For loan issuers, leverage swings from peak to valley through pandemic

U.S. leveraged loan issuers reported double-digit earnings growth for a third straight quarter through September, driving a key leverage metric to the lowest level on record and a coverage reading to a new record high, according to LCD.

For loan issuers within the S&P/LSTA U.S. Leveraged Loan Index that report results publicly, EBITDA increased 13% year over year in the third quarter. That bounce was on top of results in the third quarter last year that showcased a gathering recovery in operating results, following the earnings plunge through the early months of the pandemic.

The EBITDA reading surged 16% in the first quarter against the Jekyll-and-Hyde performance in the first quarter of 2020. It was up 21% in the second quarter, the latter result representing the biggest year-over-year bounce since the post-recession recovery period in the third quarter of 2010.

The readings are across 167 public filers in the S&P/LSTA Leveraged Loan Index, representing 14% of the issuers in the index and 13% by par amount of all performing loans.

The rising earnings tide reflects a potent increase in top-line sales this year, following on the stirrings of recovery late in 2020. Revenues increased 18% year over year in the latest quarter, following on a record-sized bounce of 27% in the second quarter and a 13% increase in the first quarter.

The back-to-back-to-back earnings gains this year had a pronounced impact for the operating inputs to the leverage calculation, resulting in a quick trip from the highest-ever leverage metrics last year to historically low levels as 2021 enters its home stretch. On average, the debt-to-EBITDA ratio for the S&P/LSTA index public filers ticked lower to 4.86x, marking a fifth straight sequential decline from an all-time high at 6.41x in the second quarter of 2020, including a 6.16x reading in the third quarter last year.

On a weighted average basis, the 5.05x leverage reading in the third quarter this year marks a record low, according to LCD.

And with refinancing efforts continuing apace and cash flow spigots again running strong, companies' ability to service their debt has never been stronger since LCD started tracking the metric in 2002. Cash flow coverage and interest coverage metrics for the public filers were at all-time highs in the third quarter, each on an average and weighted average basis, LCD's analysis shows.

Specifically, the 5.79x weighted average for interest coverage was up two full turns from the pandemic-era nadir in the second quarter of 2020. The 3.87x weighted average for the cash flow metric was up 136 basis points from a crisis low recorded in the first quarter last year.

Remarkably, 2021's final quarter started with the slimmest-ever proportion of loan issuers operating with what has historically signaled danger-level — or "outer edge" — cash flow coverage. Less than 9% of the loan issuers in the LCD sample operated with cash flow coverage of less than 1.5x, versus nearly 29% in the second quarter last year.

Meanwhile, companies with interest coverage of less than 1.5x was in the 3.1% area for a second straight quarter through September, both down roughly 3 percentage points from the highest pandemic-era readings last year. The record low was 2.6%, in the first quarter of 2019.

Back to leverage, just over 16% of the sample had outer-edge debt-to-EBITDA of more than 7x in the third quarter, reflecting five straight sequential declines, from 35% in the second quarter last year, and marking a return to the lowest levels since the pre-pandemic third quarter of 2019.

Encouragingly, the earnings boom this year is deep and wide. On a year-over-year basis, S&P Global Market Intelligence projected higher aggregated earnings per share for 10 of its 11 sector breakdowns within the S&P 500, based on data through Nov. 19. Leading those gains were projected increases of 136% for real estate, 91% for materials and 83% for industrials.

The only category projected to be in the red for the quarter was consumer discretionary, a notable outlier as COVID-19 headwinds persist. But even there, earnings in the third quarter were better than most analysts had expected. More than 73% of the earnings reports within the consumer discretionary category bested consensus analyst projections.

Indeed, majorities of the reports across 11 categories were better than expected, including upside surprises for 94% of the reports from information technology and beats for 92% in healthcare, 88% for financials, and roughly 83% for both real estate and industrials.