DEFINITION of 'Credit Cliff'

Credit cliff is jargon that refers to a company's precarious credit situation that may cause - or be caused by - a credit rating downgrade. Financial deterioration of a company that puts its ability to service debt at dangerous risk can lead to an adverse change in ratings by credit agencies. By the same token, if a credit rating downgrade does occur, a company could be moved to a credit cliff position, where the next step would be a steep fall, forcing a company to restructure, file for bankruptcy protection or liquidate in the worse case scenario.

BREAKING DOWN 'Credit Cliff'

A distressed company with a debt burden may find itself standing at the edge of credit cliff. In most cases, the distress results from poor operational performance that reduces income available to pay interest expenses or meet debt maturities. When financial covenants such as interest coverage or leverage ratios are broken in a debt agreement, creditors have the right to demand additional collateral, step up loan pricing, or accelerate the repayment schedule, among other remedies. Any one of these measures will place added stress on the company, moving it closer to the edge of the cliff or shoving it off.

A downgrade by S&P or Moody's or another credit agency could also trigger actions by creditors that would increase pressure on a leveraged firm. It is not uncommon for a lender to insert a credit agency rating downgrade in the loan agreement as a trigger for an aforementioned remedy. Suppose, for instance, a firm's credit ratings are downgraded from a B3/B- to Caa1/CCC+. A lender then moves to accelerate repayment. The repayment demand, however, pushes the firm off the credit cliff and into Chapter 11.

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