Leveraged loan default rate and distress ratio climb amid volatility

Courtesy of bankruptcy filings cineworld and Phoenix Services raised the default rate of the Morningstar LSTA US Leveraged Loan Index to 0.90% by principal amount. This is the highest level of default rates since June 2021, as the market moves away from post-crisis record highs and distress levels rise.

By issuer count, the default rate, at 0.85%, is up from a record high of 0.26% in April.

LCD’s criteria for default rates exclude troubled exchanges.

Propelling the volume of defaults in September, Cineworld became the largest index default since McDermott International in 2020, putting $3.49 billion in term loans out of business.

Just two years before the Covid outbreak, Cineworld had taken on $4.1 billion in debt to fund the Regal acquisition. Hit by a significant deterioration in the company’s operational and financial performance as pandemic-related shutdowns persisted, the company ultimately filed for Chapter 11 protection in Houston bankruptcy court, citing a total financial debt of $5. $.35 billion and an additional $4 billion in lease commitments as of the Sept. 7 petition date.

Cineworld is held in 40% of US CLO portfolios, according to Fitch.

Also triggering an index default, Phoenix Services, a steel mill service provider, filed for Chapter 11 reorganization in Delaware bankruptcy court.

According to bankruptcy court filings, the company’s customer contract portfolio has become unprofitable in recent years due to cyclical industry headwinds, including inflation and rising fuel costs, that drove down new business yields; existing contracts with sub-optimal terms; and low-key operational challenges at company sites.

The filing adds that the cash pressure this has placed on the company has been compounded by the company’s capital lease payments, rising interest rates and the company’s inability to fund its large capital expenditures. capital.

S&P Global Ratings downgraded the company to CCC+ in late April, and Moody’s downgraded it to Caa1 in mid-May, with both agencies citing declining results. The company said it would use Chapter 11 proceedings to renegotiate major customer contracts ahead of a reorganization plan that includes “significant deleveraging and new capitalization.”

Phoenix placed its (originally) $465 million senior term loan in 2018 to support Apollo’s acquisition of the company.

Technical distress
Looking at the state of play for potential trouble down the line, the volume of leveraged loans performing at a price below 80 cents on the dollar (an anecdotal marker of distress that turned out to be a leading indicator from increased default activity) rose dramatically in what was a grueling month for risk assets in September.

LCD data shows nearly $83 billion of performing loans in the Morningstar LSTA US Leveraged Loan Index were valued at less than 80 cents on the dollar on Sept. 30. To put that into perspective, this is the highest volume of loans at distressed levels since July 2020 — two months before the default peak of September 2020.

This translates to nearly 6% of the index’s performing loans now being priced below 80, down from 3% at the end of August. In number of transmitters, the distress ratio jumped to 6% in September, against 4% in August.

Loans priced below 90 cents on the dollar — indicating both idiosyncratic risk and broader market stress — now make up nearly 20% of the index. At the end of 2021, just over 2% of the index fell below this level.

At the sector level, Internet retail and direct marketing, household durable goods, IT services, healthcare providers and services, and beverages occupy the top five spots for loans below the 80 threshold.

Continuing a downward trend in rating metrics, downgrades outpaced upgrades for a fourth consecutive month, on a rolling three-month basis (a 16 month upgrade cycle for the asset class shattered in June). Again, on a rolling three-month basis, the downgrade of lending facilities in the Morningstar LSTA US Leveraged Loan Index topped upgrades of 2.28x in September, from 1.89x in August, 1.74x in July and 1.32x in June.

A final note on the risk profile of leveraged loans — borrowers from the the riskiest rung of the single B rating bucket now accounts for the largest share of the US$1.43 trillion leveraged loan asset class. This is the first time this has been the case in the Morningstar LSTA US Leveraged Loan Index’s 25-year history.

Sallie R. Loera