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After Neiman Marcus downgrade, U.S. leveraged loan default rate climbs to 1.24%

The U.S. leveraged loan default rate increased to 1.24% this week after S&P Global Ratings downgraded struggling retailer Neiman Marcus to SD (selective default) from CC due to the company's comprehensive restructuring, including what amounts to a debt exchange.

At the time of the downgrade Neiman Marcus had some $2.8 billion in outstanding leveraged loan debt, making it the largest loan default so far this year and the biggest since iHeart's $6.3 billion default on that company's Clear Channel loans, in March 2018, according to LCD.

Neiman Marcus was not the only issuer added to the default roles in June. Sheridan Fund II, an investment vehicle of oil & gas concern Sheridan Production Partners, skipped an interest payment on May 31, triggering default, according to the S&P/LSTA Loan Index.

Despite much consternation about the loan market by observers and regulators alike, the U.S. leveraged loan default rate remains low, compared to its historical average of 2.93%. Before the Neiman Marcus action the rate had been a slim 1% at the end of May and near a seven-year low of 0.93% at the end of March.

The leveraged loan asset class has come under considerable scrutiny over the past few years amid rapid growth – outstandings in the U.S. now total a record $1.2 trillion – the proliferation of loosely structured documentation and a shift toward lower-quality borrowers.

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Looking more closely at June's contributors to the default rate, Neiman Marcus settled a comprehensive restructuring in which it exchanged $1.478 billion of unsecured debt into a combination of MyTheresa preferred equity and new third-lien notes, extending at the same time the maturity of its $2.795 billion outstanding term loan due 2020.

S&P Global Ratings cut the issue-level ratings on the term loan and targeted unsecured debt to D, citing its assessment that the new securities' maturities extend beyond the original without adequate offsetting compensation.

Per LCD's criteria, a lowering of the loan rating to D triggers a default in the Index.

While interest is still being paid on the loan, portfolio managers said that in addition to S&P's rationale for statistically capturing this default, in Neiman's case, the term loan, being the most pressing and largest maturity, was also "the troubled tranche" in Neiman's pre-restructured capital structure.

Despite Neiman having just restructured, S&P Global Ratings, in lowering the issuer to Selective Default, cautioned it still sees a restructuring risk going forward. The agency said it will soon likely raise Neiman's rating to CCC, which will include base-case assumptions of "a continued risk of restructuring over the next 12 months because of the remaining meaningful outstanding balance of about $137 million on the unsecured notes due in October 2021 that were not exchanged in the restructuring," S&P analyst Mathew Christy said in a June 11 report.

Also contributing to the default tally in June, S&P Global Ratings lowered term loans issued by Sheridan Fund II to D after the investment vehicle entered into agreements with creditors to defer debt service payments on a revolving credit facility (RBL) and secured term loan to July 31. The term and RBL lenders will not receive $9 million in interest payments on the original May 31 due date, and $1.4 million in amortization payments on the term loan due at the end of June will not be made at that time.

"We view such missed payments, with no additional consideration for the deferral, as a default," S&P analyst Jeffrey Feit said.

There are three Sheridan Fund II term loans in the S&P/LSTA Leveraged Loan Index.

Sheridan Fund I, also an investment vehicle of Sheridan Production Partners and an Index constituent, meanwhile, extended the maturity date of its revolving credit facilities (RBL) to June 14, 2019, as negotiations proceed to extend the fund's debt maturities to match the expected 2022 end of the fund. S&P said in a ratings report that it would further lower the ratings on the entity's $450 million term loan to D should the transaction to extend the maturities be consummated as proposed. The ratings agency said it believes it is likely that the fund's negotiations with lenders will result in either this transaction (or a similar distressed exchange) or a Chapter 11 bankruptcy filing.

Partially offsetting June's default rate, Education Management Corp. and Westmoreland Coal Co. both rolled off the 12-month calculation on which the rate is derived.

This story was written by Rachelle Kakouris, who covers distressed debt for LCD.


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