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Leveraged Loans

US leveraged loan default rate remains low, but LMEs rise

Fourteen per cent of companies that conducted a liability management exercise in 2023 have returned with a payment or bankruptcy default.

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A bankruptcy filing by Wheel Pros led a slew of distressed activity among constituents of the Morningstar LSTA US Leveraged Loan Index in September. However, with the Fed just getting started on interest rate cuts, out-of-court transactions continue to dominate the restructuring scene from companies seeking breathing room from higher interest-rate burdens.

As of Sept. 30, the default rates of the Morningstar LSTA US Leveraged Loan Index were as follows:

  • Payment default rate by amount: 0.80%
  • Payment default rate by issuer count: 1.26%
  • Dual-track default rate by issuer count: 4.21%

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 issuer rolling off the trailing twelve-month calculation, and one new joiner courtesy of Wheel Pros, the payment default rate (excluding distressed LMEs) nudged slightly higher by amount, to 0.80% in September, from 0.78% in August.

The payment default rate by amount is now 95 bps lower than the post-rate-hike cycle peak in July 2023 of 1.75%.

By issuer count, the payment default rate inched down to 1.26%, from 1.28% in August and a recent peak of 2.07% in February. The 10-year average by issuer count is 1.64%.

When including out-of-court LMEs and payment defaults, the combined rate by issuer count climbed to 4.21%, from 4.17% in August and 4.02% in July, which was the lowest for the combined rate since December 2023.

The dual-track rate, at 4.21%, is 21 bps lower than the 4.42% peak in April, largely due to a decline in payment defaults and an increase in the number of issuers in the loan index.

In fact, out-of-court restructurings or distressed activity prompting defaults or ‘Selective Defaults’ among index companies climbed to an all-time high of 35 in this month’s trailing twelve-month calculation. This compares to 17 in September 2023, and six in September 2022.

In contrast, the trailing twelve-month count of payment defaults that make up the legacy default rate remained at 15 in September, versus 21 in September 2023.

As the above chart shows, the default landscape among leveraged loan issuers has flipped in recent years. Defaults via LMEs by trailing 12-month issuer count have outnumbered payment defaults every month since January. Conversely, defaults via interest payment misses or bankruptcy filings outnumbered LMEs in every single month of 2023.

Of course, helping to drive this trend is the Federal Reserve’s monetary tightening policy that increased base interest rates by approximately 5% between March 2022 and July 2023. Indeed, with the Fed keeping its policy rate in the 5.25%-5.50% range from July, until cutting by 50 bps last month, companies have sought breathing room outside of bankruptcy court ahead of an expected decline in interest rates.

In terms of share of the restructuring landscape, over the last twelve months, LMEs comprise 70% 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 is historically high, LMEs made up a similar share of the default landscape in September 2021, at 71%.

Sector stress
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 22% and 19% of such activity over the last 12 months, respectively.

Hitting the skids
Looking more closely at September’s restructuring situations, a year after completing an out-of-court distressed debt restructuring, Wheel Pros returned with a default via a Chapter 11 filing, implementing a restructuring agreement that will hand control to lenders from Clearlake Capital Group.

According to the declaration filed by CEO Vance Johnston, the auto parts maker faced significant pressure to its revenue and cost structure due to macroeconomic issues, including a rapid and dramatic rise in interest rates, persistent inflation, burdensome supply chain disruptions, a decline in customer demand and unsustainable debt service obligations. Despite turnaround efforts and a balance sheet restructuring in September 2023, continuing headwinds eventually resulted in the company missing interest payments to its lenders, court documents show.

Wheel Pros filed with two term loans in the Morningstar LSTA US Leveraged Loan Index, both placed as part of its September 2023 restructuring. Per court documents, the company has $235 million outstanding on its FILO term loan due February 2028, and $1.004 billion outstanding on its NewCo first-lien term loan due May 2028.

The disclosure statement estimates ABL and FILO claims will recover 100 cents on the dollar, first-lien claimants will recover 52 cents and junior debt claims will receive 0.1 cent on the dollar.

Redux
On the topic of repeat restructurings, Pretium Packaging returned with a distressed debt repurchase of its second-lien term loan due 2029, prompting a downgrade of its corporate credit rating to SD, and the term loan to D.

The plastic packaging manufacturer in October 2023 enacted a distressed exchange with a majority of its then-$1.3 billion first-lien lenders, prompting a downgrade of the company to SD and the targeted loan to D.

SI Group’s corporate credit and term loan ratings were lowered to D after the company conducted a debt refinancing transaction that S&P Global Ratings deemed as “coercive or distressed exchanges,” adding that non-participating creditors “now have weaker credit protections and reduced claims on collateral.”

SI Group in 2018 placed its $1.45 billion term loan due 2025 to finance SK Capital’s acquisition of SI Group and its merger with existing portfolio company Addivant.

Tosca Services completed a debt exchange that included a conversion of its existing first-lien term loan to a second-out, first-lien term loan with a two-year maturity extension and payment-in-kind (PIK) feature, prompting a downgrade of the company to SD, and its first-lien term loan to D.

Finally, American Rock Salt Company saw its corporate credit rating lowered to SD, and its first-lien term loan to D, after it missed an interest payment on its first-lien term loan, but remained within its extended grace period.

Redo
On the topic of repeat defaulters, the bankruptcy filing by Wheel Pros raised the share of companies that have returned with a conventional payment or bankruptcy default after conducting an LME in 2023.

Despite the short time frame, 14% of companies that conducted an LME in 2023 have already returned with a payment or bankruptcy default.

Indeed, LCD’s data show that a significant portion of issuers conducting these liability management exercises will return with a conventional default.

During the pandemic default wave of 2020, for example, 27% of issuers returned with a conventional default of missed interest payments or a bankruptcy filing within the next three years.

More recently, troubled companies conducting distressed exchanges are still confronting higher interest rate burdens on their floating-rate debt, and more expensive credit conditions in refinancing or extending obligations.

In 2022, despite the shorter timeline, the share of companies returning with a payment default or bankruptcy jumped to 33%.

Sponsor-driven
Breaking down restructuring activity between sponsored and non-sponsored companies shows that when excluding LMEs, the rate of hard defaults of payment misses and bankruptcy filings among sponsored companies topped that of non-sponsored companies for the first time since June.

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.

Still, the preference of sponsor companies to restructure via LMEs, which typically are more likely to preserve the equity stake held by private equity firms, is clear to see. In 2023, sponsor companies drove 91% of LME transactions.

In the LTM period, 81% of LMEs were sponsor driven.

Less stress
To forward-looking measures, the distress ratio, which as the below chart demonstrates is a forerunner to default activity, has dropped nearly 100 bps since July, indicating that fewer default candidates are now being priced in the market. This metric, defined as the share of loans below the 80-price distress marker, fell to 3.43% by amount in September, from 3.82% in August, and 4.41% in July.

By issuer count, the distress ratio eased to 4.79%, from 5.48% in August, and 5.83% in July.

Finally, ratings agency activity remains weighted toward downgrades, with the ratio of downgrades to upgrades on a rolling three-month basis rising to 2.21x in September, from 1.94x in August.

This compares to a 2024 low of 1.64x in March, and a recent high of 3.32x in February 2023.

Featured image: Jordan Lye/Getty Images

  • rachelle kakouris.jpg
    Rachelle covers the U.S. leveraged finance markets with a focus on stressed and distressed credits. Before joining LCD, Rachelle was a reporter for Reuters and IFR on the US high-yield corporate bond market in New York. Prior to that, she covered sovereign and covered bonds as a markets reporter for IFR Magazine and IFR Markets in London during the height of the financial crisis.
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