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Loan Amendments for Middle-Market Borrowers Without Adequate Compensation May Result in a D Rating

DBRS Morningstar published a commentary on the impact the Coronavirus Disease (COVID-19) pandemic has had on middle-market borrowers, specifically focusing on the types of loan amendments that have become prevalent in middle-market loan agreements largely in order to address a borrower's actual or anticipated default outside of a formal court-mandated restructuring process. Even where the amendments are consensual between the borrower and the lender, if DBRS Morningstar believes the economics of the loan have been eroded by the amendment, DBRS Morningstar may deem the changes to have been analogous to a formal restructuring, warranting the assignment of a D rating to the affected securities. The commentary discusses the factors DBRS Morningstar takes into account in its determination of whether a D rating is warranted, such as the materiality of the loan amendment itself relative to the terms of the original loan and whether the lender has been offered adequate compensation that reasonably offsets the eroded economics of the loan.

Key highlights include the following:

-- Amendments that are administrative or short-term in nature and that cause no material change to the overall economics of the original loan transaction are typically viewed as nonmaterial. While the facts and circumstances leading to a nonmaterial amendment may sometimes require DBRS Morningstar to consider a rating action, these types of amendments in isolation do not erode the economics of the loan and therefore are unlikely to warrant a negative rating action.
-- In contrast, amendments viewed as eroding the overall economics of the original loan transaction will typically be considered material by DBRS Morningstar and have the potential to be much more significant to the borrower’s credit rating(s). This is true even if the lender agrees to the amendment and the legal default has been avoided.
-- The presence of compensation provided by the borrower to its lender for consenting to material loan amendments may influence how DBRS Morningstar treats the subject amendment. If the compensation is considered adequate in relation to the material amendment being sought such that the terms offered put the lender in a substantially similar or better position when compared with the original transaction, a D rating is not likely (although events and circumstances triggering the need for the rating action may still warrant a negative rating action).

“Ultimately, the decision to assign a D rating following a material loan amendment is typically not triggered by detailed calculations but rather by a judgment call informed by the nature and scope of the amendments and the indemnification offered to the lender, if any,” said Arthi Sambasivan, Senior Vice President, Legal Counsel, Global Corporates.