The second quarter brought a new look at the fallout from the COVID-19 crisis for leveraged loans in the United States as rating damage hit record high and the first of pandemic-related defaults began to be felt.
Second-quarter institutional loan default activity – the type bought by CLOs – although rising rapidly and surpassing previous stages, was largely dominated by pre-pandemic situations.
A record 11 defaults in April totaling $ 6.90 billion, followed by a six-year monthly high of 10.54 billion defaults in May, ultimately helped push the S&P Leveraged Loan Index up / LSTA above its historical default average of 2.85% for the first time since 2015.
The $ 5.70 billion in defaults in June brought the second quarter total to $ 23.1 billion for 27 index issuers, the highest quarterly volume since the first quarter of 2009.
At the level of issuers, at 3.70%, the default rate is the highest since September 2010 and compares to 2.02% in the first quarter of the year. Looking for quick loan? Go to https://oakparkfinancial.com/
In rising, the default rate ended the second quarter at a five-year high of 3.23%, up sharply from 1.84% at the end of the first quarter.
Among the companies affected by COVID-19 that defaulted during the quarter, Hertz Global Holdings Inc., Cirque du Soleil inc., 24 hours of fitness, Wood energy from the fields, Technicolor, CEC Entertainment Inc. (Chuck E Cheese), and Covia (Fairmount Santrol), each of which was classified as a single or double B capacity before the global outbreak.
Large capital structures of Intelsat at Frontier Communications Corp. also folded. The former did so to ease its nearly $ 15 billion in funded debt and facilitate participation in the C-band accelerated spectrum clearing, the latter to ease its $ 17.5 billion debt burden, contracted in large part thanks to a wave of acquisitions. over the past 10 years.
Retail also added to the list of milestones achieved this quarter with defaults from leading chains J.Crew Group Inc. and JC Penney pushing the default rate to the retail sector level at a record level of 13.64% in May.
Telecommunications have been the main contributor to defaults over the past three months at 20.3%, followed by oil and gas at 13.3% and retail at 12.4%.
Prepare for impact
While the crisis may not yet show significant default activity, as a leading indicator, the impact of a few record months of downgrading is expected to manifest itself in an increase in default rates.
Until June, 35% of the loan market, in terms of nominal outstandings (at the facility level), had received a downgrade, representing $ 411.1 billion out of the $ 1,169 billion of rated loans. at the end of 2019.
On a three-month rolling calculation, the credit facility count in the S & P / LSTA Leveraged Lending Index exceeded the 43-1 leveling rate in May, before slowing from that all-time high to 18.4 times in June.
During the global financial crisis, the three-month rolling number in favor of downgrades peaked at just 8.45x.
Perhaps most importantly, as mentioned earlier, increasing downgrades usually precede a period of increasing defaults. The attached graph shows the historical development of the default rate and the downgrade / upgrade ratio. The downgrade / upgrade ratio was on average 2.7x in the six months preceding the default peak of November 2009 at 8.25% (on an issuer basis).
The fallout from this massive assault on downgrading is manifold. CLOs are breaking their structural limits for the lowest rated debt, with impressive numbers. The revaluation of downgraded corporate debt and the growing challenge for substandard loans to find housing will undoubtedly make traditional financing more prohibitive for these issuers, while the quality mix of ratings in the debt market leverage continues to deteriorate.
While the number of credit facility downgrades by S&P Global Ratings slowed to 90 in May and 50 in June, it followed a record 228 downgrades in April and a previous record of 114 in March. Even with the full effects of COVID-19 and its damage to the global economy as yet unknown, the past four months alone have surpassed the total of 364 loans for the year 2019 by 32%.
This figure was up from 244 in 2018 and 231 in 2017.
Of all the downgrades in the second quarter, by number of emissions, the highest figures come from equipment and business services (12.23%), leisure (10.05%) and industrial equipment (8.15% ). Since the start of the year, leisure has led the decommissioning activity, at 11.67%, although it only represents 4.09% of the index by number of loans.
automobiles and hotels and casinos, meanwhile, were not among the top 15 decommissioned sectors before the COVID-19 crisis. The respective decommissioning actions since the start of the year are now 4.44% and 4.26%.
This downgrade cycle has also worsened the credit rating composition of the leveraged loan market, with the share of issuers of the S & P / LSTA leveraged loan index rated B- or less climbing to 33.8% on the 26th. June, the highest figure on record.
This figure was only 10% five years ago.
Loans with issuers rated CCC, CC or C, a particular problem for secured loan bonds, represent a record 11% of the index, well above the market’s 2.9% five years ago.
The distress eases
In other forward-looking indicators, the distress ratio has remained high for most of the past three months. However, thanks to a rise in risk prices in late May-early June and the loan guarantee cushion against the outperformance of high yield bonds, distress levels have come a long way since peaking 57% on March 23.
After an average of nearly 20% in April and 15% in May, only 8% of healthy loans were rated below 80 at the end of June. This compares to 4% at the end of 2019.
Among the sectors with a more significant index share (above 1%), oil and gas, leisure and non-food retail trade show the highest distress ratios at the sector level.
This review was written by Rachelle Kakouris, LCD Research