Debt buybacks and exchanges are contentious propositions at the best of times. Present loan market trading levels make them very hard to resist for many heavily indebted entities. But rating agency treatment of these trades is having far-reaching consequences – not just for the corporates involved but for the loan market as a whole.
Critics are focusing on the treatment of distressed exchanges – or those from entities rated lower than single-B minus. The agencies treat a distressed exchange as a default, on the thesis that if it did not happen then bankruptcy would be imminent. The entity and exchanged bonds are downgraded to a defaulted rating. But many participants feel that the rating agencies are failing to reflect the circumstances that now prevail in the loan markets.
The logic behind dividing debt exchanges into distressed and opportunistic is clear, but analysts at CreditSights argue that while the treatment of distressed exchanges is appropriate for genuine out-of-court restructurings, it should not stand where voluntary exchanges and buybacks are being undertaken to reduce leverage but do not necessitate a default if they are rejected.
Clearly, any heavily indebted corporate that would be strengthened by buying back debt at a deeply discounted price will be put off if the result is a downgrade to default.