To drive down the cost of borrowing, bankers have begun using bank loan ratings rather than corporate debt ratings to determine the price of some loans.
Industry observers said the use of bank loan ratings to help determine spreads is almost certain to grow, because bank loans tend to get higher ratings than corporate debt.
"The highest rating that a company is going to have in 99 out of 100 instances is going to be the senior secured rating," said Ronald Buck, an analyst with Standard & Poor's.
A case in point is an $850 million credit for Oklahoma City-based Fleming Cos., a grocery wholesaler, which got a BB-plus rating from S&P, one notch higher than the company's BB corporate credit rating. The Fleming loan's pricing was tied to its loan rating.
The agency said the rating reflected "the strength of the collateral and the protection afforded by a comprehensive set of covenants." The loan was led by Chase Manhattan Corp., BankAmerica Corp., and Societe Generale.
"It seemed reasonable to many CFOs and their bankers that the bank loan pricing grid should reflect the rating on the loan, not the rating on the company, so more loans are being priced on that basis," said Steven Bavaria, head of the loan product group at S&P.
"The effect is to reward those borrowers that agree to more stringent security features, which better protect their lenders and result in an upgrade in their bank loan rating," he said.
Using a bank loan rating instead of a senior unsecured or other rating benefits borrowers with loans that are rated higher, due primarily to a loan's structure, financial covenants, and collateral agreements.
In another deal, a $225 million refinancing led by J.P. Morgan & Co. for Bethlehem Steel Corp., pricing was also tied to the loan's ratings, which came from Moody's Investors Service and Standard & Poor's.
Moody's rated the Bethlehem Steel loan Ba3, two notches above the company's corporate debt rating of B1.
Unlike Fitch Investors Service and S&P, Moody's rates loans whether or not the company requests it.
On J.P. Morgan's suggestion, Bethlehem also obtained a rating from S&P- of BB, two notches higher than the company's B-plus corporate credit rating.
S&P cited the loan's conservative advance rate-the amount the company can draw down from the loan versus the value of Bethlehem Steel's inventory-as well as the loan's covenants and the highly liquid collateral backing it as reasons for rating it above the company's corporate debt.
Pricing is tied to whichever of the two loan ratings is lower, according to a lender in Bethlehem's bank group.
"It's a highly secured, structured loan, so it just really didn't make sense to price it off a senior unsecured rating when the structure is so different from what that (rating is) really looking at," the lender said.
Tying loan pricing to ratings would not normally make sense for riskier leveraged credits, which often tie pricing to financial performance ratios such as the borrower's ratio of debt to earnings.
One danger in tying loan pricing to bank loan ratings, said a lender familiar with the practice, is that ratings are a trailing variable that may not be kept as up-to-date as a financial ratio.
"They tend to get stale," said the lender.
