Leveraged loan default rate by issuer count falls to 0.44%, a nearly 14-year low

The trailing-12-month volume of defaults in the S&P/LSTA Leveraged Loan Index fell to just $4.1 billion in September, the lowest since April 2012. This pushed the default rate by amount to 0.35%, just 14 basis points above the post-global-financial-crisis low.

While the pipeline for Chapter 11 and payment defaults is expected to remain benign well into next year — as data and market feedback later detailed suggests — an imminent Chapter 11 is expected from GTT Communications Inc. after the company in September entered into a restructuring support agreement with its stakeholders. This would mark only the fourth index default of 2021 under LCD’s criteria, which excludes distressed exchanges.

By issuer count, the default rate fell to 0.44%, the lowest since December 2007.

To take stock of indicators that have historically preceded default activity, the share of loans priced at distressed levels — defined as 80 cents on the dollar — fell to a nearly seven-year low of 0.72% on Sept. 30. As this chart illustrates, market distress has proven an important leading indicator for future default rates, with the exception of an isolated April 2014, $19.5 billion default by TXU.

By industry, sector-level distress remains highest in Broadcast, Radio and Television, at nearly 13%. Among other sectors with an index share over 1%, Leisure dropped out of the rankings, with no loans in distressed territory in September.

Over the history of the index, the default rate and the downgrade/upgrade ratio have cycled in a relatively synchronized manner. The number of upgrades of loan facilities in the S&P/LSTA Leveraged Loan Index outnumbered downgrades for an eighth-consecutive month in September, at a count of 60 to 31. The rolling three-month ratio of upgrades to downgrades as a result is 1.9x, down from 2.5x in August, which was the highest ratio of upgrades to downgrades since June 2011.

In May 2020, this ratio had fallen to 0.02x, or flipping the calculation, the ratio of downgrades to upgrades soared to a record high of 43x. This preceded a cycle default peak of 4.17% in September 2020.

Finally, LCD conducted its quarterly leveraged finance survey between Sept. 16 and Sept. 24, polling market professionals to assess the red-hot market conditions, and the outlook for the default environment in the year ahead. For the full survey results, see “LCD Leveraged Finance Survey: Credit valuations, inflation concern investors.”

Given the currently benign default environment in leveraged loans, LCD asked its survey base of buy-side, sell-side and advisory professionals how long they expected the leveraged loan default rate to remain below 1%, noting that in the aftermath of the 2009 default peak, the sub-1% stretch of defaults lasted for 13 months.

Forty-seven percent of respondents said they expect the sub-1% default environment to last longer than 13 months in this new, current cycle, while 27% expect a shorter run for ultra-benign default rates.

Finally, polling for predictions on the one-year forward default rate, respondents, on average, expect the leveraged loan default rate to increase from 0.35% where it ended in September, to 0.98% in the 12 months ending September 2022.