S&P to increase focus on recovery prospects in analyzing second lien debt, report says

By Sara Rosenberg

New York, March 17 - Standard & Poor's said it is introducing a new way to analyze second lien debt by increasing the focus on absolute recovery prospects and introducing recovery ratings.

The changes compare to the previous method of focusing primarily on the extent of the disadvantage of second-lien debt creditors, according to a new report, Analyzing North American Bank Loans Collateralized With Second Liens, published by S&P on Wednesday.

The bank loan rating for second-lien debt can range from being notched above the corporate credit rating, to the same as the corporate credit rating, to below the corporate credit rating by one or two notches.

"It is necessary to be particularly mindful of the correlation between recovery ratings and conventional bank loan ratings," said Solomon Samson, S&P managing director, in the report. "For example, it would be inconsistent to assign a recovery rating indicating 100% recovery, and have a conventional rating that is notched down."

More specifically, under the new methodology analysts should compute coverage levels for the first-lien debt and then compute the coverage for the aggregate of first- and second-lien debt, according to the report.

However, being that the second lien debt is not as well protected as the aggregate numbers would suggest, given the priority of the first-lien debt, first- and second-lien debt should not be rated the same for conventional ratings that are above the corporate credit rating, the report added.

It is acceptable to have the same recovery ratings due to the range of outcomes represented by those ratings.

So, for example, if the first-lien debt is two notches above the corporate credit rating, the second-lien debt can be as high as one notch above, assuming that it too would recover 100%. The recovery ratings would be 1 for both.

If the first-lien debt is one notch above the corporate credit rating, the second-lien debt can be the same as the corporate credit rating assuming 80% recovery. The recovery ratings would be 1 for the first-lien debt and 2 for the second-lien debt.

In cases where the first-lien debt is rated at the same level as the corporate credit rating, the second-lien debt can be rated at that level or it could be rated lower, depending on the fact pattern. If the first-lien debt is relatively small in comparison to the assets of the company, the disadvantage it poses to the second-lien debt is below S&P's typical threshold levels, the report explained. And, if the amount of the second lien-debt also is small relative to the corporate assets, that could translate into recovery ratings of 2 for both the first- and second-lien debt.

Normally, however, the second-lien debt recovery prospects would be viewed as worse since it comes behind the priority debt or it lacks valuable collateral in the first place, the report continued. Then it could be rated one or more notches behind the first-lien debt. If the analysis gives it a recovery rating of 3, then the bank loan rating presumably would be at least one notch down.

If the recovery rating is 4, then the bank loan rating normally would be two notches below the corporate credit rating, the report concluded.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.