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Default, Transition, and Recovery: The U.S. Leveraged Loan Default Rate Could Hit 2.5% By March 2024 Given Persistent Inflation And Higher Interest Rates


Macroeconomic conditions are weighing on issuer operating performance, further constraining credit liquidity for speculative-grade issuers. From February to April 2023, seven leveraged loan issuers defaulted in the index, pushing the default rate to 1.42%.

Through the middle of May, three more issuers in the index have defaulted, bringing the year-to-date tally to 12--up from just one during the same period a year ago. These defaults were largely due to either an inability to refinance debt due to restrictive primary markets or deteriorating credit liquidity given thinner cushions for some speculative-grade issuers, particularly at the lowest rating levels. We expect these risks to build later this year.

We expect the leveraged loan default rate to climb further over the next 12 months and hit the historical average of 2.5% by March 2024. To reach our base forecast, 29 issuers in the index would need to default (see chart 1).

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Differences In Default Rate Measurements

The high proportion of selective defaults in the U.S. has kept the broader speculative-grade corporate default rate higher than the leveraged loan index default rate. This is because the definition of default for the leveraged loan index is much narrower.

There are differences in the definitions of default for each default rate series and forecast we analyze in our reports. The S&P Global Ratings definition of default determines the U.S. trailing-12-month speculative-grade corporate default rate.

Leveraged Commentary & Data's (LCD) definition of default determines the Morningstar LSTA U.S. Leveraged Loan Index trailing-12-month default rate by number of issuers. This definition of default only includes defaults on loan instruments and excludes selective defaults from distressed debt exchanges. The differences in default definitions are important sources of variation between the two series (see table 1).

Table 1

Summary of differences in default definitions
S&P Global Ratings Definition Morningstar LSTA US Leveraged Loan Index Definition
Issuer files for bankuptcy (results in a 'D' rating) Issuer files for bankruptcy
Issuer missed principal/interest on a bond instrument (results in a 'D' or 'SD' rating)* Issuer downgraded to 'D' by S&P Global Ratings
Issuer missed principal/interest on a loan instrument (results in a 'D' or 'SD' rating)* Issuer missed principal/interest on a loan instrument without forbearance
Distressed exchange (results in a 'D' or 'SD' rating)
The baseline March 2024 forecast for the U.S. trailing-12-month speculative-grade corporate default rate is 4.25% The baseline March 2024 forecast for the Morningstar LSTA U.S. Leveraged Loan Index default rate by number of issuers is 2.50%
*Under the S&P Global Ratings defintion, an issuer is considered in default unless S&P Global Ratings believes payments will be made within five business days of the due date in the absence of a stated grace period, or within the earlier of the stated grace period or 30 calendar days.

Table 2

Morningstar LSTA U.S. Leveraged Loan Index issuers by rating category compared to all speculative-grade issuers
Rating category All speculative-grade issuers (%) Morningstar LSTA U.S. Leveraged Loan Index rated issuers (%)*
BB 29.50 20.72
B 58.82 69.73
CCC/C 11.68 8.47
B- or lower 37.52 39.82
Data as of Apr. 30, 2023. *The index includes some issuers rated in the 'BBB' category. Sources: Leveraged Commentary & Data (LCD), S&P Global Market Intelligence's CreditPro®, and S&P Global Ratings Credit Research & Insights.

How We Determine Our Default Rate Forecasts

The Morningstar LSTA U.S. Leveraged Loan Index default rate forecasts are based on recent observations and expectations for the path of the U.S. economy and financial markets. Among various factors, we consider our proprietary analytical tool for the Morningstar LSTA U.S. Leveraged Loan Index issuer base. The main components of the analytical tool are the U.S. trailing-12-month speculative-grade corporate default rate, the ratio of selective defaults to total defaults, a leveraged loan debt-to-EBITDA ratio, the Morningstar LSTA U.S. Leveraged Loan Index distress ratio, changes to the mix of rated loans toward higher or lower ratings, and the unemployment rate.

Related Research

This report does not constitute a rating action.

Ratings Performance Analytics:Nick W Kraemer, FRM, New York + 1 (212) 438 1698;
Jon Palmer, CFA, Austin 212 438 1989;

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