Fitch: Differentiating European Leveraged Issuers at 'B+' and Below Ratings
OREANDA-NEWS. Fitch Ratings says European leveraged corporate issuers in the lower speculative grade (B+ and below) differentiate themselves by the strength of their business profiles, governance, financial performance and liquidity. These factors shift in relative importance as credits move along the rating scale.
Most credits at these rating levels have fundamental weaknesses in either their business or financial profile. While point-in-time leverage and debt service ratios represent useful indicators of relative credit standing, financial metrics alone do not decide rating outcomes. Analysis of sector- and company-specific factors enables clear distinctions.
Sector-specific fundamentals such as barriers to entry, capital intensity, earnings and cash flow volatility remain key to rating differentiation. In this report, Fitch provides additional granularity to its sector-specific Ratings Navigators for understanding of key rating drivers for credits at the lower end of the rating scale.
Company-specific considerations such as relative scale, business strategy, financial policy and balance sheets are taken into account in the context of sector-specific factors to determine a credit's ability to generate operating cash flow as the principal driver of medium-term de-leveraging.
However, factors have relative importance. The principal qualitative factors distinguishing 'B+'/ 'B' ratings from 'B-' are confidence in the business model and the resilience of cash flow, and the ability to deleverage given an aggressive capital structure. Conversely, high refinancing risk and weak liquidity would inevitably shift the rating discussion towards 'B-' or 'CCC' regardless of strength in the business model or strategy.
Factors supporting an IDR of 'B+' rather than 'B' include a comparatively more robust business model, lower execution risk in strategy implementation, positive free cash flow (FCF) generation through the cycle, a clear and committed deleveraging path suggesting limited refinancing risk even in stressed capital market conditions, and a comfortable liquidity position.
Fitch rates according to its own independent forecasts, which attempt to take into account reasonable assumptions on business model, execution of strategy and competitive positioning of a credit within its sector through the cycle. Pre-set guidance on specific qualitative and quantitative benchmarks indicate positive or negative rating actions if credits outperform or underperform Fitch's rating case.
Many banks in Europe are restricted from underwriting 'B-' credits, while they face fewer restrictions on 'B' or above. In addition, collateralised loan obligation (CLO) managers and many bond funds have limits on exposures to 'CCC' or below categories and are therefore sensitive to credits with 'B-' ratings that may migrate lower.
Leveraged buyouts of various sizes, defaulted and restructured credits, dividend-related recapitalisations, asset-specific or project-related venture financings, direct lending and highly leveraged mid-market credits represent the principal sources of new issuance in the rapidly evolving highly-speculative 'B+' and below cohort of the European leveraged finance market.
Fitch rates around 400 'B+' and below European high yield bond and loan market issuers and also provides Recovery Ratings on all issuers with Issuer Default Ratings (IDRs) or Credit Opinions (IDCOs) at 'B+' and below. Recovery Ratings drive notching differentiation on instruments for highly speculative issuers with complex capital structures.
The report, "Differentiating Credits Rated 'B+' and Below" updates and expands key themes previously developed in 'EMEA Corporates: Differentiating 'B'/'B-' and 'B-'/'CCC'' dated November 2014. It focuses on sector-specific and issuer-specific quantitative and qualitative factors that drive notching distinctions in public IDRs and private (primarily loan market) IDCOs. It also includes detailed case studies in the European food retail, non-food retail and telecom sectors.