rating trigger

rating trigger

A provision in a loan agreement that initiates a specific action in the event of a change in a firm's credit rating. For example, a downgrade in a firm's credit rating may set off accelerated debt repayment in a backup credit line.

Case Study Selling in a regulated market and buying in an unregulated market caught up with California electric utility PG&E in 2000 and 2001 when wholesale electric prices skyrocketed on the West Coast. Unable to raise the price of its product in the face of rising wholesale electric prices, the firm began defaulting on its debts when rating triggers from a rating downgrade allowed financial institutions to stop funding the company's commercial paper. The lack of funding for PG&E's commercial paper caused the company to default on its pollution-control bonds and a variety of short- and medium-term notes. The importance of the rating trigger in PG&E's subsequent bankruptcy caused one major rating agency to indicate that it would consider the negative consequence of triggers in evaluating whether a company would be able to survive a rating downgrade. Some corporations began to reconsider the inclusion of rating triggers in borrowing agreements when they discovered the rating agencies would consider these triggers in evaluating the credit quality of corporate debt.