Restructuring activity among companies in the Morningstar LSTA US Leveraged Loan Index slowed in July, with a missed interest payment by Rodan & Fields, and a distressed debt exchange targeting AMC Entertainment’s term loan as part of a wider liability management exercise, contributing to LCD’s trailing twelve-month loan default rate.
As of July 31, the trailing 12-month default rates of the Morningstar LSTA US Leveraged Loan Index were as follows:
- Payment default rate (PDR) by amount: 0.92%
- Payment default rate (PDR) by issuer count: 1.45%
- Dual-track default rate (DTDR) by issuer count: 4.02%
LCD’s monthly default report features the legacy payment default rate and a dual-track default rate by count that includes index issuers conducting distressed liability management exercises (LMEs). More details and the methodology can be found here.
With one new joiner, and two issuers leaving the trailing twelve-month calculation, the payment default rate (excluding distressed LMEs) by issuer count fell to 1.45% in July, from 1.55% in June, and a recent peak of 2.07% in February. The 10-year average by issuer count is 1.62%.
By amount, the default rate was unchanged at 0.92%.
The payment default rate by amount is now 83 bps lower than the recent peak in July 2023 of 1.75%.
Combined rate
When including out-of-court LMEs and payment defaults, the combined rate by issuer count fell to 4.02%, the lowest for the combined rate since December 2023.
Note that the decline in the combined rate is largely driven by fewer issuer payment defaults compared to 12 months ago.
Indeed, soft defaults in the form of out-of-court distressed exercises, or LMEs, climbed to an all-time high of 32 in June’s trailing twelve-month calculation, easing only slightly, to 30 in July. This compares to 16 in July 2023, and 4 in July 2022.
In contrast, the trailing twelve month count of payment defaults, or hard defaults, fell to 17 in July, from 24 in July 2023.
The above chart demonstrates how the default landscape among leveraged loan issuers has flipped in recent years. Soft defaults via LMEs by traliing-12-month issuer count have outnumbered payment defaults every month since January. Conversely, hard defaults of interest payment misses, or bankruptcy filings outnumbered LMEs every single month of 2023.
In terms of share of the restructuring landscape, over the last twelve months, LMEs comprise 64% of the count, up from 47% at the end of 2023, 53% at the end of 2022, and 55% at the end of 2021.
For context, though the current share of LMEs looks historically high, LMEs made up a higher share of the default landscape in September 2021, at 71%.
Given the ongoing need of companies to gain breathing room on interest burdens in this higher-for-longer rate environment, the outsized share of LMEs is expected to continue while rates remain elevated.
Sector specifics
Breaking down LMEs among index companies, there remains a clear dominance among healthcare and software companies, with Healthcare Equipment & Services and Software & Services making up 27% and 23% of such activity over the last 12 months, respectively.
When excluding LMEs, breaking down sponsored versus non-sponsored companies shows the rate of hard defaults of payment misses and bankruptcy filings among sponsored companies topped that of non-sponsored companies in April, May, and June. In July, non-sponsored companies inched ahead.
Past trends show that during elevated periods of payment and bankruptcy defaults, such as the 2016 uptick in defaults driven by increased oil prices and the 2020 pandemic, sponsored companies typically defaulted at a much lower rate.
Zooming in on July’s default situations, joining the legacy payment default rate, Francisco-based MLM skincare company Rodan & Fields failed to make the amortization and interest payments due on its super priority second- and third-out term loans at the end of June, prompting a downgrade of the issuer and its loans to D.
Per S&P’s July 18 downgrade report, the company entered into a transaction support agreement (TSA) to recapitalize its capital structure through a series of proposed transactions, including extending its maturities, priming existing term debt with new money and pushing down existing lenders into less-favorable collateral positions, allowing for paid-in-kind (PIK) interest payments, and equity conversions.
R&F joins the list of repeat defaulters, having conducted a liability management exercise in June 2023. Despite the short timeframe, nearly 10% of LMEs from 2023 have already returned with a hard default of a payment miss or bankruptcy filing.
AMC Entertainment also entered the dual calculation that includes LMEs after the motion picture company announced a distressed debt exchange targeting its term loan as part of a broader liability management exercise. Among other transactions, the company will also exchange between $1.1 billion and $1.9 billion of its existing $1.9 billion term loan due 2026 for the new term loan at a newly formed subsidiary. Nonparticipating lenders will not have a claim against assets held at the new subsidiary and would have substantially all their restrictive covenants removed.
On the horizon
To forward looking measures, the distress ratio, which as the below chart demonstrates, is a forerunner to default activity, remained steady at 4.41% by amount in July, from 4.42% in June and from 4.47% in May.
This metric, defined as the share of loans below the 80-price distress marker remains elevated by comparison from the 2024 low of 3.35% in February, but sits well below the high of 7.36% in December 2022, ahead of an interest rate-driven uptick in defaults in 2023.
By issuer count, the distress ratio ticked higher, to 5.83% in July, from 5.64% in June, and compares to a 2024 low of 4.95% in March.
Finally, ratings agency activity was weighted toward downgrades in July, with the ratio of downgrades to upgrades on a rolling three-month basis rising to 2.23x, from 2.09x in June.
This compares to a 2024 low of 1.64x in March, and a recent high of 3.32x in February 2023.
Featured image: Krisanapong Detraphiphat/Getty Images
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