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Leveraged Loan Portfolio Managers Foresee Steady Increase in Default Rate, to 2.24% in 2018

Market pros see leveraged loan default rate holding at low levels

S&P: BBB downgrade risks in Europe look manageable

As specter of rate cuts grows, investors retreat from leveraged loan asset class

Retail investors flock to US high yield bond funds with $1.8B inflow

Leveraged Loan Portfolio Managers Foresee Steady Increase in Default Rate, to 2.24% in 2018

Rather than a sudden spike, portfolio managers of U.S. leveraged loans foresee a slow inflection higher in the headline default rate, marked by pockets of distress in certain sectors. With energy having already experienced its own default cycle, retail, broadcasting, and healthcare are seen as the next potential trouble spots.

At the macro level, participants in LCD’s quarterly survey reined in their default forecasts somewhat, but still see a steady increase, with expectations that the loan default rate will end 2018 at 2.24%, from the current 1.91%.

The sentiment is more benign than that expressed in the third-quarter survey, when respondents had forecast a 2018 rate of 2.42%.

Almost all responses regarding where the expected one-year forward default rate will fall, at year-end 2018, were in a range of 2–2.70%.

Default Rate Projection 2018

Further out, loan investors, on average, expect the default rate to finish 2019 at 2.65%. The views here, polled for the first time this quarter, for the most part (80%) ranged from 2.25–3.30%.

Looking back

The end of year is an opportune time to review the accuracy of past predictions.

Defaults within the S&P/LSTA Leveraged Loan Index jumped to 1.95% in November. While still well short of the 2.44% year-end 2017 rate predicted by loan managers this time last year, a potentially substantial default lurks in the shadows. With few expecting iHeartMedia to even hold another earnings call with its current balance sheet intact, a default on the company’s Clear Channel term loans D and E would, hypothetically speaking, push the default rate to a 33-month high of 2.63%.

LCD also asked participants when they expect the default rate to breach 3.1%—the historical average. More than half (67%) now expect this to be a 2020 event (on an intra-year basis), with only 33% expecting the historical average to be breached in 2019. This is down from 93% forecasting 2019 at the third-quarter reading.

— Rachelle Kakouris

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