The default rate of the Morningstar LSTA US Leveraged Loan Index fell for a second consecutive month in November. With no new payment misses or bankruptcies among issuers in the index, and with one default rolling off the 12-month calculation, the default rate by amount eased to 0.73%.
The default rate has edged up from a pandemic-era low of 0.18% in April, but remains well below its 10-year average of 1.89% and its historical average of 2.73%.
By issuer count, the default rate closed November at 0.69%. This is up from a record low of 0.26% in April.
LCD’s criteria excludes distressed exchanges.
Though default activity is light, stress indicators have risen in recent months.
Per LCD’s data, the “below 80" cohort of performing index loans is five times higher than at the beginning of the year, at $103 billion. Though for context, during the height of the pandemic market crash in March 2020, this skyrocketed to $672 billion.
Currently 7.3% of performing loans in the index are priced below this measure for distress.
Furthermore, rating momentum remained negatively skewed in November, with the ratio of loan facility downgrades outpacing upgrades for a sixth consecutive month, at 2.24x (on a three-month rolling basis). This is down from 2.47x in October, which marked the highest rate of downgrades over upgrades since the default peak of September 2020.
As a measure of potential risk, a jump in downgrade activity has proven a forward indicator for future defaults, albeit a short one. During the pandemic, the downgrade-to-upgrade ratio jumped to 11.4x in March 2020, from 3.8x the previous month, preceding an increase in the default rate of the Morningstar LSTA US Leveraged Loan Index above its (then) 2.85% historical average
Leveraged loan issuers refinanced term loans and extended maturities at breakneck pace last year and in January this year. As a result, just $105.8 billion of the $1.4 trillion in outstanding loans, per the Morningstar LSTA US Leveraged Loan Index, mature in 2024 or earlier.
However, 49% of this total, or $52 billion, is from issuers rated B-minus or lower.
With all that said, the big question as market participants begin to plan for 2023 is how much the default rate could rise, particularly in the event of a hard landing. With Street predictions varying massively, LCD looked at the data to see how much in terms of defaulted volume (again excluding distressed exchanges) it would take to match previous default rate peaks.
To reach the trailing twelve-month default peak of 4.17% during the 2020 pandemic, this would require $56 billion of index defaults in the current market size. To hit the all-time high default rate of 10.81% seen in 2009, $145 billion of leveraged loans would need to default.
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