DBRS Releases Leveraged Finance Rating Methodology; Introduces Recovery Rating Scale

DBRS has today unveiled its new Leveraged Finance rating methodology, which will be applied in rating all speculative-grade corporate debt going forward. DBRS uses its traditional credit ratings, plus its newly introduced recovery ratings, to capture an issuer’s risk of default as well as the impact of default on that issuer’s various debt classes. Full details are available in the report, “DBRS Rating Methodology for Leveraged Finance,” available on DBRS’s website, www.dbrs.com or by email from any of the contacts listed below.

“Our firm has been planning a major push into the North American leveraged finance market for some time,” says Peter Bethlenfalvy, DBRS Group Managing Director and head of global corporate ratings. “That’s why we went out last year and recruited Steve Bavaria, who previously created loan and recovery ratings and introduced them to the leveraged finance market during his 15 years at Standard & Poor’s.”

“Credit ratings have become well established in the leveraged loan, high-yield bond and private placement markets,” Mr. Bethlenfalvy says. “Now with defaults starting to rise and investors more credit-sensitive than ever as a result of recent events, we believe our clients and constituents will see value in DBRS’s ratings, insights and analysis in the leveraged sector, as they have for many years in other credit markets.”

“Credit analysis is basically the same as you move up and down the credit spectrum,” says Mr. Bavaria, who is DBRS’s Managing Director of Leveraged Finance, “but the nature of the risk being analyzed changes dramatically as we go from investment grade down into speculative grade or ‘leveraged finance’.” Mr. Bavaria notes that almost three-quarters of all rated companies in North America are speculative grade, with over half of those in the lower single-B category. “Single-B rated companies have historically been highly default-prone,” he added, “with close to one-third defaulting over the term of a typical leveraged loan or high-yield bond.”

As a result of this, leveraged investors approach credit analysis and monitoring of these issuers as a more “dynamic exercise,” Mr. Bavaria adds. He says this includes “not only maintaining an intensely close watch on the issuer’s basic credit fundamentals,” but also “preparing for the worst” in structuring leveraged credits with appropriate precautions built in such as covenants, collateral and other protections uncommon in the investment-grade world.

“Professional lenders and investors have always known this,” Mr. Bavaria says, “but the hyper-liquidity and easy credit standards of the past few years – now long gone – dulled the collective senses of the market. Investors have told us they would welcome another rating opinion on future deals, especially one that captures the various elements of the credit risk – default and the potential for loss and recovery in the event of default – and expresses them clearly.”

DBRS’s new recovery rating scale will complement its traditional ratings. Issuers will continue to be assigned an issuer rating, on the traditional letter-based scale, which focuses on the risk of default in timely payments of the issuer’s obligations. The new recovery ratings will focus on the expected recovery that a particular instrument’s holders may expect to receive if the issuer defaults. Recovery ratings will be on a 1 to 6 scale, with 1 representing ‘outstanding’ recovery and the lowest rating of 6 denoting ‘poor’ recovery. Each instrument will also be assigned a traditional letter-based rating, which may be above, below, or the same as, its issuer rating, depending on the recovery prospects of that particular instrument as reflected in its recovery rating. (Please refer to the full report for complete details.)

DBRS is an international rating agency headquartered in Toronto, providing timely and comprehensive rating opinions to the world’s capital markets. Privately owned and independent, DBRS offers in-depth credit analysis of corporate, financial institution and government issues in North America, Europe, Asia and Latin America, with ratings on over 1,650 issuers and 48,000 active instruments worldwide.