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US Leveraged Loan Default Rate Holds at Low 1.97%

After a blemish-free July, the default rate for U.S. leveraged loans continues stubbornly low, holding at 1.97%, according to LCD.

The rate has been inside the historical norm of 3.1% since early in 2015, when the behemoth TXU/Energy Future default, which entailed more than $20 billion of outstanding loan debt, was part of the calculation (that issue dropped off the 12-month roll in April 2015).

U.S. leveraged loan defaults have remained scarce as the current issuer-friendly credit cycle heads into its tenth year.

One reason for the lack of defaults: corporate earnings continue robust, enabling borrowers to service debt they incur (unless they refinance it, of course).

Speaking of refinancing: Easy access to leveraged loans is another reason defaults have been rare.

With interest rates rising, institutional and retail investors have been throwing cash into this floating-rate asset class, allowing issuers to quickly refinance existing debt or – more alarming to some – structure the credits with few restrictions. In theory, these covenant-lite loans could allow borrowers to gloss over poor financial performance, with little warning for investors, until the company defaults. – Staff reports

This story was abstracted from analysis by LCD’s Rachelle Kakouris

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Covenant-lite Leveraged Loans: After Default, Whither Recoveries?

Covenant-lite has been the talk of the leveraged loan market for a while now.

Specifically, when the current, long-running credit cycle finally turns, how much less will investors recover on these loosely structured deals, if they end up in default, than on defaulted loans offering traditional safeguards?

covenant-lite loan recoveries

It is far from an academic question. Right now roughly 78% of the more than $1 trillion in outstanding U.S. leveraged loans are cov-lite, compared to just 29% in 2007, at the peak of last credit cycle (and just before the financial crisis).

Cov-lite loans place fewer restrictions on a borrower than do traditionally structured credits. They have soared in popularity over the past few years as institutional and retail investors have poured tens of billions into the U.S. leveraged loan asset class, looking to take advantage of continued rate hikes by the Fed – leveraged loans are floating rate – and, recently, a steady rise in LIBOR.

For a glimpse into how the current cov-lite market dominance might hinder recoveries on leveraged loans in cases of default, LCD looked at average recoveries on cov-lite credits undertaken prior to 2010 – before the financial crisis – and those undertaken after 2010 (so-called cov-lite 2.0), using data from LossStats.

While the data set for recent-vintage cov-lite loans that have entered and emerged from the default/distressed exchange/bankruptcy processes is necessarily thin – leveraged loan default rates have been stubbornly low for much of the current credit cycle – it offers insight into how today’s cov-lite loan binge might impact recoveries.

Specifically, the average discounted recovery rate on cov-lite loans undertaken before 2010 is 78%. That figure drops to 56% for cov-lite loans originated in 2010 and after, according to LossStats.

For purposes of this analysis LCD has used discounted, as opposed to nominal, recoveries. Because restructurings can last years (and years), eliminating the noise of time is important to maintain comparability. The discounted recovery time-values the nominal recovery back to the date of default using the pre-petition default rate, normalizing recoveries over long periods of analysis, and creating parity among the recovery outcomes from various events.

It is important to note, again, that the data set for cov-lite is thin indeed. There are only 40 of those defaulted instruments in total, and only 13 in the 2010-or-later pool. We should also bear in mind that this pool represents cov-lite debt that has defaulted, then recovered. The lurking danger of cov-lite is not just the risk of poor recoveries. It is also the risk of “zombie” credits that do not default, but simply limp through a prolonged downturn. The costs and risks to investors in that scenario is not captured in these recovery numbers.

That being said, there are clear indicators that cov-lite issued after the credit crunch—the 2.0 incarnation—will be more problematic in recovery than were its 1.0 predecessors.

This story is abstracted from a longer piece of analysis by LCD’s Ruth Yang, based on data from S&P’s LossStats.

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Market Pros: US Leveraged Loan Default Rate to Remain Low, but Creep Higher

us default forecast

Portfolio managers of U.S. leveraged loans expect default activity to continue its modest ascent over the next 18 months, with the long-anticipated spike above historical averages materializing in 2020, according to LCD’s latest buyside poll.

On average, managers predict the one-year-forward default rate of the S&P/LSTA Index to finish June 2019 at 2.46%, up slightly from the previous one-year-forward prediction of 2.43% polled in March, versus the current default rate by amount of 1.95%.

Managers, in the near term, say they continue to see idiosyncratic risk as the main driver of loan defaults, rather than a broad-based uptick at a systemic level.

Conducted in June before the end of the second quarter, LCD’s Default Survey also asked portfolio managers their predictions on the loan default rate at the end of 2019. The consensus estimate was 2.65% by then, a slightly more bullish read this time around, with managers reining in the forecast from 2.81% at the March reading (but keeping it close to their 2.64% prediction from December).

Historically, U.S. leveraged loan defaults have averaged roughly 3.1%.

The default rate has been of particular scrutiny over the past year or so for two important reasons. First, the current, borrower-friendly credit cycle is approaching its 10th year, an unusually long stretch. And, related, with the ubiquitousness of loosely structured covenant-lite loans in today’s market, many observers are concerned that, once the credit cycle does turn, defaults could pile up quickly, as traditional protections for lenders/investors – a set of covenants – no longer are routinely structured into loan agreements. – Rachelle Kakouris

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Leveraged Loan Experts Hike US Default Rate Expectations

default rate forecasts

Portfolio managers in the U.S. leveraged loan market have raised their forecasts for near-term default rates by almost 20 bps since the last quarterly survey, though few expect the historical average of 3.1% to be surpassed before the end of next year.

According to LCD’s Default Survey, conducted at the end of each quarter, the consensus now calls for a one-year forward default rate of 2.43%, from a one-year forward rate prediction of 2.24% at the December reading.

More than 50% of loan managers surveyed raised their one-year-out default prediction, by an average of 0.42%. In fact, LCD’s quarterly survey last revealed an increase of this magnitude back in 2016—when borrowers in the oil-and-gas and metals/mining sectors were increasingly inflating the default stats.

Meanwhile, predictions for the 12-month trailing U.S. default rate by principal amount for year-end 2019 came in at 2.81%, an increase from December’s read of 2.64%.

LCD’s U.S. Leveraged Loan Default Rate Survey is conducted by Rachelle Kakouris, who covers the distressed debt market for LCD.

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US Leveraged Loan Default Rate Hits 3-Year High, Courtesy iHeart

The default rate of the S&P/LSTA Leveraged Loan Index jumped to its highest level in three years after iHeartMedia, one of the largest highly levered remnants still standing from the LBO boom, filed for Chapter 11 bankruptcy protection.

The radio giant’s highly anticipated filing included $6.3 billion of Clear Channel term loans, propelling the rate to 2.42%, from 1.7% previously, and marking the fifth largest default in the history of the Leveraged Loan Index.

iHeart default chart 1Though significantly higher than the 18-month low of 1.36% where it stood the end of July 2017, the current rate still remains well inside the 3.1% historical average.

By number of issuers, the default rate is now 1.93%, from 1.94% at the end of February.

As the table below shows, all but one of the 10 largest S&P/LSTA Index defaults on record were products of the 2006/2007 credit boom, or in the case of Energy Future Holdings and Caesars, the resultant LBO boom.

For iHeart’s part, the media giant, formerly known as Clear Channel, filed for Chapter 11 in bankruptcy court in Houston after more than a year of negotiations with its creditors with an agreement in principle to cut its $20 billion debt load by half.

According to a Form 8-K filed with the Securities and Exchange Commission, the company said it expects to formally enter into a restructuring support agreement “in short order.” Court filings show an early challenge from the legacy, pre-LBO noteholder group, is expected to the proposed restructuring deal. (See “iHeart files Chapter 11, sees challenge from legacy noteholder group,” LCD News, March 15, 2018).

As with almost all of its $20 billion debt pile, Clear Channel’s $5 billion D term loan due 2019 (L+675) and $1.3 billion E term loan (L+750) were put in place as part of the company’s 2008 buyout by Bain Capital and Thomas Lee Partners, and extended in 2013.

Finally, following iHeart’s bankruptcy filing, the default rate within the broadcast radio and television sector jumped to 33.59% by amount, from 7.23% previously.

For context, Ocean Rig and Answers Corp. rolling off the calculation has partially offset the impact of iHeart’s default, with the default rate falling from 2% at the end of February, to 1.60% at the beginning of this month upon the removal of the two issuers, and prior to this month’s defaults from iHeartMedia and Harvey Gulf. — Rachelle Kakouris

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As iHeart Looms, US Leveraged Loan Default Rate Tops 2%

US leveraged loan default rate

The U.S. leveraged loan default rate continues to hold well below historical levels, ending February at a relatively slim 2%, according to LCD.

A downgrade of gun manufacturer Remington Outdoor to D was the only default during the month (Remington had been in restructuring talks well before the resurgence of the current gun control debate in the U.S., prompted by the high school shooting in Parkland, Fla.).

Perhaps as important as the actual default rate: Radio/media concern iHeart, with some $20 billion in outstanding debt resulting from an LBO of the company in 2008, has been negotiating a debt swap for nearly a year, and there have been published reports recently saying iHeart could file as early as this weekend. That would entail some $6.3 billion of subsidiary Clear Channel debt, which would lead to a jump in the U.S. leveraged loan default rate to roughly 2.73%, according to LCD. – Staff reports

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iHeart Could Propel Leveraged Loan Default Rate to 3-Year High

iHeart story chart

iHeartMedia is widely expected to trigger a default on its $6.3 billion of Clear Channel term loans D and E after the company yesterday disclosed that it has elected not to make a $106 million Feb. 1 interest payment due to bondholders.

Hypothetically speaking, a default by Clear Channel would push the current 12-month default rate of the S&P/LSTA Leveraged Loan Index, which tracks U.S. credits, to a near-three-year high of 2.67%, from 1.94% currently.

A default by iHeart would displace Idearc as the fifth-largest default among the constituents of the S&P/LSTA Leveraged Loan Index.

The historical norm for the U.S. leveraged loan default rate is 3.1%, according to LCD. – Rachelle Kakouris

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European Leveraged Loan Default Rate Looks to Remain Low Until 2020

european leveraged loan default rate

Investors in the leveraged finance market believe defaults will remain below 2% over the next 12 months, and will not rise back to the historical average until at least 2020, according to an LCD survey of European buyside investors.

But they were also in agreement that low default rates are not necessarily a comfort, as the real risks at the moment are in weaker documentation. “Default rates are becoming less relevant because documentation is so weak,” said one respondent. “Companies won’t default as quickly, so the default rate will be lower, but recoveries will also be lower.”

Default rates for loans in the S&P European Leveraged Loan Index (ELLI) by principal amount hit a record low of 1.16% in November, the lowest point since LCD began tracking this data in 2008. This was down from 1.41% in October, and from 2.43% a year ago in November 2016. – Taron Wade

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European Leveraged Loan Default Rate Drops to Record Low

european leveraged loan default rate

In November, for the fifth month running, there were no defaults among loans in the S&P European Leveraged Loan Index (ELLI). As a result, the European leveraged loan default rate dipped to 1.16%, its lowest point since LCD began tracking this data in 2008, from 1.41% the previous month.

In the 12 months ended Nov. 30 the ELLI tracked €1.3 billion of institutional loan defaults and restructurings, down from €2.3 billion tracked at the end of 2016.

The ELLI default rate is calculated by summing up the par amount outstanding for issuers represented within the index that have defaulted in the last 12 months, and dividing that by the total amount outstanding in the index at the beginning of the 12-month period (excluding issuers that have already defaulted prior to this date).

For the purposes of this analysis, LCD defines “default” as (a) an event of default, such as a D public rating, a D credit estimate, a missed interest or principal payment, or a bankruptcy filing; or (b) the beginning stages of formal restructuring, such as the start of negotiations between the company and lenders, hiring of financial advisors, etc.

An historical low for loan defaults comes at an interesting time for the asset class. First off, the current bull-market credit cycle is chugging along in its ninth year, leading more than a few to speculate that defaults are bound to kick and (and soon).

Also, as credit market bears are fond of pointing out, part of the reason defaults remain low is that more and more issuers now take advantage of ‘covenant-lite’ loan structures, which place fewer restrictions on the borrower. Because of the cov-lite loans, issuers have much more room to maneuver in the face of financial obstacles, often putting off default proper (for a while, anyway, bears will add). – Staff reports

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US Leveraged Loan Default Rate Rises to 13-Month High

US leveraged loan default rate

With four issuers filing for bankruptcy protection in November —Pacific DrillingExGen Texas PowerCumulus Media, and Walter Investment Management—the default rate of the S&P/LSTA Leveraged Loan Index jumped to a 13-month high of 1.95%, from 1.51% at the end of October.

The rate has climbed steadily from an 18-month low of 1.36% at the end of July, but remains well inside the high of 2.17% in July 2016. By number of issuers, the default rate has increased to a 10-month high of 1.72%, from 1.41% in October.

While the rate climbed noticeably last month, loan market players remain relatively sanguine regarding defaults, and the credit cycle in general. Per LCD’s survey of North American portfolio managers and buyside players, the U.S. leveraged loan default rate likely won’t hit its historical average of 3.1% in 2019.

This quarterly survey was conducted in late September. It will be interesting to see if market players adjust their expectations for the next survey, which LCD will publish before year-end. – Rachelle Kakouris

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