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Loan-issuer leverage plunges as earnings climb 21% from pandemic depths

Leveraged loan issuers in recent weeks reported the strongest earnings rebound in more than a decade, and a resulting sharp drop in operating leverage, highlighting the stakes for borrowers as the fast-spreading delta variant imperils global recovery.

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For loan issuers in the S&P/LSTA Leveraged Loan Index that report publicly, EBITDA results for the second quarter this year surged 21% on a year-over-year basis against the dismal numbers posted last year amid initial COVID-19 lockdown orders. That strong gain followed on from a 16% year-over-year jump in first-quarter EBITDA, and it represents the strongest growth rate since the metric gapped up 24% in the third quarter of 2010, as earnings gained traction against 2009 recession-era comparisons.

Notably, revenues across the group increased 27% year-over-year in the second quarter of 2021, marking the most acute recovery for LCD records since 2008. That surging top-line result was on top of 13% growth in the first quarter.

The readings are across 165 public filers in the S&P/LSTA Leveraged Loan Index, representing 13% of all performing loans, or $163.8 billion.

The stronger EBITDA inputs helped drive down the average leverage ratio for the sample to 4.92x from 5.36x in the first quarter. The latest reading is down roughly 1.5 turns from the 6.41x level in the year-ago second quarter, a high for LCD records since 2001. For reference, that leverage metric ebbed to its lowest level since a similar 4.91x reading in the first quarter of 2019. The long-term low is 4.62x, in the second quarter of 2004.

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Looking at leverage for the group on a weighted average basis, the 5.08x reading in the second quarter marks a record low, reflecting a decline from 6.73x a year earlier.

Coverage metrics tracked higher alongside those leverage improvements. Cash flow coverage increased to 3.59x, up 30 basis points sequentially, and versus 2.74x in the second quarter of 2020, a low since 2012. On a weighted average basis, the 3.63x level is an all-time high, marking a rise of more than a full turn from 2.59x a year earlier.

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As a historic refinancing wave continues across the credit-quality spectrum, interest coverage increased to a record-high 5.63x (5.52x on a weighted average basis) from 4.14x (3.79x on a weighted average basis) in the second quarter of 2020.

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The still-fragile recovery pulled big swaths of issuers back from the brink over the last year. Issuers operating with so-called outer edge leverage of greater than 7x accounted for more than 35% of the loan-issuer sample in the second quarter of 2020 as business activity withered. That proportion was nearly halved as earnings regained traction, dropping to 18% for the latest quarter, a low since the pre-pandemic third quarter of 2019.

Meanwhile, the number of issuers operating with cash flow coverage of less than 1.5x plunged to just 12% of the sample in the second quarter this year from 29% a year earlier.

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A look at earnings from a higher altitude brings the scope of the recovery into sharp relief. All 10 industry categories of the S&P 500 index showed stronger year-over-year earnings per share results for the latest quarter, according to S&P Capital IQ data compiled Aug. 13. Those EPS increases ranged from outsized gains for cyclical categories (including a 385% rise for industrials and a 199% rise for consumer discretionary names) down to 3% for utilities.

Those results came in around a nearly 87% rise in EPS across the S&P 500 constituent group, which was a level of vigor that caught most equity analysts flat-footed. The majority of EPS results across all 10 industry categories beat analyst expectations, including upside surprises for nearly 97% of IT constituents and almost 92% of healthcare names. Upside surprises were the fewest for utility names at a still-potent 67% of the carve-out.