If the two effects above were combined, for example with a 6-times greater LGD (comparing Scenarios A & B), and a 2-times greater PD (to simplify from Scenarios A & C), then the net effect of the 75% CC might be a 12-times increase in expected loss. So if the expected loss for senior debt in Scenario A was 0.25%, consistent with A3 (notional expected loss of 0.19-0.297% over a four year horizon), then this 12-times multiplier might transform expected loss from 0.25% to 3%, equivalent to a Ba2 (expected loss of 2.31-3.74%), an impact of minus 5 notches5 as noted above, this would be an extreme example, but our analysis suggests that this may be justified in such cases, where the presence of a large CC transforms the credit proposition for the senior debt tranche.
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5 Toggling the treatment of CCs in the methodology model from Neutral to Adverse may deliver a negative adjustment of less than a whole notch in some cases, minus 1-2 notches for a more substantial CC, or minus 3 in an extreme scenario. This is because the equity amount is unchanged – the model is effectively comparing Scenarios A and B. If the equity contribution was reduced below typical levels, as in Scenario C, that might need to be reflected through a further qualitative adjustment to the output from the methodology model.