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Leveraged Finance: U.S. Leveraged Finance Q2 2021 Update: Credit Metric Recovery Shows Sector, Rating, And Capital Structure Mix Disparities

The second half of 2021 began on an encouraging note for speculative-grade borrowers. Accelerating economic recovery has fueled optimism; transactions across the credit spectrum were executed on the perception that business operating conditions and results will continue to improve.

This report features the effect of the pandemic and the ensuing recovery on corporate borrowers' leverage and cash reserve statistics. In particular, we track the transition of median leverage and cash balances for the 12-month periods ended between Sept. 30, 2019, and March 31, 2021.

Leverage in the study is calculated as gross debt over EBITDA, both as reported in companies' financial statements and without adjustment by S&P Global Ratings, which should provide useful insight into the leverage trends even if these statistics are different than those we use in our rating analyses.

Open For Business: Half Of Sectors Have Fully Returned To Pre-Pandemic Leverage Levels

Here, we spotlight some noteworthy trends that emerged in the first quarter:

  • Speculative-grade borrowers are reporting encouraging earnings growth. About 70% of companies in our sample experienced LTM EBITDA growth in first-quarter 2021. This resulted in median LTM leverage on the whole continuing to slide. It dipped to 6.1x by the end of the first quarter, returning to levels last seen at the onset of the pandemic (tables 1 and 2). More companies such as Boeing Co. have vowed to prioritize debt reduction once normality restores.
  • 'B' category ('B+'/'B'/'B-') companies cut their median LTM leverage by 0.2x-0.5x in the first quarter. Despite this meaningful decline, the recovery of lower credit tiers will likely trail that of higher-rated peers. One reason is the pressure to service excessive debt, which limits issuers' capacity to fund future growth initiatives. Also, there is a discernable bias toward smaller companies among lower-rated entities. Smaller business borrowers lack the funding options and the lender depth that their larger peers enjoy. Some public companies were able to access the equity market to obtain fresh financing at attractive costs. For example, AMC Entertainment Holdings Inc., helped by retail investors' enthusiasm for meme stocks, has raised about $1.83 billion in total equity so far this year. The liquidity infusion, combined with expected improvement in theater attendance, resulted in a two-notch upgrade in June. Our positive rating outlook indicates the potential for another upgrade if AMC prioritizes its sizable cash balance toward debt repayment. For small companies, loan funding is the principal source of outside capital.
  • The leverage of 'B-' rated companies still runs a full turn above its 2019 record. Significant challenges lie ahead: Constrained labor supply, erratic commodity price movements, soaring transportation cost, and supply chain disruptions all could dampen any further acceleration of economic recovery and pressure smaller borrowers that are price takers.
  • Improvements in first-quarter 2021 center on sectors most exposed to consumer demand: chemicals, consumer products, and health care. In fact, leverage for chemical companies declined to the lowest level since late 2019. We expect demand for chemicals will continue to rise as economies across the globe reopen and GDP recovers. The strong demand this year will make it easier for companies to pass on higher input costs to customers.
  • Telecommunications and technology are among the least disrupted by COVID-19, evidenced by having the smallest swings of median LTM leverage. Leverage for each sector increased about 0.5x within our observation period.
  • The technology sector remains of high interest among sponsors and lenders. The modest uptick in sector leverage observed in the first quarter coincided with a surge of first-time software and services issuers. About 18% of new corporate issuers in the U.S. and Canada in the first quarter came from the technology sector (16 in software and services, two each in semiconductors and tech equipment, chart 1). Further, there has been less caution from lenders regarding leverage levels as these companies are often cited for their predictable and sustainable revenue business models.

Table 1

Median Gross Leverage Transition By Credit Rating
Third-quarter 2019 to first-quarter 2021
Median gross leverage (x)
Issuer credit rating* Entity count Third-quarter 2019 LTM 2019 First-quarter 2020 LTM Second-quarter 2020 LTM Third-quarter 2020 LTM 2020 First-quarter 2021 LTM
BB+ 100 3.2 3.3 3.5 3.6 3.5 3.2 3.0
BB 106 3.3 3.3 3.6 4.1 3.9 3.7 3.8
BB- 107 3.6 3.6 3.9 4.0 4.3 3.8 3.7
B+ 133 4.8 4.8 5.1 5.6 5.3 5.2 5.0
B 242 5.7 5.6 6.1 6.3 6.1 5.9 5.5
B- 294 7.6 7.6 8.5 9.0 8.9 9.2 8.7
CCC+ 110 8.5 8.6 9.7 12.9 13.7 14.0 14.3
CCC 21 12.6 11.5 13.1 20.6 29.2 14.9 16.7
CCC- 8 10.9 11.9 13.3 17.5 19.6 19.9 19.0
CC - N.A. N.A. N.A. N.A. N.A. N.A. N.A.
Total 1,121 5.5 5.4 6.1 6.7 6.5 6.3 6.1
Ratings as of June 22, 2021. LTM--Lagging 12 months. N.A.--Not applicable. Source: S&P Global Ratings.

Table 2

Media Gross Leverage Transition By Industry
Third-quarter 2019 to first-quarter 2021
Median gross leverage (x)
Industry Entity count Third-quarter 2019 LTM 2019 First-quarter 2020 LTM Second-quarter 2020 LTM Third-quarter 2020 LTM 2020 First-quarter 2021 LTM
Aerospace/defense 27 5.2 4.8 5.0 6.2 5.5 5.6 6.1
Auto/trucks 32 3.7 3.7 4.2 6.6 6.3 5.3 5.0
Business and consumer services 89 6.6 7.1 7.3 7.5 7.5 7.0 6.8
Capital goods/machine and equipment 128 5.7 5.8 6.2 6.3 6.3 5.5 5.8
Chemicals 47 5.2 5.3 5.5 6.6 6.0 6.0 5.2
Consumer products 106 6.0 6.1 6.6 6.4 5.8 6.1 5.5
Forest product/building materials/packaging 42 4.4 4.4 4.6 4.0 3.9 3.6 3.8
Health care 98 6.9 6.9 7.8 7.9 7.5 7.5 6.8
Media, entertainment, and leisure 148 5.5 5.3 6.2 8.0 8.1 7.5 7.4
Mining and minerals 48 3.0 2.9 3.3 4.0 4.3 4.5 4.1
Oil and gas 67 2.5 2.9 3.0 4.2 5.4 5.1 5.5
Restaurants/retailing 81 4.0 4.4 4.9 6.9 6.0 6.1 5.9
Real estate 32 7.1 6.9 7.7 7.7 8.2 7.9 7.5
Technology 101 7.3 7.6 8.0 7.9 7.4 7.4 7.7
Telecommunications 44 5.0 5.2 5.3 5.1 5.1 4.9 4.6
Transportation 31 4.7 4.6 5.0 6.9 8.5 7.2 7.5
Total 1,121 5.5 5.4 6.1 6.7 6.5 6.3 6.1
LTM--Lagging 12 months. Source: S&P Global Ratings.

Chart 1


The COVID-19 Pandemic Has Been More Than A Hiccup

  • On the downside, the pandemic has caused long-term damage across the board, such that median LTM leverages increased 0.8x year over year in 2020 on the whole and as much as eightfold in the bottom tier 'CCC-' (albeit a small population, tables 3 and 4).
  • The largest increase came from the most vulnerable 'B-' (a 0.7x year-over-year increase) and 'CCC' ('CCC+'/'CCC'/'CCC-') categories (year-over-year increase of 4.8x-8.0x). While the number of 'CCC' category-rated companies in the U.S. and Canada has declined to a 15-month low, the remaining 'CCC' rated companies are facing crushing debt loads. The gap between this segment and the higher-rated entities has widened significantly over the pandemic.
  • Unsurprisingly, leverage deterioration is most pronounced among the pandemic-battered sectors for which EBITDA of many turned negative for consecutive quarters. Leverage of the media, entertainment, and leisure sector, which contains companies that were severely hurt by social distancing such as cruise operators, movie theaters, and hotels, experienced the largest spike of three turns and only recently started to see signs of life.
  • Transportation in general suffered during the pandemic, but airlines took the biggest hit as people stayed home, with LTM EBITDA falling an average of 150% year over year in 2020.

Table 3

Median Gross Leverage By Credit Rating
2019 compared to 2020
Median gross leverage (x)
Issuer credit rating* Entity count 2019 2020
BB+ 103 3.2 3.2
BB 113 3.4 3.8
BB- 113 3.5 3.7
B+ 148 4.7 5.2
B 294 5.6 5.8
B- 388 7.8 8.5
CCC+ 125 8.4 13.1
CCC 34 9.9 17.3
CCC- 8 11.9 19.9
CC 0 N.A. N.A.
Total 1,326 5.6 6.4
Ratings as of June 22, 2021. N.A.--Not applicable. Source: S&P Global Ratings.

Table 4

Median Gross Leverage By Industry
2019 compared to 2020
Median gross leverage (x)
Industry Entity count 2019 2020
Aerospace/defense 30 4.7 5.5
Auto/trucks 41 4.0 5.9
Business and consumer services 108 7.2 7.0
Capital goods/machine and equipment 144 6.0 6.2
Chemicals 48 5.3 5.8
Consumer products 127 6.3 5.9
Forest products/buildingg materials/packaging 53 4.6 3.9
Health care 127 7.0 7.7
Media, entertainment, and leisure 181 5.3 8.3
Mining and minerals 52 3.1 4.9
Oil and gas 76 3.0 5.0
Restaurants/retailing 91 4.5 5.9
Real estate 33 7.0 7.8
Technology 126 7.7 6.9
Telecommunications 54 5.7 5.0
Transportation 35 4.6 7.2
Total 1,326 5.6 6.4
Source: S&P Global Ratings.

Loan-Only Issuers Exhibit Credit Profiles Different From Those Of HY-Only Issuers

A comparison of the data groups by funding source revealed significant variations in size, credit quality, and leverage reduction patterns for the loan-only and HY-only groups:

  • Our review showed differences in leverage for the loan-only and HY-only groups, with the mixed-debt-structure group's leverage numbers falling in between.
  • Loan-only issuers that we identify on the basis of our rated debt structure are clearly skewed toward small and midsize companies. About 30% of loan-only issuers generated EBITDA of less than $50 million in the 12-month period ended March 31, 2021, compared to only 14% of the HY-only issuers. In fact, more than 20% of the HY-only issuers generated EBITDA of more than $500 million.
  • Similarly, loan-only issuers tend to fall on the lower end of the credit quality scale with ratings closer to 'B' or 'B-', compared to HY-only issuers, which we typically rate closer to 'BB+' or 'BB'.
  • Loan-only issuers have lower recovery expectations in a default scenario (as measured by our recovery ratings and point estimates) on their first-lien debt, reflecting the impact of both higher debt leverage and thinner or no cushions of junior debt.
  • The median LTM leverage levels for the loan-only group has shrunk since the latter half of 2020. In comparison, the median figures have barely changed for the HY-only issuers, which, when combined with their broadly better credit quality, suggest that these companies are likely more content with current levels of leverage. In other words, HY-only issuers feel less pressure to immediately reduce debt. As a result, the gulf between the two groups has narrowed to mid-2x from 3x-plus as we moved through the observation period.

Chart 2


Chart 3


Chart 4


Most Cash Has Yet To Be Deployed

  • Companies are building up and preserving cash (chart 5). The median size of cash reserve (including cash, cash equivalents, and short-term investments) is running about 175% above the year-end 2019 level after having remained elevated during the pandemic.
  • Record tight credit spreads have reduced the opportunity cost of hoarding cash. Healthy cash reserves mean more headroom for absorbing demand volatilities and provide a guard against credit tightening. We see most companies being prudent about their post-pandemic strategies to allow for some level of financial flexibility.
  • Decisions around financial policy influence credit quality and the potential direction of rating actions, particularly for borrowers on the cusp between two ratings. Currently favorable funding rates may continue to make more-aggressive financial strategies, such as shareholder distributions and debt-financed acquisitions, appealing, and they may limit improvements to credit statistics and ratings.
  • Total debt reached new high in the first quarter of 2021. This is attributable in part to new issuers being added to the sample set at a record pace. The latest additions include borrowers returned from a Chapter 11 restructure such as car renter Hertz Global Holdings Inc. and guitar manufacturer and distributor Gibson Brands Inc. Tightening lending spreads and robust liquidity in the system should encourage continued high leverage borrowing, especially in the recession-resistant sectors such as technology, as noted earlier in the section about leverage transition.

Chart 5


First-Lien New-Issue Recovery Lingered In The Lower Half Of Its Multiyear Range

Recovery expectations on newly issued debt vary quarterly based on supply-demand conditions and the mix of issuers during the period. Chart 6 illustrates the quarterly trends of our recovery expectations for first-lien new issues, measured by the average recovery point estimates. Recovery estimates have predominantly hovered around the low- to mid-60% area over the past few years, with the latest cohort only drifting marginally higher from the historic low. The quarterly averages slumped to an all-time low of 62% at the end of 2020, after peaking at 71% in the second quarter.

While interest rates remain low, the market now expects rates to pick up over the next few years. That means floating-rate instruments such as leveraged loans, which have already benefited from strong collateralized loan obligation (CLO) formations, are becoming more attractive to investors. This may lead to a continuation of accommodative loan markets, with more aggressive structures (i.e., high leverage), which generally results in less promising recovery prospects, because recovery expectations generally fluctuate inversely with shifts in investor risk tolerance. That said, the magnitude of quarterly swings of average recoveries has been fairly rangebound over the past four years and may not deviate significantly from prior-year levels.

Chart 6


Breaking down by the trends by recovery rating category, we expected more than 60% of new issuance by count--or 213 new issues in the second quarter--to recover 50%-70% in a payment default, equating to a '3' recovery rating (chart 7). A much smaller share (31%) of new issuance was expected to recover 70% or more ('1' [90%-100%] or '2' [70%-90%] recovery ratings), which is substantially lower than would be expected based on historical norms with average recoveries for first-lien debt of 70% or higher. Our study of U.S. corporate debt recoveries found that about two-thirds of the first-lien debt of the companies that defaulted between January 2008 and June 2020 achieved 70% recovery or higher. We attribute the decline in first-lien recovery expectations to the influx of highly leveraged new issuers in recent years and an increasing reliance on first-lien debt, including first-lien-only debt structures and a shrinking cushion of junior debt where it still exists.

Chart 7


Related Research

Editor: Tracy M. Cook

This report does not constitute a rating action.

Primary Credit Analyst:Hanna Zhang, New York + 1 (212) 438 8288;
Secondary Contacts:Robert E Schulz, CFA, New York + 1 (212) 438 7808;
Steve H Wilkinson, CFA, New York + 1 (212) 438 5093;
Olen Honeyman, New York + 1 (212) 438 4031;
Research Contributor:Maulik Shah, CRISIL Global Analytical Center, an S&P affiliate, Mumbai
Analytical Group Contact:Ramki Muthukrishnan, New York + 1 (212) 438 1384;

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