The trailing 12-month default rate of the S&P/LSTA Leveraged Loan Index fell for a sixth straight month in March, to 3.15% by amount. The rate has declined by just over 100 basis points from its September 2020 peak of 4.17%.
By issuer count, the default rate, at 3.56%, has steadily fallen from a 10-year high of 4.64% in September.
In terms of volume, there were no bankruptcies or payment misses among Index issuers in the month of March, putting the LTM amount of defaults 74% ahead of the March 2020 pace, at $37.53 billion.
With a heavy schedule of defaults set to roll off the 12-month calculation in the coming months, the rate is still on course to decline toward its 2.9% historical average.
According to LCD, by July, $30.8 billion should exit the rolling index, which would take 257 bps off the 3.15% March default rate.
Forward indicators and broader economic recovery expectations, meanwhile, would suggest limited prospects for a broad-based surge of new restructuring activity to offset the volume soon to exit the calculation.
In the macro picture, S&P Global Ratings has raised its real GDP growth forecasts for 2021 and 2022 to 6.5% and 3.1%, respectively, from 4.2% and 3.0% in its December report.
“With both business and consumer confidence well into expansion territory, the U.S. economy is on the mend,” Ratings states in the report, which was led by U.S. Chief Economist Beth Ann Bovino.
Even accounting for a possible resurgence of the virus later in the spring, “it's hard to see a contraction this year that is severe, broad, or long-lasting enough to be considered a recession by the National Bureau of Economic Research,” the report continues.
S&P Global Ratings, as such, sees a risk for recession over the next 12 months of 10%-15%, down sharply from the 20%-25% range in January, and around the U.S. economy's long-term unconditional recession risk average of 13%.
Looking at indicators from the loan market, secondary prices continue to point to little near-term risk for spiking defaults. According to LCD, the share of loans in the S&P/LSTA Leveraged Loan Index priced in technical distress — i.e., below 80% of face value — has shown little movement after falling below 2% at the start of this year. Just 1.13% of performing loans were below 80 as of March 31, well below the peak of 57% in March 2020.
Even in bull markets, distress cycles across various industries are a typical feature of leveraged credit. Among sectors with a meaningful Index share above 1%, Broadcast, Radio and Television currently has the highest sector-level distress ratio, with nearly 13% of loans in this sector priced below 80. Utilities follows, at 9%, and then Automotive, with a 5% distress ratio.
The following chart shows how this sector-level distress translates as a share of overall distress in the broader loan market. With an index share of 2.18%, the 13% sector-level distress ratio for Broadcast, Radio and Television equates to 24% of all distressed loans in the index. On the flip side, Business, Equipment and Services has a sector level distress ratio of just 0.82%, but with an index share of 10%, this sector represents 7% of all distressed loans in the index.
In a read of credit conditions, a rebound in earnings from the depths of the COVID-19 pandemic has helped to ease leverage among the public filers within the S&P/LSTA Leveraged Loan Index. According to LCD’s analysis of a 157-company sample, average debt-to-EBITDA leverage eased for a second straight quarter in the fourth quarter of 2020, to 5.9x, matching the 2020 first-quarter level while holding half a turn above the reading for the final quarter of 2019. At the highs, the loan-issuer sample spiked to 6.4x in the second quarter of 2020, up more than a full turn from 5.2x a year earlier.
In terms of issuers' ability to service their debt on a running basis, the level of interest coverage improved to a seven-quarter high of 4.8x, from 4.4x in the third quarter of 2020, and 4.1x at the pandemic-era nadir in the second quarter. Cash-flow coverage ticked up to a six-quarter high at 3.2x, from 2.7x at the crisis low in the second quarter.
Finally, each quarter, LCD surveys leveraged finance professionals to gauge sentiment on the $1.2 trillion asset class. Results from our polling, conducted between March 3 and March 17, indicate a constructive outlook for the year ahead, with default fears ebbing among participants.
Denoting a significant improvement in sentiment from the December reading, the consensus view among respondents is that the default rate peaked when it hit 4.17% in September 2020. In the fourth-quarter reading, in almost equal share, 29% had said they expected the default rate would peak at 5%-5.99%, and 28% said the peak default rate in this cycle would be less than 5%.
Even with the sky beginning to clear over the U.S. economy, and supportive market conditions allowing troubled companies to access liquidity and breathing room, only 25% of respondents think the default cycle will end in less than one year. While that’s up from 18% at the end of 2020, the remaining 75% of respondents still believe the cycle of above-average defaults will end in one to two years or more. More specifically, 41% expect default rates to normalize within one to two years, and 21% in two to three years. This implies that while the peak might be lower than previously expected, and indeed while defaults could well dip below the historical average, the narrative of lower-for-longer, when it comes to defaults, is still the consensus as companies kick the can in pushing out maturities and securing covenant headroom.