The benign credit conditions before the COVID-19 pandemic coupled with prolonged low interest rates encouraged investors to pursue a variety of alternative assets for higher returns. Middle-market loans were among asset classes with increased investor interest as direct lenders used collateralized loan obligations (CLO) to fund these investments.

Before the pandemic, default rates were low for middle-market entities, like their broadly syndicated counterparts (see "Middle Market Loan Performance: A Decade In Review", published Sept. 11, 2017). In addition to richer spreads on these loans compared to larger institutional loans, recent surveys show middle-market loans have better documentation than larger counterparts that collateralize broadly syndicated-loan CLOs. Middle-market CLOs also tend to have more tranche subordination than broadly syndicated CLOs. For middle-market loans, however, there is significant reliance on CLO managers and their ability to select assets as investors typically don't have visibility into the underlying entities in their middle-market CLOs.

Based on S&P Global's Leveraged Commentary Data, we rated six U.S. middle-market CLOs in 2016. That more than quadrupled to 27 in 2019 (Chart 1).

Chart 1

This growth increased the number of credit estimates S&P Global Ratings has reviewed and assigned. With increased interest in middle-market CLOs and U.S. credit estimates, we are updating these frequently asked questions on what credit estimates are, how they differ from credit ratings, and the informational and other process requirements for us to assign them.

Frequently Asked Questions

What are credit estimates and private credit analyses?

A credit estimate is a point-in-time, confidential indication of our likely rating on an unrated entity or instrument. Corporate credit estimates are primarily used in our analysis of middle-market CLOs. Credit estimates may also be used to arrive at ratings for other structured finance products or other internal purposes.

A private credit analysis (PCA) is also a confidential indication of our likely credit rating on an unrated entity or issuance and also primarily used in our analysis of middle-market CLOs. For more on the difference, see "S&P Global Revises Global Debt Issuance Limits For Credit Estimates And Private Credit Analysis", published March 6, 2020. Given the nonanalytical nature of the difference, any reference to a credit estimate here also applies to a PCA.

How do S&P Global Ratings' credit estimates/PCAs differ from credit ratings?

It is important to note a credit estimate is not a rating. It is a point-in-time credit view based on an abbreviated analysis and, generally, does not include all aspects of a credit rating. For these and other reasons, a credit estimate does not constitute a rating and cannot be substituted for one. Credit estimates do not have CreditWatch placements or outlooks.

While credit estimates share the same scale as a credit rating, they are denoted in lower case ('aaa', 'aa', 'bbb', 'bb', 'b', 'ccc', 'cc', 'sd', and 'd', generally with plus and minus modifiers). They usually do not involve direct contact with the issuer/obligor's management or in-depth insight into operating, financial, or strategic issues that such contact allows. They are typically based on information provided by the requesting party, together with information from third-party sources we consider reliable. Almost all third-party credit estimates are done at the behest of, typically, a CLO manager and based on information provided by such parties. While we may update a credit estimate within 12 months, there is no ongoing surveillance in a general sense. Further credit estimates do not have CreditWatch placements or outlooks.

What is the process for getting a credit estimate?

The process for credit estimate analysis begins when a CLO manager (or requesting party) uploads the necessary and complete information (detailed below) in the S&P Global Ratings system (https://creditestimates.spglobal.com). For the portfolio of credit estimates in a new CLO, we generally require between six and eight weeks to analyze and issue a credit estimate from the time we have all the information. However, this timing will vary depending on the number of credit estimates in process due to the pipeline of new middle market CLOs being rated.

Once a credit estimate is determined, it is sent to the CLO manager via the S&P Global Credit Estimate Portal or system. If there are multiple managers holding that same entity, other CLO managers also get the updated credit estimate score. There is no appeal process for a credit estimate.

What information does S&P Global Ratings require to provide a corporate credit estimate?

They are typically based on information provided from the requesting party, together with information from third-party sources we consider reliable:

• A detailed description of the company, its lines of business, and markets.
• Ownership structure with legal entity names.
• Three years of consolidated audited financial statements, including income statement, statement of cash flows, balance sheet, and financial notes. The latest audited financial statements should be received within 365 days from period end or as per local regulatory requirements. In between receipt of audited accounts, we expect the latest unaudited financial statements that are less than six months old. In exceptional circumstances, we accept a quality of earnings in the absence of an audit. We require an audit for the next fiscal reporting period when available.
• The most recent interim financial statements since the date of last annual report and the comparable period of the previous year (to calculate trailing-12-months financials); the most recent interim financials used in the analysis cannot be more than six months old.
• A description of the recent transaction, if any, with pro forma projections and models, particularly for such situations involving new capital structures (mergers or acquisitions) or restructurings.
• A summary of the debt structure and amortization schedule.
• Latest-four-quarters or last-12-months covenant compliance certificates, including ratio calculations, if applicable.
• Executed copies of the credit agreement, including exhibits, amendments, or waivers (including forbearance agreements), if applicable.
• Other documentation (preliminary and/or final versions of term sheet, indenture, intercreditor agreement, etc.).
• A summary of recent material events (acquisitions, divestures, recapitalizations, etc.).
• Guarantees, if applicable.

If the company has recently restructured or refinanced its capital structure, we require:

• At least one year of restated or pro forma financials.
• Preliminary and/or final versions of agreements (term sheet, indenture, intercreditor agreement, etc.).
• Updated forecast/bank model reflecting the new structure (including consolidated cash flow, income, and balance sheet).
• A summary of the new debt structure and amortization schedule.

When managers are issuing new CLOs, can they use the credit estimate scores for entities from previous CLOs if loans from the issuer will also be held in the new CLOs?

Managers are allowed to use S&P Global Ratings' credit estimate score for entities from any of their previous CLOs in the new CLO they are issuing. They can do so as long as the audited or interim financial statements used in the analysis of credit estimates for the earlier CLOs are less than six months old at the time of review of credits in the loan tape of the new CLO. If the audited or interim financials are greater than six months old, the manager should provide updated financials that are less than six months old so credit estimates can be refreshed for use in the new CLO. To provide a credit estimate on any entity that is going into a new CLO, the financials will have to be under six months old.

Does S&P Global Ratings maintain surveillance on credit estimates?

Credit estimates are formulated using an abbreviated analysis and do not include all aspects of a credit rating. For these reasons, among others, a credit estimate is not a substitute for a credit rating and does not constitute a credit rating.

A CLO manager is expected to furnish financial information on the loan-issuing company at least once every 12 months if such loans are still held in their CLOs. However, in practice, we end up reviewing many of these entities more frequently since multiple CLO managers own a piece of the loan and have different schedules for their maturity calendars. When we refresh a point-in-time credit estimate, we generally disseminate the updated score to every CLO manager who holds the specific credit-estimated loan in a rated CLO portfolio--not just the manager who provided the updated financial information for our review.

While we generally do not maintain ongoing surveillance of credit estimates, we may review them for possible changes as we deem appropriate. In addition to our regularly scheduled reviews, S&P Global Ratings may review point-in-time credit estimates at other times, as and when we deem appropriate. Middle-market CLO transaction documents typically contain provisions that require CLO managers to notify us of material changes (via specified amendments). These include amendments or other changes that have a material bearing or impact on the credit quality of the entity issuing the loan (see "Monitoring Middle Market Entities Amid COVID-19", published Aug. 6, 2020).

Under what circumstances does S&P Global Ratings expect the requesting party to provide updates due to "material changes"?

We expect to be updated promptly of what we view to be material adverse changes affecting the obligation that is the subject of the credit estimate. These would include:

• Nonpayment of interest or principal, including the rescheduling of interest or principal in any part of the capital structure.
• Changes in payment terms--the addition of payment-in-kind terms, changes in maturity dates, and changes in coupon rates.
• Any high likelihood of covenant breach or actual covenant breach with the details of an amendment or waiver.
• Any restructuring of debt (including proposed debt).
• The occurrence of significant transactions (new debt issuance, sale, or acquisitions of assets).
• Loss of major customer(s).
• Other events that in the opinion of the manager will affect credit (asset transfer, etc.).

We generally view the disclosure of a watch list or similar identification of problem credits in a CLO trustee report as helpful, but we do not regard such information as a substitute for the prompt communication of material changes.

Since an S&P Global Ratings credit estimate may sometimes differ from a rating assigned subsequently or previously, what factors can contribute to the existence of a potential discrepancy?

The credit estimate analysis is not the same as a typical ratings analysis. The abbreviated process means we may view information somewhat differently than we generally would during the ratings process. Because we don't meet with the management team, there is no insight into aspects such as management, governance, or risk framework. In the absence of such information, we may consider taking a more conservative view.