DBRS Downgrades Sears Canada MTN to BBB (low) on Refinement of Methodology

DBRS has today downgraded the Medium-Term Notes (MTN) rating of Sears Canada Inc. (Sears Canada or the Company) to BBB (low) from BBB. The Company’s Issuer Rating is unchanged at BB and all trends are Stable. Today’s rating action reflects a refinement of DBRS’s leveraged finance ratings methodology to limit the notching-up of ratings for the secured debt of high-yield issuers that are just below the investment-grade level and have a strong recovery rating. Under the revised policy, the result of any notch-up of the instrument rating for a high-yield issuer will be limited to an instrument rating of BBB (low), regardless of the level of the recovery rating that may have been assigned to the instrument (see the concurrent DBRS press release on the methodology changes for more details).

In assigning ratings to leveraged finance (i.e., high-yield) issues, DBRS first assigns an issuer rating that reflects the default risk of the issuer itself, then assigns separate recovery ratings and instrument ratings to the issuer’s specific debt instruments. The instrument rating is a blend of both the issuer rating and the recovery rating and, therefore, may be notched up from the issuer rating in cases where the recovery rating reflects above-average post-default recovery prospects. Likewise, the instrument rating may be notched down in cases where the recovery rating reflects diminished recovery prospects.

In Sears Canada’s case, the Company was originally assigned an issuer rating of BB. However, based on DBRS’s recovery analysis, expected recovery is 90% to 100% for the MTN holders in a post-default scenario. This level of recovery equates to a recovery rating of RR1 and an MTN rating of BBB, or three notches above the issuer rating (see the DBRS rating report dated September 19, 2008).

In reviewing our leveraged finance methodology, DBRS noted that as a company moves through the BB rating range and approaches investment grade, the likelihood of default is significantly less; therefore, DBRS felt it appropriate to restrict the beneficial impact of the recovery rating on the final instrument rating outcome. Thus, the effect of this policy refinement is to lessen the weighting of recovery on the instrument ratings of non-investment-grade credits that are on the cusp of becoming investment grade.

The revised leveraged finance methodology has therefore capped Sears Canada’s MTN rating at BBB (low), two notches above the issuer rating. DBRS notes that our recovery analysis has not changed and the RR1 recovery rating still applies to the MTN. DBRS notes that because this change reflects a change in methodology, it is considered technical in nature and in no way reflects any change of DBRS opinion on the credit quality of Sears Canada.

Notes:
The applicable methodologies are Rating Merchandisers and DBRS Rating Methodology for Leveraged Finance, which can be found on the DBRS website under Methodologies.

This is a Corporate rating.