Key Takeaways
- We have revised our estimate for the December 2021 S&P/LSTA Leveraged Loan Index issuer default rate to 2.75% from our prior projection of 3.5% because our outlook for the U.S. economy in 2021 has improved.
- The improved outlook comes as the pace of COVID-19 vaccinations in the U.S. has picked up and signs point to a faster and sustained reopening of the economy. We expect fiscal stimulus passed since December 2020 to provide a tailwind for demand in the second quarter that continues into the second half of the year.
- While the outlook has improved, we still expect the credit impact of the pandemic to linger into 2023 for certain industries, and index default risk remains high with over 40% of issuers rated 'B-' or lower. As the recovery continues, the issuer default rate will likely remain elevated rather than peak and trough.
Chart 1
S&P Global Ratings Research expects the S&P/LSTA Leveraged Loan Index lagging-12-month default rate (by number of issuers), which was 3.6% as of March 2021, to fall to 2.75% by December 2021 (see chart 1). This forecast is a favorable revision of our prior estimate for the leveraged loan default rate at year-end of 3.5%. In this base-case scenario, about 30 issuers default in the index over the 12 months that began Jan. 1, 2021.
S&P Global economists now expect the U.S. economy to grow 6.5% in 2021, substantially higher than their December forecast of 4.2%. This comes as economic growth is expected to be much stronger in the first quarter as business and consumer activity normalizes at a faster pace. The $2.8 trillion in stimulus passed since December 2020 should provide a tailwind for demand in the second quarter that continues into the second half of the year. The improved trajectory for the U.S. economy and further improvement in credit indicators support the downward revision to the year-end default rate forecast for the index.
This revision follows our revision of the December 2021 base default forecast for the U.S. trailing-12-month speculative-grade corporate default rate to 5.5% from 7% (see "U.S. Speculative-Grade Corporate Default Rate Forecast For Year-End 2021 Falls To 5.5%," March 30, 2021).
Differences In Default Rate Measurements
The high proportion of selective defaults since the pandemic hit the U.S. has kept the broader speculative-grade corporate default rate higher than the leveraged loan index default rate. This is because the definition of default for the leveraged loan index is narrower than the definition for the speculative-grade corporate default rate.
There are differences in the definitions of "default" for each default rate series and forecast we analyze in our reports. The S&P Global Ratings definition of default determines the U.S. trailing-12-month speculative-grade corporate default rate.
S&P Global Market Intelligence's Leveraged Commentary & Data (LCD) definition of default determines the S&P/LSTA Leveraged Loan Index lagging-12-month default rate by number of issuers. The differences in default definitions are important sources of variation between the two series (see table).
| Summary Of Differences In Default Definitions | ||||
|---|---|---|---|---|
| S&P Global Ratings Definition | S&P/LSTA Leveraged Loan Index Definition | |||
| Issuer files for bankruptcy (results in a 'D' rating) | Issuer files for bankruptcy | |||
| Issuer missed principal/interest on a bond instrument (results in a 'D' or 'SD' rating)* | Issuer downgraded to 'D' by S&P Global Ratings | |||
| Issuer missed principal/interest on a loan instrument (results in a 'D' or 'SD' rating)* | Issuer missed principal/interest on a loan instrument without forbearance | |||
| Distressed exchange (results in a 'D' or 'SD' rating) | ||||
| --Forecasts-- | ||||
| The baseline December 2021 forecast for the U.S. trailing-12-month speculative-grade corporate default rate is 5.5%. | The baseline December 2021 forecast for the S&P/LSTA Leveraged Loan Index lagging-12-month default rate by number of issuers is 2.75%. | |||
| *Under the S&P Global Ratings definition, an issuer is considered in default unless S&P Global Ratings believes payments will be made within five business days of the due date in the absence of a stated grace period, or within the earlier of the stated grace period or 30 calendar days. | ||||
S&P Global Ratings definition
S&P Global Ratings deems 'D' (default) and 'SD' (selective default) ratings to constitute defaults for the purposes of its default studies. An issuer rated 'SD' or 'D' is in default on one or more of its financial obligations, including rated and unrated financial obligations but excluding hybrid instruments classified as regulatory capital or in nonpayment according to terms.
An issuer is considered in default unless S&P Global Ratings believes payments will be made within five business days of the due date in the absence of a stated grace period, or within the earlier of the stated grace period or 30 calendar days. A 'D' rating is assigned if the default is expected to be a general default and the issuer is expected to fail to pay all or substantially all of its obligations as they come due. An 'SD' rating is assigned if the issuer has selectively defaulted on a specific issue or class of obligations but will continue to meet its payment obligations on other issues or classes of obligations in a timely manner.
S&P Global Ratings will typically lower the issuer credit rating to 'SD' if the issuer conducts a distressed debt exchange offer. We consider debt exchange offers tantamount to default when they meet two conditions: if they are distressed rather than purely opportunistic, and if the investor will clearly receive less value than the promise of the original securities without adequate and offsetting factors.
S&P/LSTA Index definition
S&P Global Market Intelligence's LCD definition of default only includes defaults on loan instruments and excludes distressed debt exchanges. For an issuer default to be counted under the LCD definition, the issuer either filed for bankruptcy, S&P Global Ratings downgraded it to 'D', or it missed a principal or interest payment on a loan without forbearance. Not all borrowers we rate speculative grade are included in the S&P/LSTA Index. For an issuer to be included, it must have issued a U.S. dollar-denominated, senior secured, syndicated term loan instrument with a minimum term of one year at inception, a minimum initial spread of LIBOR+125, and a minimum initial size of $50 million. Loans are retired from the index when no bid is posted on the facility for at least 12 successive weeks or when the loan is paid out or paid down to a negligible amount.
Chart 2
How We Determine Our Default Rate Forecasts
The S&P/LSTA Leveraged Loan Index default rate forecasts are based on recent observations and expectations for the path of the U.S. economy and financial markets. Among various factors we consider is our proprietary analytical tool for the S&P/LSTA Leveraged Loan Index issuer base. The main components of the analytical tool are the U.S. trailing-12-month speculative-grade corporate default rate, a leveraged loan debt-to-EBITDA ratio, the ratio of selective defaults to total defaults, changes to the mix of rated loans toward higher or lower ratings, the S&P/LSTA Leveraged Loan Index distress ratio, and the unemployment rate.
S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Related Research
- U.S. Speculative-Grade Corporate Default Rate Forecast For Year-End 2021 Falls To 5.5%, March 30, 2021
- Economic Outlook U.S. Q2 2021: Let The Good Times Roll, March 24, 2021
- COVID-19 Heat Map: Some Bright Spots In Recovery Amid Signs Of Stability, Feb. 17, 2021
This report does not constitute a rating action.
| Ratings Performance Analytics: | Nick W Kraemer, FRM, New York + 1 (212) 438 1698; nick.kraemer@spglobal.com |
| Jon Palmer, CFA, New York; jon.palmer@spglobal.com | |
| Kirsten R Mccabe, New York + 1 (212) 438 3196; kirsten.mccabe@spglobal.com |
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