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Defaults Remain Scarce but Leveraged Loan ‘Weakest Links’ Spike to New High

loan weakest links

The number of leveraged loan “Weakest Links,” or at-risk debt issuers that can be viewed as potential default candidates, spiked to 87 in 2018’s second quarter, the most since LCD started tracking this indicator in 2013. The recent figure is up from 78 in the first quarter and from 81 at the start of the year.

The second-quarter activity brings the Weakest Links share of the outstanding U.S. leveraged loan issuer universe to 7.2%, the second-highest level on record.

LCD’s Weakest Links analysis tracks the queue of at-risk credits—defined as U.S. loan issuers with a corporate credit rating of B– or lower (excluding defaults) by S&P Global Ratings, with a negative outlook or implication. The analysis is based on credits in the S&P/LSTA Leveraged Loan Index, but if a credit exits the Index it remains in the Weakest Links universe until its rating is withdrawn or until it defaults.

Of note, several high-profile consumer-related industries continue to contribute heavily to the Weakest Links, including retail and oil & gas.

As far as Weakest Links go, there is good news. Of the 78 issuers that were Weakest Links at the end of 2017, 10% (eight issuers) have been upgraded out of the Weakest Links category. Additionally, two issuers have had ratings withdrawn due to positive actions: Aricent was acquired by Altran and Caribbean Restaurants withdrew its rating after paying down debt.

The bad news: 14% (11 issuers) of those 2017 year-end Weakest Links defaulted or completed distressed exchanges in the first half of 2018. The defaulters include iHeart Communications, of course (iHeart entails $6.3 billion in Clear Channel bank debt), retailer Nine West, and two Oil & Gas producers—Fieldwood Energy and Philadelphia Energy SolutionsDel MonteProserv, and Sears each underwent distressed exchanges.

While the number of leveraged loan Weakest Links climbs, defaults in the market remain stubbornly rare. The current U.S. loan default rate is roughly 2%, according to LCD, compared to an historical average of about 3%. While a low default rate generally points to a healthy asset class, loan market detractors note the booming share of covenant-lite leveraged loans now in place, saying those credits could be especially hard hit when the credit cycle turns, and defaults surge. – Ruth Yang

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