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Loan-issuer earnings revival tamps down late-cycle leverage

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Loan-issuer earnings revival tamps down late-cycle leverage

U.S. leveraged loan issuers in the second quarter posted their highest rate of earnings growth since the early days of this credit cycle, improving leverage and cash-flow readings and muting the impact of last year's brush with weakening credit metrics.

The growth in earnings boosted loan issuer interest coverage, among other metrics, suggesting that an end to the borrower-friendly credit cycle is still some way down the road.

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Revenue for S&P/LSTA Leveraged Loan Index issuers swelled 14% in the second quarter, and core EBITDA growth was 12% on a last-12-months basis, compared with the second quarter of 2017. Averages over the last five years are 10% at the top line and 7% for EBITDA, and there have not been higher quarterly growth results since 2014 and 2012, respectively, according to LCD News.

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The pop in operating results, which follows a strong first quarter, helped drive down debt-to-EBITDA ratios across the Index issuer universe, to a weighted average of 5.44x. That is down about half a turn from both the 2017 second-quarter reading and the five-year average, and marks the lowest group leverage since 2007, according to LCD.

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Meanwhile, the weighted average of cash-flow coverage mounted to 3.1x, up more than a quarter-turn versus the year-ago level and the trailing five-year average, setting a high-water mark since LCD started tracking this indicator in 2001. Similarly, interest coverage of 4.4x in the second quarter bested all results since 2001, marking a rise of about 30 basis points year over year, and 40 basis points relative to the trailing-five-year average.

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Further, the proportion of credits with the weakest leverage and cash-flow characteristics has ebbed as earnings surge, after a rising tide of "outer-edge" issuers set off alarms last year. The portion of loan issuers with debt-to-EBITDA greater than 7x was slightly below 18% in the second quarter, down more than four percentage points year over year, while issuers with cash flow coverage of less than 1.5x held near 19% for a second straight quarter, down from 24% a year earlier.

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The growth tallies for corporate America were even loftier when following the line from tax policy to the headline earnings-per-share results. Overall EPS for S&P 500 companies grew 25% in the second quarter, and growth is projected to continue near 20% during the second half of the year, before moderating in 2019 against much tougher comparisons. As noted, EPS results and growth projections are running about 2x what they were before tax legislation was passed in late 2017.

Earnings growth for loan issuers was broad-based across industry baskets and included healthy results from a number of cyclical sectors including leisure, industrial equipment and chemicals, and a rare incidence of steady aggregate results from non-food-and-drug retailers as the beleaguered sector's participants engage in Darwinian struggles for survival.

The latest results dovetail with LCD's latest loan default survey conducted at the end of the second quarter, which indicated that portfolio managers continue to expect loan default activity to rise only modestly in the next 18 months, before a long-anticipated breach of historical averages sometime in 2020.

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Further, managers continue to see idiosyncratic risk as the main driver of loan defaults over the near term, rather than a broad-based uptick at a systemic level.

LCD News is an offering of S&P Global Market Intelligence.