Stung by their indirect responsibility for such spectacular meltdowns as Enron Corp. and Pacific Gas & Electric Co., credit-rating firms are taking a closer look at how corporate credit agreements employ rating triggers. Most vocal has been Moody's Investors Service. It warns that such triggers--particularly those setting off accelerated debt repayment, or "puts" in backup credit lines when there's a downgrade--can rapidly push already shaky borrowers into bankruptcy. "The result is mutual assured destruction" for borrower and creditor, says Moody's senior vice president Pamela Stumpp.
At PG&E, "rating triggers created a tangled web of cross defaults," she notes. A downgrade allowed banks to stop funding the utility's commercial paper, which, when unpaid, triggered defaults on floating-rate notes, unsecured senior notes, pollution-control bonds, and medium-term notes. The California Power Exchange also demanded collateral for all power trades. The utility filed for bankruptcy, turning commercial-paper holders into unsecured claim holders.
From now on, says a report written by Stumpp, "we will incorporate the serious negative consequences of those triggers in our ratings and in our research"--meaning that Moody's will evaluate whether a company can survive a downgrade. "We are going to assume the triggers are triggered. The issuer has to have the wherewithal to repay the resulting debt obligations to survive the consequences of the trigger and meet debt-service obligations without relying on the backup line," she explains.
Standard & Poor's Corp.'s Solomon B. Samson agrees with Moody's assessment of the dangers, but says his agency is taking a more cautious approach. For example, if a company with a long-standing BBB- rating (the lowest investment grade) decides to adopt financing that includes triggers, a downgrade would instantly set the triggers off. "Then we're not providing information about the risk, we're just blowing it away," says Samson, calling that result "a paradox."
S&P is surveying all investment-grade corporate clients about the use of triggers, and will issue its findings as soon as possible. In the meantime, says Samson, "people might start taking triggers out."
Indeed, Houston-based El Paso Corp. has already responded to Moody's stepped-up scrutiny, announcing that it plans to "eliminate or renegotiate the ratings triggers" in certain financings.