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Leveraged loan market upgrades outpace downgrades at fastest rate since 2012

Upgrades of leveraged loans are outpacing downgrades at the fastest rate since May 2012 as favorable funding conditions for lower-rated companies and a strengthening U.S. economy have facilitated the return of favorable ratings actions.

The ratio of upgrades to downgrades of loan facilities in the S&P/LSTA Leveraged Loan Index in the three months through the end of April climbed to 2.1x, marking the third consecutive month the rolling count of upgrades has exceeded downgrades.

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The last time leveraged loans had such a stretch of positive ratings actions was in 2015 as the ramifications of the oil price crash were beginning to unfold.

Even before the pandemic hit, ratings downgrades had so dominated since late 2015 that only one month (February 2017) featured more upgrades than downgrades in the rolling-three-month readings — until this current reversal.

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At the pandemic-driven height, in the three months through May 2020, there were 43 downgrades for every one upgrade.

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As the below charts show, this trend reversal offsets only a small portion of the torrent of downgrades in 2020, with April 2020 featuring the worst onslaught of 228 downgrades against just five upgrades.

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More broadly, in the last-12-months calculation, 335 loans facilities were downgraded, against 182 upgrades.

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Delving deeper, out of 261 issuers that were downgraded in the busiest months of March and April of last year, only 52 received any upgrades.

During those months, the two biggest sectors in the S&P/LSTA Leveraged Loan Index Business Equipment & Services, with a 9.8% index share, and Electronics, with 15.9% index share — unsurprisingly had heavy downgrade activity, with 23 and 18 companies downgraded, respectively. Industrial Equipment and Leisure, with respective market shares of 3.5% and 3.8%, saw 23 and 30 downgrades.

Of the upgrades in February through April of 2021 (a total of 63), there were nine from Electronics and another nine from Chemicals and Plastics.

Helping to alleviate the CCC haircut pressure for CLO investors, 13 out of 63 upgrades lifted the companies out of the vulnerable triple-C band by one notch, to B-. Traditionally, CLOs have specified that CCC rated assets would be limited to a maximum of 7.5% of the portfolio. At the height of the 2020 downgrade cycle, almost all the deals within S&P's CLO Insights Index of 410 CLO 2.0s in May 2020 exceeded that limit.

According to S&P Global Ratings, the median CCC bucket of the successor CLO Insights 2021 U.S. BSL Index improved to 6.97%. At the May 2020 peak, this number had skyrocketed to 12.3%, from 4.1% at the start of 2020.

The return of upgrades has, of course, improved the ratings quality mix in the broader S&P/LSTA Leveraged Loan Index, with the triple-C bucket most notably declining.

Loans rated at CCC, CC or C now make up 7.6% of the index, versus 9.3% at the end of 2020, and 11.2% at the April 2020 high. For context, the portion is still elevated by historical standards, as it has averaged 6.3% over the past 10 years and has steadily risen from a post-financial crisis low of 2.54% in March 2015.

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Amid record issuance volume of B-minus rated loans and the general deterioration of the ratings mix over the years, the share of B-minus rated issuers in the Loan Index stood close to record highs at 24.5% at the end of April. This puts 32%, or just over $380 billion of outstanding loans, rated either in the vulnerable CCC/CC/C range or just one notch above it.

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