Fitch launches new rating criteria in response to rising number of distressed debt exchanges

By Angela McDaniels

Seattle, April 10 - Fitch Ratings announced new standards for examining distressed debt exchanges saying they have become too significant to ignore.

While bankruptcy filings encompass the vast majority of defaults, the incidence of distressed exchanges - when an issuer is essentially forced to restructure its debt in order to avoid bankruptcy or a liquidity crunch - has grown, the rating agency said.

"Though junior creditors ordinarily bear the brunt of any loss, senior creditors can be highly adversely affected in a distressed debt exchange as well," Fitch senior director James Batterman said in an agency release.

"The nature of a distressed debt exchange is considerably different from other types of defaults, and therefore some special handling is called for, particularly as ratings are prospective in nature."

Fitch said that it will lower a company's issuer default rating, Fitch's benchmark probability of default, to C if it considers an exchange offer as a distressed exchange.

If the distressed debt exchange executes successfully, the rating will be lowered to D or RD, as appropriate, before immediately being raised to a rating appropriate for its prospects on a forward-going basis.

"This ensures that the default is registered for the market at large and within our statistical tracking of defaults," Fitch managing director Richard Hunter said in the release.

Batterman noted that the determination of whether or not a proposed exchange should be considered a distressed debt exchange is at times "very subjective, requiring Fitch to examine whether or not bondholders realistically have any alternative, apart from a bankruptcy filing, to participating in the exchange."

The agency said its research showed that 5% to 10% of all corporate bond defaults in the United States in recent years have taken the form of a distressed debt exchange.

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