Issuers and other market participants often ask S&P Global Ratings about the methodology and assumptions we apply when determining whether a debt restructuring transaction constitutes a selective default ('SD'). We detail our approach to these transactions in "S&P Global Ratings Definitions," primarily in the section titled "Distressed Debt Restructuring And Issue Credit Ratings."

When companies employ preventive measures to stave off a pending, if not imminent, conventional default, we may reach the conclusion that such measures are tantamount to a default, as we define it. Our determination is based on both of these two conditions being met:

• We believe that the debt restructuring implies the investor will receive less than the original promise on the securities (without adequate compensation); and
• We believe that if the debt restructuring doesn't happen, there is a realistic possibility of a conventional default (the issuer could file for bankruptcy, become insolvent, or miss an interest or principal payment) over the near to medium term.

The questions below highlight our key considerations when assessing these matters, which only apply to restructurings completed before a payment is missed. If the issuer fails to make a payment and then negotiates with its creditors, we'd consider the missed payment a default regardless of the outcome of the negotiations.

FREQUENTLY ASKED QUESTIONS

What does S&P Global Ratings consider to be a restructuring?

By "restructuring," we mean any modification of the original payment terms of a debt agreement, including debt exchanges, maturity extensions, tender offers, and secondary market purchases under certain conditions. We wouldn't view changes to non-payment terms--such as a covenant waiver--to be a restructuring.

How does S&P Global Ratings define "less than the original promise?"

We would consider an offer as providing less than the original promise if one or more of the following happens without adequate offsetting compensation:

• The price offered is below par value;
• The interest rate is lower than the original yield;
• The new debt's maturity extends beyond the original;
• The timing of payments is slowed (such as to zero-coupon from quarterly paying, to bullet from amortizing, or payment-in-kind [PIK] versus cash payment); or
• The priority of repayment, access to collateral, or value of collateral is lowered.

How does S&P Global Ratings define "adequate compensation?"

We consider an exchange offer to have provided adequate offsetting compensation when the current assessed market value of the compensation approximates the accreted value of the original debt (par and any accrued interest), regardless of whether the offer is in cash, securities, or common equity. However, the value of common equity for companies in financial distress can often be close to zero.

Elements of an offering we'd consider include:

• The value of fees received (or to be received);
• The value of a higher interest rate.

We do not generally view tighter covenants, a higher priority ranking, or early repayment as offsetting compensation. However, when interest rates are higher than at the time of original issuance, we would look to compare the exchange offer with what we believe an issuer with a similar risk profile would have to pay to raise new capital at the time of the transaction. In these cases, adequate compensation implies a significantly higher interest margin than the original issue.

How does S&P Global Ratings determine whether an issuer faces a realistic possibility of a conventional default?

The issuer credit rating (or, in some cases, the stand-alone credit profile; SACP) is a relevant guideline but is taken into consideration with other factors, such as:

Cash flows and liquidity:  We look at our expectations for the company's cash flows and liquidity over the next 12-24 months to assess whether the company can make its interest and principal payments. An important factor, especially at the 'B-' rating level, is whether the company can generate positive free operating cash flow under its existing capital structure and organically reduce leverage over time. We don't typically give credit for asset sale proceeds unless there's a signed agreement.

Time to maturity:  The restructuring of a debt instrument maturing shortly (for example, within the next 12 months) is more likely a sign of distress than an instrument maturing several years out.

Market indicators:  The trading prices of the debt securities, the offering prices, or both can also provide some insight about the characterization of the debt restructuring. We would compare actual or implied yields to the yields on similarly rated entities and those within the same sector to assess the market's view of the company's financial condition. This also helps support our view on whether the entity would be able to successfully refinance or attract new capital at the offer price.

Underlying rationale:  Is the company trying to avoid a conventional default, avoid a covenant breach that could lead to a default, or buy time for a more fulsome restructuring? Any of those would likely signal distress.

Why can debt restructuring transactions that are financially beneficial to the issuer or completed with the willing participation of debtholders still be viewed as equivalent to a default?

Distressed debt restructurings often improve the company's capital structure and liquidity position. In below-par debt-repurchase transactions, the company's resulting debt burden would be lower because of the discount, while transactions involving the introduction of PIK interest or maturity extensions result in an improvement in the company's near-term liquidity. However, this is also true of bankruptcy proceedings, a process that relieves an entity of its previous financial burdens. Accordingly, we consider failure to pay in accordance with the initial terms of the obligation to be a default, unless we believe the lenders are being provided adequate offsetting compensation.

Upon completion of the distressed debt transaction, we re-evaluate the company's creditworthiness based on the updated liquidity position and capital structure. When the restructuring has had a material positive impact on credit quality, this could lead to higher ratings than those prior to the debt restructuring.

How does S&P Global Ratings define "materiality" in a restructuring transaction?

How much of the original par amount that gets restructured doesn't directly matter because even very small amounts may be deemed a selective default, just as if a company misses a minimal payment amount. However, if a transaction involves only a minimal outstanding amount--typically less than 1 basis point (bp) of the security being exchanged--we wouldn't characterize that as a restructuring.

It's important to note that while we would consider any modification above 1 bp to be a restructuring, we would only consider a restructuring as a default if the issuer were distressed and the investors received less than the original value.

When are below-par secondary market purchases considered a default?

We don't typically treat below-par debt repurchases in the secondary market as a restructuring unless either of the following two conditions are present:

• We believe there is direct or indirect negotiation with the sellers, such as a tender offer or similar mechanism; or
• A significant portion of the debt issue is repurchased.

In those cases, we treat the repurchases as a restructuring and assess whether the offer is distressed or opportunistic and if there is adequate offsetting compensation.

We've updated our ratings definitions to remove the language stipulating that below-par debt repurchases by an issuer have to be done anonymously to not be viewed as a selective default. Now, as long as there is neither a direct nor indirect negotiation with the seller, and the amount being repurchased is not significant, below-par secondary market repurchases won't be considered a selective default.

Can restructuring a revolving credit facility be considered a selective default?

We could consider a restructuring of a revolver as tantamount to default only if the revolver is drawn at the time of the restructuring agreement. If a revolver is undrawn, there is no debt to default on. As with all selective defaults, we must view the entity as being distressed (facing the realistic probability of a conventional default over the near to medium term) and the transaction to be providing less than the original promise on the facility without adequate offsetting compensation.

How does S&P Global Ratings treat priming transactions, amend and extend (A&Es), and forbearance agreements?

Priming transactions typically occur when an entity issues new debt in a super-priority position that will prime (rank higher than) existing senior secured debt. These new tranches will receive super-priority status on collateral, pushing down existing debt to a less-favorable position.

If the issuance of senior priority debt was prohibited by the terms and conditions of the existing secured debt, then we would treat the priming transaction as a restructuring, consider whether the offer is distressed or opportunistic, and evaluate any offsetting compensation to determine if the transaction is a default. (For examples, see "A Closer Look At How Uptier Priming Loan Exchanges Leave Excluded Lenders Behind," June 15, 2021.)

If the issuance of senior priority debt wasn't prohibited by the terms and conditions of the existing secured debt, then there would be no immediate issuer credit rating impact. However, the change in ranking could very well alter the recovery rating and thus the issue-level rating on the debt that has been primed.

Typically, unsecured debt doesn't have terms and conditions prohibiting the issuance of higher-priority debt. Therefore, we generally don't view priming of unsecured debt as tantamount to a default, absent other factors.

A&E transactions:  These transactions occur when existing lenders are asked to alter the terms of their original agreement in exchange for a maturity extension. Often, for an A&E to be executed, there will be a minimum threshold of lenders required to approve the changes.

By definition, an A&E extends the maturity of a debt instrument, thereby altering the timing of the final payment. As a result, we view it as a restructuring. We would then evaluate whether the A&E is distressed or opportunistic. Healthy borrowers routinely amend and extend debt instruments as a normal course of business, which we would not view as a selective default. However, if we view the issuer as distressed for the reasons highlighted earlier, we would then assess whether the lenders are receiving adequate compensation for the extension--typically through amendment fees or a higher interest rate commensurate with current market rates for issuers with a similar risk profile.

Forbearance/standstill agreements:  We view a standstill or forbearance agreement that refers to payment obligations--and which is completed before a payment is missed--as a restructuring. As with any restructuring, we would look at whether the issuer is in distress and whether the agreement provides sufficient compensation to the lenders for the payment deferral. The consent fees, higher interest cost, and other compensation must be sufficient to make the agreement's compensation comparable to the originally promised payment terms. If we view the proposed agreement as distressed, we would lower the ratings to 'D/SD' when the agreement is signed or the default is formalized. We wouldn't wait for the payment to be missed.

If a payment is missed and then the forbearance agreement is negotiated, we would view that as a post-default negotiation and not as a restructuring. Likewise, we wouldn't consider a standstill or forbearance on a condition not related to payments (a covenant waiver) to be a restructuring or default.

Related Research

• S&P Global Ratings Definitions, updated from time to time
• A Closer Look At How Uptier Priming Loan Exchanges Leave Excluded Lenders Behind, June 15, 2021
• Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012