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Loan-issuer earnings surge squashes leverage back to pre-pandemic levels

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Loan-issuer earnings surge squashes leverage back to pre-pandemic levels

U.S. leveraged loan issuers are back to operating at pre-pandemic leverage metrics, after the first quarter produced the sharpest year-over-year earnings growth since the economy emerged from the Great Recession, according to LCD.

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Average leverage for companies within the S&P/LSTA Leveraged Loan Index that report their results publicly declined to 5.36x as of March 31, or the lowest level since a comparable 5.35x in the fourth quarter of 2019, LCD data show. Leverage spiked more than a full turn through the early months of the pandemic, reaching a record-high 6.41x in the second quarter last year. That level fell to 5.91x by the end of 2020 as the earnings recovery gathered steam, aided by vaccine breakthroughs.

The reading is across 150 public filers in the S&P/LSTA index, representing 13% of all performing loans, or roughly $158 billion.

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The continued slide in the debt-to-EBITDA leverage ratio in the first three months this year reflects a potent recovery on the earnings side of the calculation. EBITDA growth for the public filers in the S&P/LSTA index surged to 16% in the first quarter, building on 5% growth in the fourth quarter. It was the biggest jump since EBITDA grew 17% for the second quarter of 2011, and it reflected a 13% growth rate for loan-issuer revenue in the first quarter this year, an 11-quarter high.

The impending second-quarter comparisons may be even more dramatic as they will come against the deepest contraction for loan-issuer EBITDA on record last year, at negative 23%, per LCD data since 2003. Encouragingly, the first-quarter growth this year was on top of positive earnings growth — albeit a mild 1% — for last year's Jekyll-and-Hyde first quarter.

Other key credit metrics are showing comparable gains amid upbeat cash flow trends and an ongoing low-cost refinancing wave. Cash flow coverage, at 3.29x, reached an eight-quarter high in the first quarter, up more than half a turn from the pandemic nadir at 2.74x, in the second quarter last year. Interest coverage advanced to 4.97x, a high since the same reading in the first quarter of 2019 and up from 4.14x in the second quarter last year.

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And, after gazing into the abyss last year, many of the most at-risk issuers are stepping back from the brink. The percentage of public filers in the S&P/LSTA index operating with "outer-edge" leverage metrics — namely debt-to-EBITDA of 7x or more — tumbled to 22% in the first quarter, down from nearly 26% in the fourth quarter and a record-high 35% in the second quarter of 2020. The latest level is a low since the fourth quarter of 2019.

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Companies with cash flow coverage of less than 1.5x reached a high at 29% in the second quarter last year, up significantly from the 23% share in the fourth quarter of 2019. Impressively, that metric has now declined sharply for three consecutive quarters, reaching an all-time low at 15% in the first quarter this year.

Ebbing credit risk is plainly evident in ratings trends, following last year's shockwave of downgrades. On a rolling three-month basis, the number of upgrades of loan facilities in the S&P/LSTA Leveraged Loan Index topped downgrades for a fourth straight month in May by 2.1x. The last time upgrades outpaced downgrades by a higher margin was in May 2012. Downgrades routinely outpaced upgrades from the fourth quarter of 2015 through January this year, including virtually no upgrade activity from March to June last year.

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Managing expectations remains a challenge for the marketplace, as evidenced by the ripples of unease that spread in the wake of weaker-than-expected April data, including disappointing jobs numbers. In the first quarter, however, most analysts were unprepared for the robustness of the earnings recovery. For the broad S&P 500, majorities of first-quarter EPS results beat consensus expectations across all 11 industry categories, according to S&P Global Market Intelligence.

Nearly 97% of Information Technology companies beat EPS forecasts, and 87% or more beat estimates in the Consumer Discretionary, Industrials, Financials, and Communication Services sectors. At least 75% beat estimates for the remaining sectors, excepting Real Estate, where 55% beat forecasts.

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