affirmed.
The information in this presentation is provided as is without any representation or warranty. A Fitch Ratings credit rating is an opinion as to the
creditworthiness of a security and does not address the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned. A Fitch
Ratings report is not a substitute for information provided to investors by the issuer and its agents in connection with a sale of securities.
Ratings may be changed or withdrawn at any time for any reason in the sole discretion of Fitch Ratings. The agency does not provide investment advice of
any sort. Ratings are not a recommendation to buy, sell, or hold any security.
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS AND THE
TERMS OF USE OF SUCH RATINGS AT WWW.FITCHRATINGS.COM.
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