Two fresh defaults in November drove the default rate in the U.S. leveraged loan market to a nine-month high of 1.48% by principal amount, marking a small increase from 1.43% in October, in what has proven to be a slow, steady climb since the first quarter's seven-year low of 0.93%, according to LCD.

By issuer count, the rate is nearly unchanged at 1.63%, from a 12-month high of 1.64% in October.

While the default rate is inching higher it remains well below the 2.9% historical average, according to LCD.

The leveraged loan segment has fallen under increasing scrutiny from regulators over the past few years amid rapid growth — outstandings per the S&P/LSTA Leveraged Loan Index have swelled to $1.2 trillion — and as protections in loan documentation for lenders and investors have eroded steadily, thanks in part to sustained appetite for loan paper from collateralized loan obligations, which snap up about 75% of loans being issued today.

Indeed, approximately 80% of the $1.2 trillion in loan outstandings are covenant-lite, according to LCD, meaning they offer lenders and investors less protection than do traditionally structured credits. Because of the additional flexibility today's relatively loose loan documentation offers borrowers, some issuers that might have had to default on credits have been able to skirt default, sources say.

November defaults
Contributing to the default tally in November, S&P Global Ratings downgraded the corporate and issue-level ratings of Carlyle-owned Acosta and its B term loan to D, from SD and CCC–, respectively, tripping a default per the S&P/LSTA Loan Index.

The downgrade comes after the marketing company failed to make interest payments due Oct. 31, 2019, on its TLB and extended revolver.

"We believe the decision was strategic given the company's efforts to complete a prepackaged Chapter 11 bankruptcy filing," Ratings analyst Brennan Clark said in a Nov. 15 report.

Acosta disclosed in early November that it had reached an agreement with an ad hoc group of first-lien lenders and senior noteholders on a prepackaged Chapter 11. The company filed its petition for Chapter 11 bankruptcy in Wilmington, Del., on Dec. 1 — seeking a plan confirmation hearing to be held in less than two weeks, on Dec. 13—but only after changing certain terms of the deal in order to placate a minority group of first-lien lenders.

Under Acosta's restructuring plan, all outstanding notes and bank debt will receive equity in the reorganized company while first-lien lenders and senior noteholders would contribute $325 million of new money via a $65 million direct preferred equity investment for the ad hoc group, and a $260 million preferred equity rights offering open to all first-lien lenders and senior noteholders.

First-lien lenders can also participate in $150 million in debtor-in-possession financing (backstopped by the ad hoc group), which would be repaid with the proceeds of the preferred equity investment.

Acosta previously deferred an interest payment on its senior unsecured notes and a principal payment under its non-extended revolver.

The company's $2.06 billion covenant-lite term loan due September 2021, repriced in 2015 at L+325, was originally placed in 2014 at L+400 to back Carlyle Group's purchase of Thomas H. Lee Partners LP's majority stake in the company.

Also contributing to the default total, David's Bridal Inc. last month reached an agreement in principle with lenders to exchange $276 million of existing term loans, including the $240 million senior secured take-back term loan facility due 2024, for equity in the company.

The deal comes less than a year after the bridal chain emerged from Chapter 11 with pre-petition lenders, including Oaktree Capital, receiving 76.25% of the reorganized company's equity and take-back term debt.

With David's Bridal's previous default and Catalina Marketing Corp. rolling off the trailing-12-month calculation, the default rate by amount started the month at 1.28%, according to LCD.

Distress signals
Though the trailing default rate in leveraged loans has remained stubbornly below its 2.9% historical average, several indicators point to increasing pressure.

In a measure of stress being priced in by the market, the distress ratio in leveraged loans, a forward indicator of potential defaults, spiked in the third quarter, and remains at its recently elevated levels.

According to LCD, the share of performing loans quoted below 80 cents on the dollar climbed to 5.87%, up from a three-year high of 5.33% in October. For loans trading below 70 cents on the dollar — a level normally associated with deep distress and significantly high default risk — the distress ratio now sits at 2.49%, the highest level of distress since September 2016.

In other potential trouble points, the share of loan facilities carrying a rating of single-B or below increased for a seventh consecutive month, to 50.23%. This is the highest that share has ever been, and when the credit cycle eventually does turn, loans rated single-B are at greater risk of being downgraded by the rating agencies to CCC. Of particular note, CLOs are not designed to absorb triple-C loans in larger quantities.

On a weighted average basis, leverage ticked up to 5.7x in the latest quarter, marking a third consecutive increase, from 5.2x in the fourth quarter last year.

This article was written by Rachelle Kakouris, who covers distressed debt for LCD.

LCD is an offering of S&P Global Market Intelligence.