Amid continued focus on deteriorating credit quality in the U.S. leveraged loan market, borrowers remain relatively well-positioned to service the growing amounts of debt they’re incurring, according to one important metric.
The share of loan issuers with an interest coverage ratio of less than 1.5x – a level typically indicative of a company that is struggling to service debt – just hit its lowest level since late 2012, when LCD began tracking this statistic on a quarterly basis. A slim 3% of issuers in the S&P/LSTA Loan Index now have an interest coverage ratio below that level.
By way of comparison, at the height of the financial crisis – at year-end 2008 – the share of issuers with an interest coverage ratio below 1.5% was 18% (before 2012 LCD tracked this data on an annual basis, not quarterly).
Roughly defined, interest coverage is a company’s earnings, divided by the interest payments on debt that are due.
One reason interest coverage is relatively high: Earnings continue robust. Buoyed by tax cuts passed late last year, EBITDA growth for companies underlying the Index hit 9.25% in the first quarter, up from 5% in the fourth quarter, according to LCD. That’s the highest since the third quarter of 2014.
This relatively bullish take might surprise market bears who see the widespread acceptance of covenant-lite loans, and other examples of easing credit structure in the $1 trillion U.S. leveraged loan market, as nothing short of a pale horse on the economic horizon.
Some concern is warranted, of course. With almost 80% of loans underlying the S&P/LSTA Index now cov-lite there is broad expectation that, when the current, long-running credit cycle finally turns, recoveries on cov-lite loans that default will indeed be less than seen on traditionally structured deals.
The questions, of course, are how severely will loan defaults spike, and how impacted will recoveries on those cov-lite loans be? – Staff reports
This story was abstracted from analysis by LCD’s Rachelle Kakouris
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