OREANDA-NEWS. S&P Global Ratings today assigned its 'B+' issue rating to the proposed senior secured payment-in-kind (PIK) toggle notes to be issued by Schaeffler Verwaltung Zwei GmbH, a company holding 75% of Schaeffler AG (BB/Stable/--) and 36% in Continental AG (BBB+/Stable/A-2). Schaeffler proposes a total issuance of about €2.5 billion, including a mix of U. S. dollar - and euro-denominated instruments with various maturities ranging from five to 10 years. The recovery rating on these debt instruments is '6', indicating that we expect recovery prospects in the event of default to be negligible, in the 0%-10% range.

Our recovery expectations are constrained by the structural and contractual subordination of the proposed bonds to Schaeffler AG's debt instruments. The proposed PIK toggle notes will be secured by pledges over shares in Schaeffler AG and in Continental AG, but will not benefit from any subsidiary guarantees.

We expect Schaeffler Verwaltung Zwei GmbH to change its name to IHO Verwaltungs GmbH. Renaming will become effective in September or October 2016, subject to entry in the commercial register, but in this report we refer to Schaeffler Verwaltung Zwei (SVZ).

We expect that SVZ will use the proceeds of the proposed notes, along with proceeds from a new senior facility agreement, for the following purposes: To redeem about €1.7 billion outstanding under the existing junior PIK debt instruments at Schaeffler Holding Finance B. V., To refinance the existing €600 million term loan at Schaeffler Verwaltungs GmbH, To partially repay about €674 million under intercompany loans held by Schaeffler AG, andTo pay early redemption premiums and transaction costs. We will withdraw the ratings on the outstanding Schaeffler Holding Finance B. V. debt instruments once they have been redeemed in full. In the meantime, we have affirmed our 'B+' issue ratings on the existing bonds.

At the same time, SVZ is also refinancing the existing senior loan facilities at the holding level. The new facilities will be secured by the same collateral that secures the proposed notes, on a pari passu basis. The new loan agreement, similar to the new bonds' documentation, includes less restrictive covenants for the holding restricted group and clearly defines the operating companies, Schaeffler AG and its subsidiaries, as "unrestricted subsidiaries." These subsidiaries will not provide any collateral or guarantee to the benefit of the notes or the facilities, and will not be subject to the covenants under SVZ's debt documentation. There will be no cross-default between SVZ's debt instruments and Schaeffler AG's bonds and facilities.

The proposed bonds' documentation includes a PIK toggle option, which allows the company to capitalize interest if liquidity falls below a certain level. We assume that the company would most likely use this option in a default scenario, due to liquidity constraints, but that it would pay interest on the bonds in cash until our hypothetical default in 2021.

We do not include in our recovery analysis Schaeffler's 46% equity interest in Continental, of which 36% is directly held by issuing entity SVZ. This is because we regard the value of this investment as volatile.

The 'BB' issue ratings and '3' recovery ratings on Schaeffler AG's senior secured bonds--remain unchanged, as well as the 'B+' issue rating and '6' recovery rating on Schaeffler Finance B. V.'s €500 million senior unsecured notes due 2019. We have not included in our analysis the potential partial redemption--about $850 million--of some of Schaeffler AG's senior secured bonds with proceeds from the partial repayment of the intercompany loans mentioned above, but we do not expect any significant change in our recovery ratings on Schaeffler AG's senior secured debt if this bond redemption happens. See our recent publication "German Auto Supplier Schaeffler Debt Ratings Affirmed Following Partial Refinancing," published July 25, 2016.

The 'BB' corporate credit rating on Schaeffler AG is based on our assessment of the group's satisfactory business risk profile and aggressive financial risk profile. The outlook is stable. For our corporate credit rating rationale, see "German Auto Supplier Schaeffler Upgraded To 'BB' On Further Deleveraging; Outlook Stable," published April 28, 2016, and "Schaeffler AG," published June 24, 2016, both on RatingsDirect. SIMULATED DEFAULT ASSUMPTIONSYear of default: 2021EBITDA at emergence: €838 millionImplied enterprise value multiple: 6.0xJurisdiction: Germany SIMPLIFIED WATERFALLGross enterprise value at default: €5.03 billionAdministrative costs: €352 millionNet value available to creditors: €4.7 billion-------------------------------------------------------Priority claims: €1.1 billionSecured debt claims: €6.2 billion*--Recovery expectations: 50%-70% (lower half of range)Senior unsecured debt claims: €508 million*--Recovery expectation: 0%-10%Subordinated debt claims: €3.2 billion*--Recovery expectations: 0%-10% *All debt amounts include six months of prepetition interest.