Four corporate bankruptcy filings in June lifted the default rate of the Morningstar LSTA US Leveraged Loan Index to 1.71% by amount, from 1.58% in May.
The default rate is up 143 basis points from where it stood a year ago and has moved within 15 bps of its 10-year average of 1.86%.
Note that the 10-year average by amount is elevated by the nearly $20 billion, 2014 default from Energy Future Holdings (formerly TXU), the largest default in the history of the index.
By issuer count, the default rate at 1.86% has already surpassed the 10-year average of 1.57%.
The four bankruptcy filings in June brought the trailing 12-month default volume total to $24 billion, the highest it’s been since April 2021.
The default rate is of course coming off post-pandemic lows, but defaults are nevertheless rising at a pace not seen since the pandemic. Climbing 99 bps over the past six months, this is the largest increase to the 12-month trailing rate on a six-month basis since October 2020 following a wave of Covid-19 related defaults.
Prior to 2020, the last time default rates rose this much over a six-month period was during the fall of 2014. With that said, the current default rate is still well below the long-term historical average at 2.7% (since 1998).
In this advance from a record low default rate of 0.26% (by issuer count) just 14 months ago, non-sponsored companies continue to default at a higher rate than their sponsored counterparts, though the differential narrowed In June. The loan default rate for sponsored companies in June was 1.49%, which compares to a rate of 2.42% for non-sponsored. (LCD’s criteria does not include distressed exchanges, which are more likely to preserve the equity stake held by private equity owners and their control of the company, a particular pain point for PE firms during market downturns).
Among the defaults, ATM maker Diebold Nixdorf on June 1 filed for Chapter 11 in bankruptcy court in Houston, placing two index loans totaling $934 million into non-performing status just six months after it closed an out-of-court debt restructuring.
Leading up to the bankruptcy petition, the company said it continued to face liquidity headwinds throughout 2022. In its court disclosure statement, Diebold cited changes in operations and sales due to Covid-19 supply chain disruptions and rising inflation that raised manufacturing costs, further reduced net income and contributed to an order backlog that grew to $1.3 billion by the end of 2022.
Also on the chopping block, data operator Cyxtera Technologies filed for bankruptcy in New Jersey, citing significant headwinds from inflation and macroeconomic volatility, which have driven up interest rates and energy prices.
Inflation swelling in 2021 and 2022, and the Federal Reserve reacting by raising interest rates at the fastest pace in decades, “contributed to the ballooning of annualized interest expense on funded debt from $35.9 million in Q1 2022, to $75.7 million in Q1 2023,” Cyxtera stated in court documents.
Furthermore, these challenges, along with the impending maturity of the company’s revolving credit and term loans, placed increasing pressure on Cyxtera’s capital-intensive business, straining the company’s liquidity profile and ability to invest in the business, the company said.
Cyxtera placed its $815 million term loan as part of a financing package that funded a leveraged buyout by a consortium led by BC Partners and Medina Capital.
GenesisCare, which is backed by KKR and China Resources (Holdings), filed for Chapter 11, also on June 1, marking the second healthcare portfolio company of KKR’s to be put into bankruptcy in the space of one month.
High debt levels stemming from the company’s 2020 purchase of 21st Century Oncology and rising borrowing costs (despite some hedging) slowed demand for the company’s services, according to its bankruptcy filing, which also cited labor and supply shortages resulting from the Covid-19 pandemic and synergies that failed to materialize.
In addition to the company’s $350 million term loan B due 2027 (L+500, 1% floor), GenesisCare in 2020 also placed a €500 million term loan B due 2027 (E+475, 0% floor) to back its buyout of 21st Century Oncology. As a constituent of the Morningstar European Leveraged Loan Index, the GenesisCare bankruptcy, along with Diebold Nixdorf’s Chapter 11 filing, lifted the default rate of the ELLI to 1.45% by issuer count, the highest level since September 2021.
Finally, slot machine operator Lucky Bucks filed for Chapter 11 in Delaware bankruptcy court, placing its term loan B due July 2027 (L+550, 0.75% Libor floor), with $520 million outstanding, into default. According to the court disclosure statement, while the company historically enjoyed strong economic growth, numerous macro-economic challenges in 2022 significantly impacted its business and financial performance. “In particular, rising interest rates, an end to federal stimulus programs implemented in response to the COVID-19 epidemic, and historic inflation negatively affected the discretionary income of coin operated amusement machine (COAM) customers and the associated demand for COAM gaming,” the document reads. Lucky Bucks was also adversely impacted by increased regulatory enforcement within the industry, court documents state.
Stress signals
Looking at stress indicators in terms of future default activity, the share of performing loans priced below 80 eased significantly in June, as loans rallied to raise the weighted average bid of the index 135 bps on the month. The share of loans priced between 98-99 cents on the dollar jumped to 53% of the index, from 36% at the end of May.
That said, when looking at the volume of distressed loans in the performing index, versus the end of 2022, a large chunk of the decline is due to default activity. At the end of 2022, $103 billion of performing loans were priced below 80. At the end of June, this had fallen to $83 billion, however, more than $15 billion of that reduction comes from defaulted loans leaving the calculation.
With the amount of performing loans priced below 80 at $83 billion, the distress ratio fell to 6% at the end of June, from 6.74% in May.
Across the industries, Software and Healthcare Providers & Services, as large index sectors, were leading in the share of index loans below 80. Software in June took top billing, accounting for 21.9% of index loans below 80. Healthcare Providers & Services fell from top place in May, to second billing in June, making up 18.2% of index loans below 80.
In another measure of credit conditions, downgrades outpaced upgrades for a 13th consecutive month in June (on a rolling three-month basis), though the pace of downgrades over upgrades eased to 2.37x, from 2.85x in May.
With the downgrade activity continuing to outpace upgrades, 36% of the Index consists of borrowers rated B-minus or lower, a record high, up from 35% at the start of the year and 31.5% a year ago (excluding D rated loans). At the end of 2019, before the pandemic wave of downgrades, and later, a substantial risk-on wave of lower rated issuance, the share of the index rated B- of lower was 25%.
Turning to the landscape of debt coming due, the recent spate of refinancing efforts, combined with amend-to-extend activity, has helped borrowers to reduce 2024 maturities by more than half in the year to June 30. However, the amount coming due in the next two to three years remains more than any other comparable period at the 2Q mark. Moreover, roughly 52% of those loans coming due in the next two years belong to borrowers rated B-minus (and lower), where financing costs (for those with access to the broadly syndicated market), once again neared double digits in June.
As a final read of market sentiment as far as the trajectory of loan defaults is concerned, LCD once again polled market pros to ask for their view on what to expect in the year ahead. LCD’s quarterly Leveraged Finance Survey shows a median expectation that the trailing 12-month loan default rate (as measured by the Morningstar LSTA US Leveraged Loan Index) will be between 2.5% and 2.99% one year from now.
At the 2.75% midpoint, this would push the loan default rate slightly above its 2.7% historical average.
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