Credit estimate (CE) volume in the second quarter of 2024 was down from Q1, but on par with Q2 2023, and new CE demand is expected to increase in the third quarter, Morningstar DBRS said in an Aug. 23 report.
At the same time, Morningstar detected a “modest deterioration” in financial metrics for new borrowers.
“In Q2 2024, the average Interest Coverage Ratio for new borrowers was approximately 1.53 times (x), a decrease from the 1.72x observed in Q1 2024,” the report said.
Revenue growth was slower, Morningstar DBRS’s CE data showed.
“In the second quarter of 2024, the year-over-year growth percentage for new borrowers and refreshed borrowers was approximately 14% and 10%, respectively, reflect[ing] an approximate decrease of 3%.”
CEs provide a lens into the possibility of borrower default in CLOs and funds. They differ from ratings in that they are “point-in-time assessments” of credit quality. These CEs include both CLOs and fund managers.
Morningstar currently assigns CEs to roughly 1,400 leveraged corporate borrowers.
“We expect new issuance volume to pick up in the third quarter as total new corporate loan borrowings in the pipeline from July and August have already surpassed Q2 2024,” said the Morningstar DBRS report entitled “Morningstar DBRS Credit Estimate Snapshot: Q2 2024 Financial Metrics Deteriorate Modestly.”
Morningstar issued and refreshed a total of 286 CEs across 279 borrowers for 26 lenders in the second quarter. New CEs made up 23% of the total. The other 77% were refreshes, which are CEs the ratings agency previously assessed for the same lender.
The relatively modest proportion of new CEs suggests that M&A activity, which drives the demand for new CEs, remains subdued.
Of the 65 new borrowers rated in Q2, approximately 82% were either assigned CE scores equivalent to B or B (low), versus approximately 70% of B or B (low) issuance for refreshes.
The share of weaker CCC-range new CEs was below the refreshes. “This is a result of higher EBITDA and slightly lower leverage seen in the new borrowers compared with refreshed borrowers,” the report said.
The report noted that upgrades and downgrades were balanced. In the second quarter, 198 out of 214 existing borrowers had an active CE from 2023, with 27 upgrades, 28 downgrades, and 143 confirmations.
“We continue to expect the ratio of upgrades to downgrades to remain around parity for the rest of 2024 as most of the underperforming borrowers had been downgraded in 2023,” the report said.
“In the first half of 2024, we observed that the median adjusted EBITDA for new CE borrowers surpassed that of refreshed borrowers by approximately $5 million to $10 million,” the report stated.
The report notes that leverage across all industries has been increasing. New borrowers have slightly lower leverage than refreshed borrowers.
Leverage on existing borrowers increased to 6.27x in the second quarter, from 5.44x in the first quarter.
As of the second quarter, median leverage for CE borrowers in the industrials group is 4.99x (versus 4.78x in the first quarter), while healthcare is 6.1x (5.4x), technology is 8.61x (6.39x), and financial services is 5.89x (5.15x).
“In this quarter, higher leverage and lower interest coverage were seen across all sectors, and consumer cyclical sector had the biggest decline in Revenue Growth, with other sectors remain[ing] stable,” the report stated.
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