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Ranks Of Leveraged Loan "Weakest Links" Hit Record As Credit Downgrades Mount

The number of "Weakest Links" in the U.S. leveraged loan market jumped to 145 in 2019's fourth quarter, from 125 in September and 95 at the end of 2018, according to LCD, as increasing numbers of downgrades chip away at credit quality in the segment.

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The fourth-quarter activity brought the loan Weakest Links share to 10.9% at year-end, up from 9.6% as of Sept. 30 and 6.8% at the end of 2018. The most recent numbers are, hands down, the largest count and share of loan Weakest Links that LCD has tracked since the study's base date of year-end 2013.

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Weakest Links are loans in LCD's universe that have a corporate credit rating of B– or lower and a negative outlook from S&P Global Ratings. The Weakest Links composite can change on a historical basis as LCD expands the universe of loans it tracks for the purpose of this analysis.

Along with a swelling constituency of Weakest Links, the share of defaults and restructurings among these ranks increased last year, to 27 as of Dec. 31, from 21 in 2018 and 25 in 2017. Fourth-quarter additions included Rite Aid Corp. (lowered to selective default, regarding a distressed exchange), Deluxe Entertainment Services Group Inc. (Chapter 11), Acosta (downgraded to SD on missed principal and interest payments in October), and McDermott International Inc. (lowered to SD due to a missed interest payment in December). The first three borrowers have been on the loan Weakest Links list for at least one year.

The number of Weakest Links increased in the fourth quarter because of downgrades proper, along with worsening outlooks. A dozen issuers became Weakest Links as a result of a one-notch downgrade to B– (with a negative outlook). Examples include 24 Hour Fitness, Speedcast International Ltd., and Rodan and Fields, LLC.

Overall, downgrades helped push the share of borrowers rated B– in the S&P/LSTA Loan Index to 20% by the end of last year, the highest reading since July 2010, from 14% a year earlier. Moreover, in absolute terms, B– rated debt totaled $231.5 billion as of Dec. 31, a record high. (This includes all B– rated borrowers, regardless of outlook.)

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Although virtually all sectors expanded their Weakest Links ranks in 2019, some industries saw a more drastic increase than others. Healthcare had the highest count of deals in the cohort, at 17, up from 11 in 2018—a year-over-year increase on par with the overall average (from 95 borrowers to 145, or up 53%). This industry is the second-biggest sector in the loan market overall, accounting for roughly 10% of the $1.2 trillion par amount outstanding, according to the S&P/LSTA Index.

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Computers & Electronics (LCD's proxy for the technology sector) tied with Retail as the second-biggest share of borrowers in the Weakest Links cohort, with 15. The Tech segment had just five in 2018. This sector holds a dominant position in the loan market overall—it is the largest sector in the Index, accounting for nearly 15% of $1.2 trillion outstanding. All but one name on the list became a Weakest Link in 2019 as a result of a downgrade or a change in outlook from stable to negative.

Retail—an industry always seen as ripe for restructuring—has dominated the corporate default landscape in recent years, and accounted for the second-biggest slice of the Weakest Links pie last year, with 15 borrowers. Most of these names have been on investors' distress radar screens for a while, however, as 11 of these borrowers have been a Weakest Link for more than a year.

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Although the U.S. leveraged loan default rate increased to its highest level in 15 months in January, at 1.83%, the rate remains stubbornly low, compared to its 2.9% historical average. However, an increase in the ranks of loan Weakest Links indicates a heightened risk of default down the line. Indeed, 46% of loans from the year-end 2016 cohort have since defaulted or restructured, while 31% of loans from two years ago (year-end 2017) have defaulted or restructured, and 16% of those from the end of 2018 have done so.

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Beyond default rates, another reading on the health of the loan market is the ratio of downgrades to upgrades, especially those at the lower end of the credit quality spectrum. In the 12 months through Dec. 31, for every loan in the S&P/LSTA Index that was upgraded, 3.2 were downgraded, the highest reading since the financial crisis.

This analysis was conducted by Marina Lukatsky, Senior Director at LCD.

LCD is an offering of S&P Global Market Intelligence. S&P Global Ratings is a separately managed division of S&P Global.


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LCD comps is an offering of S&P Global Market Intelligence. LCD’s subscription site offers complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.