Key Takeaways
- In the third quarter, the number of 'CCC' category-rated entities is growing (albeit slowly) among reinvesting U.S. BSL CLO portfolios, mirroring the trend observed in speculative-grade U.S. corporate issuers.
- On average, during the previous three recessions (2001, 2009, and 2020), about a quarter of 'B-' rated companies were downgraded to 'CCC', 'CC', or 'C' within the recession year, an indication of the vulnerability of the increasingly crowded 'B-' space.
- One of the identifying characteristics of the entities lowered to the 'CCC' category this year is consistently negative cash flow generation. Median EBITDA interest coverages of the group fell to 1x before a downgrade.
- EBITDA growth has diminished further, pulled down by sizable drops in sectors more directly exposed to consumer spending. More companies reported flat or higher revenue but weaker EBITDA margins in second quarter of 2022, mainly owing to inflationary cost pressures.
- New-issue recovery estimates have been relatively stable thus far in 2022, despite economic conditions worsening considerably since the year's start. This is, however, based on a comparatively small pool of new issues.
Like many other asset classes, the U.S. leveraged finance market lost its charm this year, and new issuance volume plunged. Since the economic outlook remains bleak, we expect issuance to stay muted in the last quarter of 2022 and into early 2023 as both sides of the market patiently wait for the right window to return. Here, we analyze the growing share of 'CCC' category-rated entities and how this might affect key loan investors by looking at data from previous recessions. Also, we continue to track key credit trends such as profit growth, debt leverage, interest coverage, and free cash flow within our speculative-grade corporate rating universe. Last, we will review the trends in first-lien new-issue recovery ratings, which have been stable despite all the turbulence.
'CCC' Ratings In CLOs On The Rise
The recovery that began following the COVID-19 pandemic has lost its momentum, sparking concerns about the credit quality of low speculative-grade issuers by collateralized loan obligations (CLOs) and other investors heavily invested in this cohort of companies.
Specifically, the number of 'CCC' category-rated entities is growing again from the lows seen earlier this year among speculative-grade U.S. corporate entities in the third quarter and the trend is mirrored in CLOs holding as well. On average, 'CCC' category-rated issuers held by reinvesting U.S. BSL CLO portfolios (CLOs invested in broadly syndicated loans) declined gradually for the first half of the year, hitting a low of 4.0% in August before making a u-turn and increasing to 4.4% (including issuers rated 'B-' on CreditWatch with negative implications). While this is still a fraction of the 12% average 'CCC' basket seen during its pandemic peak, it marks an end to 18 months of positive corporate rating trends.
Positioning themselves for a potential change in the credit cycle, many CLO managers have been trading out of 'CCC' rated companies and into 'B-' and 'B' rated companies that have a track record of revenue resiliency, which may allow them to hold their ground during a recession. On that note, 'B-' exposure has continued to increase gradually in CLO portfolios to 28.9%, up from 26.4% at the start of the year, largely due to the corporate downgrades this year. On a more positive note, only 2.8% of 'B-' rated issuers have negative outlooks, much lower than the average of 16.5% with negative outlooks for speculative-grade ratings at large.
Most broadly syndicated loan CLOs have a 'CCC' threshold of 7.5%, above which the value of 'CCC' assets take a haircut for purposes of calculating the overcollateralization (O/C) tests. Most CLOs generally try to limit their 'CCC' exposure in order to avoid these market value haircuts. This is evidenced by average CLO 'CCC' exposures being historically lower than that of the overall speculative-grade corporate universe, 4.4% compared with 9.1% as of September. Energy and retail names make up a notable proportion of the 'CCC' bucket across the speculative-grade ratings universe in previous cycles and CLOs have lower holdings of these two sectors. Despite the recent uptick of corporate downgrades into the 'CCC' category, most reinvesting U.S. BSL CLOs are not yet at imminent risk of breaching the 7.5% 'CCC' thresholds, and many have built junior O/C test cushion, taking advantage of price dislocations in the loan market and building par.
Lastly, we also note the vintage effect across CLO portfolios. Compared with post-pandemic CLOs (ones issued after the arrival of the pandemic in the first quarter of 2020), pre-pandemic CLOs have a higher proportion of 'CCC' holdings and tighter O/C ratio test cushions due to par loss. Because most CLOs are actively managed, CLO managers for deals closer to failing O/C tests may have an incentive to make trades to maintain (or even build) O/C cushion for a rainy day. Given lower loan prices since February of this year, some CLO managers have been able to take the risk out of their portfolios through trading while keeping the O/C cushions and par balance of their portfolios steady.
Chart 1
What We Learned From Previous Recessions
Leveraged loan investors of all stripes are watching for the credit fallout from threats ranging from a slowdown in consumer spending and spiking interest rates to geopolitical turmoil that could trigger downgrades into the 'CCC' category (and for CLOs, push the 'CCC' bucket closer to the typically allowed 7.5% threshold). To provide clues on what a recession could entail, we consider ratings lowered to 'CCC', 'CC', or 'C' or 'D' (default) in the past three recessionary times: 2001 (Dot-com recession), 2009 (global financial crisis), and 2020 (COVID-19 recession) (see charts 2 and 3). Unsurprisingly, downgrades increased in recessions. Previous recessions saw between 19% and 27% of the 'B-' ratings and 9% and 10% of the 'B' ratings slip into 'CCC', 'CC', or 'C' ratings within the year. The worst in terms of these downgrades was 2020 while the worst default experience was in 2001; each recession saw about half of the 'CCC', 'CC, and 'C' ratings going to 'D'.
On average, 23% of 'B-' rated companies that were outstanding at the beginning of a recession year were lowered to 'CCC', 'CC', or 'C' within the year, and another 19% went to 'D', an indication of the vulnerability of the increasingly crowded 'B-' category. The record share of assets from 'B-' rated obligors today means ratings need to fall less to reach the same mass as in previous downturns. However, we emphasize that the 'B-' population this time around is of a different composition--more entities debut at 'B-' rather than being downgraded to 'B-' from a higher rating--and may not necessarily exhibit similar behaviors.
Turning to S&P Global's economic forecast, first, we expect a "shallow" recession in the U.S. in early 2023, a product of increased aggregate demand and classic overheating as well as supply disruptions. Second, during the economic rebound last year, many issuers built up cushion in their credit metrics against their rating. The result is negative bias (the proportion of ratings with negative outlooks or on CreditWatch with negative implications) remains below historical averages for most sectors, although we expect a downward migration over the next 12 months. The diminished need to refinance (given limited near-term maturities and refreshed liquidity stemming from heavy financing volumes in 2021) means that most companies, even entities rated 'B' and 'B-', have limited need for refinancing in the near term in a period of increasing borrowing costs.
Chart 2
Chart 3
Steadily Declining Economic Expectations And Rising Costs Have Led To 'B-' Downgrades In 2022
Forty-one CLO corporate obligors were downgraded to 'CCC' or below since the start of this year, with an overwhelming majority coming from 'B-'. Our expectation for lower GDP in 2023, a profit margin squeeze from ongoing inflationary pressure on costs, rising interest costs, and refinancing risk are critical factors behind many of our rating decisions. In some cases, these pressures drove up leverage or pushed cash flow below breakeven. Among them, Brand Industrial Services (the 177th most widely held name in CLOs as of the end of the third quarter of 2022) also signaled negative headwinds from foreign-exchange rates in its international operations, which added a new challenge in its efforts to improve operating margins that are depressed by inflationary pressures. In the example of Artera Services LLC (215th most widely held CLO obligor), increased inflation caused costs to outpace any price increases, pushing adjusted leverage to above 10x this year. Also, consumers pulling back from discretionary spending is hurting companies like Party City, which is particularly vulnerable to diminished consumer spending.
The performance of 'B-' rated companies that remain at their current rating compared with those that were lowered to 'CCC' or below (among CLO obligors) this year through early October is reflected by the following two credit metrics: Free operating cash flow (FOCF) to debt and EBITDA interest coverage (see chart 4. [given the small sample size, we didn't further break the companies down by sector]).
One of the identifying characteristics of the downgraded entities is consistently negative cash flow generation. After a steady decline, the median FOCF to debt of the group is negative 6% for the past 12 months, ending at the end of the second quarter. That is significantly lower than the median of the overall 'B-' cohort of companies that, at negative 1.1%, alone can be a sign of trouble. However, we believe that unlike 'CCC' category issuers, many within the 'B-' group can still help preserve liquidity by trimming investments, merger and acquisition activity, capital spending, and shareholder distributions.
Meanwhile, median EBITDA interest coverages of the downgrades fell to 1x, a level generally associated with distress. The gap between the weakest and survivor 'B-' issuers has widened considerably, leading to downgrades of such weakest issuers. Looking forward to 2023, an increasingly murky economic outlook reduces the odds of a successful business turnaround. We now see an increasing risk of restructurings or distressed exchanges ahead of maturities that begin to increase in 2024.
Chart 4
Credit Metrics Show Feeble Economic Growth And Strained Free Cash Flow
Below, we summarize key sector-level credit trends, including profit growth, leverage, FOCF to debt, and interest coverage. We review how these metrics have transitioned over time through rolling 12-month windows (last-12-months or LTM) that ended on each quarter-end. To track the EBITDA growth transition, we've compared the quarter-over-quarter change in these LTM metrics. The sample covers 1,071 public and private companies that we rate in the U.S. and Canada. More details on how we built the sample are in the "Data Used In This Report" section at the end of this report. Some noteworthy trends emerged in the second quarter of 2022 financial results:
Profit growth suffered from persistent inflationary pressures
- The second quarter was a mixed picture: 38% of companies reported flat or higher revenue but weaker EBITDA margins, mainly owning to inflationary cost pressures.
- EBITDA growth has diminished further, pulled down by sizable drops in sectors more directly exposed to consumer spending. On the aggregate level, the median growth slowed to 2.3% at the end of June from 2.8% three months earlier (see tables 1 and 2).
- Six sectors exhibit slowing growth, unlike the continuing strong rally in the oil and gas sector, which has held on to its double-digit expansions. The oil and gas and mining and minerals sectors benefitted from favorable commodity price trends and are the top performers, with increases of 171% and 44% in median EBITDA when comparing the 12 months ended June 30, 2021, and June 30, 2022, respectively.
- Despite gains in median revenue, the consumer products sector continued to see median profit contraction, albeit at a slower pace, thanks to price increases implemented earlier in the year that helped offset cost inflation in the second quarter. We expect more profit pressure going into 2023 as consumers react to high inflation by cutting discretionary purchases, as well as trading down in quality to offset higher prices.
- Health care and restaurants/retailing have joined the list of sectors that reported a decline in median EBITDA. Both were constrained by labor shortages and elevated labor costs.
- For health care, a decline was also partly expected, given that the significant government support provided to the industry to help alleviate the impact of revenue losses and higher costs to treat COVID-19, such as CARES Act funds and grants in 2021, ended in 2022. Furthermore, the temporary suspension of Medicare automatic payment reductions (sequestration) expired in 2022, meaning providers will see automatic 2% reductions in reimbursement. Meanwhile, health care companies that benefitted from peak pandemic demand, such as laboratory companies, saw a decline in demand and EBITDA as the pandemic threat receded in 2022. We believe health care companies will be challenged to pass along the bulk of its higher costs in upcoming reimbursement negotiations with payors.
- Our updated metrics include some revisions to numbers for previous quarters due to changes in the constituent mix. For health care, the quarter-over-quarter change in the first quarter of 2022 was revised down to negative 0.4% from 0% after a few new additions--which happened to be skewed toward lower-rated companies.
- The downward shift in telecommunications reflects idiosyncratic challenges as a handful of small issuers navigate secular demand headwinds not broadly seen sector-wide. Intrado Corp. suffered from secular declines in traditional conferencing and intense competition in the business collaboration market, which led to a downgrade to 'CCC+' from 'B-'.
Table 1
| Median EBITDA Growth By Issuer Credit Rating | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Median EBITDA growth, reported last 12 months (%) | ||||||||||||||||
| Issuer credit rating* | Entity count | 12 months ended March 31, 2021 (qoq) | 12 months ended June 30, 2021 (qoq) | 12 months ended Sept. 30, 2021 (qoq) | 12 months ended Dec. 31, 2021 (qoq) | 12 months ended March 31, 2022 (qoq) | 12 months ended June 30, 2022 (qoq) | |||||||||
| BB+ | 117 | 5.1 | 11.0 | 4.5 | 5.0 | 3.4 | 2.5 | |||||||||
| BB | 115 | 4.5 | 10.6 | 4.4 | 1.8 | 1.8 | 2.3 | |||||||||
| BB- | 102 | 6.9 | 15.4 | 4.8 | 4.9 | 2.9 | 0.1 | |||||||||
| B+ | 157 | 7.8 | 15.0 | 7.3 | 5.7 | 4.1 | 1.8 | |||||||||
| B | 206 | 5.0 | 11.3 | 6.8 | 4.5 | 3.7 | 5.3 | |||||||||
| B- | 266 | 5.0 | 7.2 | 3.4 | 2.8 | 1.5 | 1.6 | |||||||||
| CCC+ | 74 | (5.5) | 6.6 | 1.2 | (1.5) | (1.3) | 6.6 | |||||||||
| CCC | 26 | 2.1 | 11.5 | (9.7) | (2.1) | (5.1) | (2.0) | |||||||||
| CCC- | 6 | 4.5 | 14.0 | (8.0) | (12.1) | (1.3) | (34.7) | |||||||||
| CC | 2 | 5.4 | (3.7) | 1.4 | (5.1) | (10.2) | (1.8) | |||||||||
| Total | 1,071 | 5.0 | 10.9 | 4.5 | 3.9 | 2.8 | 2.3 | |||||||||
| *Rating as of Sept. 29, 2022. Reported EBITDA without adjustment by S&P Global Ratings. The sample in this study is rebalanced each quarter following selection criteria, as detailed in the "The Data Used In This Report" section. qoq--Quarter over quarter. Source: S&P Global Ratings. | ||||||||||||||||
Table 2
| Median EBITDA Growth By Industry | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Median EBITDA growth, reported last 12 months (%) | ||||||||||||||||
| Industry | Entity count | 12 months ended March 31, 2021 (qoq) | 12 months ended June 30, 2021 (qoq) | 12 months ended Sept. 30, 2021 (qoq) | 12 months ended Dec. 31, 2021 (qoq) | 12 months ended March 31, 2022 (qoq) | 12 months ended June 30, 2022 (qoq) | |||||||||
| Aerospace/defense | 27 | (0.4) | 1.9 | 3.6 | 4.4 | (0.4) | (0.3) | |||||||||
| Auto/trucks | 34 | 15.3 | 32.7 | 3.3 | 4.4 | 1.1 | 4.3 | |||||||||
| Business and consumer services | 92 | 3.0 | 5.9 | 3.5 | 3.9 | 2.7 | 3.5 | |||||||||
| Capital goods/machine & equipment | 115 | 3.6 | 5.0 | 1.8 | 1.4 | 3.4 | 5.1 | |||||||||
| Chemicals | 33 | 5.8 | 12.1 | 7.5 | 2.8 | 2.3 | 2.9 | |||||||||
| Consumer products | 98 | 7.4 | 8.1 | 1.5 | 0.9 | (1.2) | (0.5) | |||||||||
| Forest prod/bldg. mat./packaging | 44 | 7.9 | 11.2 | 1.3 | 1.0 | 7.9 | 10.2 | |||||||||
| Health care | 94 | 8.9 | 8.7 | 3.3 | 0.2 | (0.4) | (2.0) | |||||||||
| Media, entertainment & leisure | 148 | 2.8 | 26.3 | 9.4 | 5.5 | 4.7 | 2.8 | |||||||||
| Mining & minerals | 46 | 7.0 | 22.0 | 14.3 | 11.2 | 10.1 | 7.1 | |||||||||
| Oil & gas | 68 | 1.4 | 37.5 | 25.3 | 35.4 | 18.0 | 27.8 | |||||||||
| Restaurants/retailing | 86 | 9.4 | 28.9 | 1.7 | 4.5 | 0.7 | (1.3) | |||||||||
| Real estate | 20 | 2.5 | 6.8 | 4.6 | 5.2 | 3.6 | 5.0 | |||||||||
| Technology | 95 | 6.6 | 5.4 | 4.6 | 4.7 | 2.6 | 0.2 | |||||||||
| Telecommunications | 45 | 3.2 | 2.9 | 1.2 | (0.7) | (1.4) | (2.8) | |||||||||
| Transportation | 26 | (1.8) | 22.3 | 12.2 | 10.6 | 1.3 | 3.7 | |||||||||
| Total | 1,071 | 5.0 | 10.9 | 4.5 | 3.9 | 2.8 | 2.3 | |||||||||
| Table shows reported EBITDA without adjustment by S&P Global Ratings. The sample in this study is rebalanced each quarter following selection criteria, as detailed in the "The Data Used in This Report" section. Qoq--Quarter over quarter. Source: S&P Global Ratings. | ||||||||||||||||
Valuation declines and risk-off sentiment curbed debt growth
- Debt and profit growth slowed down, leaving the overall leverage picture relatively unchanged. The median LTM leverage ended the second quarter at 5.2x (see tables 3 and 4). Except for the 'CCC-' category, leverage across all ratings is flat to fractionally lower.
- Still, four sectors see median leverage over 6x, and as high as 8.5x in health care and 7.3x in technology.
- As recovery continued to build on pent-up demand, most transportation companies had the opportunity to break into sustained and positive operating profits. Airlines, in particular have been a bright spot. Benefiting from a persistent appetite for travel and higher fares, they are now breaking into solid earnings despite much higher fuel expenses. As such, the share of transportation companies reporting negative LTM EBITDA has dropped to 12% from nearly 33% at the peak. The median leverage of the sector has recovered to close to the pre-pandemic level.
Table 3
| Median Gross Leverage By Issuer Credit Rating | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Median gross leverage (x), reported last 12 months | ||||||||||||||||||||||||||
| Issuer credit rating* | Entity count | 12 months ended Dec. 31, 2019 | 12 months ended March 31, 2020 | 12 months ended June 30, 2020 | 12 months ended Sept. 30, 2020 | 12 months ended Dec. 31, 2020 | 12 months ended March 31, 2021 | 12 months ended June 30, 2021 | 12 month ended Sept. 30, 2021 | 12 months ended Dec. 31, 2021 | 12 months ended March 31, 2022 | 12 months ended June 30, 2022 | ||||||||||||||
| BB+ | 121 | 3.2 | 3.4 | 3.7 | 3.5 | 3.3 | 3.3 | 2.9 | 2.8 | 3.1 | 2.8 | 2.8 | ||||||||||||||
| BB | 121 | 3.3 | 3.5 | 4.0 | 4.0 | 3.8 | 3.8 | 3.2 | 3.1 | 3.1 | 3.1 | 3.0 | ||||||||||||||
| BB- | 109 | 3.9 | 4.5 | 4.6 | 4.6 | 4.1 | 4.0 | 3.2 | 3.0 | 3.2 | 3.3 | 3.3 | ||||||||||||||
| B+ | 165 | 4.6 | 5.3 | 5.8 | 5.7 | 5.4 | 5.1 | 4.5 | 4.3 | 4.1 | 4.1 | 4.1 | ||||||||||||||
| B | 216 | 5.7 | 6.5 | 6.9 | 6.6 | 6.4 | 6.2 | 6.0 | 5.8 | 5.8 | 5.8 | 5.5 | ||||||||||||||
| B- | 272 | 7.7 | 8.3 | 8.7 | 8.3 | 9.1 | 8.9 | 8.4 | 8.7 | 8.5 | 8.8 | 8.7 | ||||||||||||||
| CCC+ | 77 | 9.0 | 9.9 | 12.9 | 12.6 | 12.3 | 13.9 | 12.6 | 13.4 | 13.1 | 13.2 | 12.8 | ||||||||||||||
| CCC | 26 | 7.8 | 9.9 | 30.6 | 17.9 | 14.1 | 13.3 | 12.0 | 16.8 | 17.5 | 19.9 | 15.3 | ||||||||||||||
| CCC- | 6 | 11.0 | 15.1 | 18.6 | 19.6 | 9.4 | 9.0 | 7.9 | 9.8 | 20.3 | 20.0 | 29.5 | ||||||||||||||
| CC | 2 | 10.0 | 9.4 | 10.6 | 10.5 | 7.0 | 6.7 | 7.0 | 6.7 | 6.9 | 8.0 | 8.0 | ||||||||||||||
| Total | 1,115 | 5.2 | 5.9 | 6.6 | 6.4 | 6.3 | 6.1 | 5.5 | 5.5 | 5.4 | 5.3 | 5.2 | ||||||||||||||
| *Rating as of Sept. 29, 2022. Leverage is calculated as reported gross debt over reported EBITDA, without adjustment by S&P Global Ratings. The sample in this study is rebalanced each quarter following selection criteria, as detailed in the “The Data Used in This Report” section. Source: S&P Global Ratings. | ||||||||||||||||||||||||||
Table 4
| Median Gross Leverage By Industry | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Median gross leverage (x), reported last 12 months | ||||||||||||||||||||||||||
| Industry | Entity count | 12 months ended Dec. 31, 2019 | 12 months ended March 31, 2020 | 12 months ended June 30, 2020 | 12 months ended Sept. 30, 2020 | 12 months ended Dec. 31, 2020 | 12 months ended March 31, 2021 | 12 months ended June 30, 2021 | 12 months ended Sept. 30, 2021 | 12 months ended Dec. 31, 2021 | 12 months ended March 31, 2022 | 12 months ended June 30, 2022 | ||||||||||||||
| Better: Improved or deleveraged compared to year-end 2021 levels | ||||||||||||||||||||||||||
| Aerospace/defense | 27 | 3.3 | 4.5 | 6.0 | 5.3 | 5.2 | 5.4 | 5.9 | 5.3 | 4.8 | 4.4 | 4.2 | ||||||||||||||
| Media, entertainment & leisure | 153 | 5.0 | 6.2 | 8.6 | 8.6 | 8.7 | 9.2 | 7.1 | 6.5 | 6.5 | 6.0 | 5.7 | ||||||||||||||
| Mining & minerals | 47 | 3.1 | 3.3 | 4.2 | 4.4 | 4.6 | 5.0 | 3.0 | 2.5 | 2.1 | 2.0 | 1.6 | ||||||||||||||
| Oil & gas | 70 | 2.9 | 3.0 | 4.1 | 5.1 | 5.0 | 5.3 | 4.0 | 3.0 | 2.0 | 1.8 | 1.2 | ||||||||||||||
| Real estate | 29 | 7.2 | 8.8 | 7.9 | 8.3 | 7.8 | 6.0 | 5.8 | 6.6 | 5.7 | 5.7 | 5.1 | ||||||||||||||
| Transportation | 26 | 4.0 | 4.4 | 6.7 | 8.4 | 9.3 | 9.7 | 6.9 | 5.9 | 6.0 | 5.3 | 4.7 | ||||||||||||||
| Worse: Leverage increased from year-end 2021 levels | ||||||||||||||||||||||||||
| Health care | 102 | 7.0 | 8.0 | 8.3 | 8.1 | 8.0 | 7.3 | 6.7 | 6.9 | 7.6 | 7.9 | 8.5 | ||||||||||||||
| Telecommunications | 47 | 5.0 | 5.0 | 4.9 | 4.9 | 4.8 | 4.7 | 4.9 | 4.5 | 4.8 | 5.6 | 5.4 | ||||||||||||||
| Leverage remained relatively flat since year-end 2021 | ||||||||||||||||||||||||||
| Auto/trucks | 37 | 3.8 | 4.3 | 6.8 | 6.3 | 5.7 | 5.5 | 4.0 | 3.9 | 4.0 | 4.1 | 4.3 | ||||||||||||||
| Business and consumer services | 93 | 6.8 | 7.1 | 7.2 | 7.0 | 6.9 | 6.9 | 7.0 | 7.1 | 6.7 | 6.4 | 6.2 | ||||||||||||||
| Cap goods/machine & equip | 116 | 5.9 | 6.2 | 6.1 | 5.8 | 5.3 | 5.3 | 5.4 | 5.3 | 5.4 | 5.8 | 5.6 | ||||||||||||||
| Chemicals | 33 | 5.4 | 5.6 | 7.1 | 7.1 | 7.4 | 5.2 | 4.3 | 4.2 | 4.1 | 4.1 | 4.3 | ||||||||||||||
| Consumer products | 101 | 5.5 | 6.0 | 5.8 | 5.6 | 6.2 | 5.3 | 5.7 | 6.2 | 6.0 | 6.0 | 6.1 | ||||||||||||||
| Forest prod./bldg. mats/packaging | 45 | 4.7 | 5.3 | 4.4 | 4.4 | 4.3 | 4.1 | 4.0 | 3.9 | 4.1 | 4.5 | 3.7 | ||||||||||||||
| Restaurants/retailing | 86 | 4.6 | 5.6 | 6.5 | 5.9 | 5.7 | 5.1 | 4.0 | 4.0 | 3.8 | 3.8 | 3.7 | ||||||||||||||
| Technology | 103 | 7.6 | 7.3 | 7.3 | 7.1 | 6.9 | 7.2 | 7.1 | 7.0 | 7.1 | 7.1 | 7.3 | ||||||||||||||
| Total | 1,115 | 5.2 | 5.9 | 6.6 | 6.4 | 6.3 | 6.1 | 5.5 | 5.5 | 5.4 | 5.3 | 5.2 | ||||||||||||||
| Leverage is calculated as reported gross debt over reported EBITDA, without adjustment by S&P Global Ratings. The sample in this study is rebalanced each quarter following selection criteria, as detailed in the “The Data Used In This Report” section. Source: S&P Global Ratings. | ||||||||||||||||||||||||||
Free operating cash flows have fallen to their lowest levels in more than two years
- Cash flows are weakening. For the 12 months ended June 30, 2022, the median ratio of FOCF to debt was 2.4%, compared with 4.4% during 2019 (see tables 5 and 6). Except for oil, gas, mining, and minerals, all sectors compare unfavorably with levels a year ago.
- 'B-' rated issuers are feeling the pinch because their median FOCF to debt slipped further into negative territory. The ratio has been declining at a quarterly average of 90 basis points since the first quarter of 2021--showcasing the risk of increased input costs (even though interest rates continue to rise, most of the increases to date are not yet reflected in the trailing 12-month results).
Table 5
| Median FOCF To Debt By Issuer Credit Rating | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Median free operating cash flow to debt (%), reported last 12 months | ||||||||||||||||||||
| Issuer credit rating* | Entity count | 12 months ended Dec. 31, 2019 | 12 months ended Dec. 31, 2020 | 12 months ended March 31, 2021 | 12 months ended June 30, 2021 | 12 months ended Sept. 30, 2021 | 12 months ended Dec. 31, 2021 | 12 months ended March 31, 2022 | 12 months ended June 30, 2022 | |||||||||||
| BB+ | 117.0 | 13.5 | 17.9 | 20.7 | 18.9 | 18.8 | 16.0 | 15.3 | 12.2 | |||||||||||
| BB | 115.0 | 12.1 | 16.1 | 14.6 | 16.5 | 17.8 | 14.3 | 14.0 | 12.2 | |||||||||||
| BB- | 102.0 | 9.6 | 15.6 | 18.2 | 15.6 | 13.5 | 10.9 | 8.5 | 8.9 | |||||||||||
| B+ | 157.0 | 5.7 | 8.5 | 8.4 | 9.9 | 10.7 | 7.7 | 6.9 | 7.4 | |||||||||||
| B | 206.0 | 4.1 | 6.5 | 7.0 | 5.8 | 3.9 | 3.5 | 2.6 | 1.7 | |||||||||||
| B- | 266.0 | 0.7 | 3.5 | 3.4 | 1.8 | 0.7 | 0.1 | (0.4) | (1.2) | |||||||||||
| CCC+ | 74.0 | (2.8) | (0.2) | (0.4) | (2.4) | (3.7) | (5.0) | (5.8) | (6.4) | |||||||||||
| CCC | 26.0 | (0.2) | 3.0 | 1.7 | (2.8) | (5.9) | (6.1) | (5.6) | (6.9) | |||||||||||
| CCC- | 6.0 | (3.8) | (2.1) | (2.0) | (2.6) | (4.3) | (3.4) | (8.2) | (5.3) | |||||||||||
| CC | 2.0 | (1.6) | 2.5 | 6.1 | 6.9 | 5.9 | 3.4 | 0.2 | (0.7) | |||||||||||
| Total | 1,071.0 | 4.4 | 6.7 | 7.2 | 6.5 | 5.2 | 4.3 | 3.2 | 2.4 | |||||||||||
| *Rating as of Sept. 29, 2022. FOCF--Free operating cash flow, as reported and without adjustment by S&P Global Ratings. The sample in this study is rebalanced each quarter following selection criteria, as detailed in the "The Data Used In This Report" section. Source: S&P Global Ratings. | ||||||||||||||||||||
Table 6
| Median FOCF To Debt By Industry | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Median free operating cash flow to debt (%), reported last 12 months | ||||||||||||||||||||
| Industry | Entity count | 12 months ended Dec. 31, 2019 | 12 months ended Dec. 31, 2020 | 12 months ended March 31, 2021 | 12 months ended June 30, 2021 | 12 months ended Sept. 30, 2021 | 12-month ended on Dec. 31, 2021 | 12 months ended March 31, 2022 | 12 months ended June 30, 2022 | |||||||||||
| Aerospace/defense | 27.0 | 6.1 | 4.8 | 7.0 | 8.8 | 4.0 | 5.7 | 4.1 | 6.7 | |||||||||||
| Auto/trucks | 34.0 | 7.3 | 8.8 | 8.7 | 11.8 | 2.1 | (0.4) | (2.7) | (1.2) | |||||||||||
| Business and consumer services | 92.0 | 5.0 | 6.1 | 7.7 | 6.2 | 4.4 | 3.3 | 2.7 | 2.0 | |||||||||||
| Cap goods/machine & equip | 115.0 | 3.1 | 8.3 | 8.6 | 5.7 | 2.8 | 0.8 | (0.0) | (0.2) | |||||||||||
| Chemicals | 33.0 | 3.9 | 2.8 | 4.9 | 4.6 | 2.8 | 4.9 | 2.6 | 0.5 | |||||||||||
| Consumer products | 98.0 | 6.2 | 9.1 | 8.4 | 6.5 | 4.1 | 2.6 | 1.1 | 1.0 | |||||||||||
| Forest prod./bldg. mats/packaging | 44.0 | 9.4 | 14.4 | 15.2 | 10.7 | 4.9 | 3.0 | 0.8 | 1.2 | |||||||||||
| Health care | 94.0 | 1.6 | 4.9 | 7.2 | 4.2 | 2.9 | 1.9 | 1.3 | 0.2 | |||||||||||
| Media, entertainment & leisure | 148.0 | 6.6 | 4.4 | 4.8 | 7.3 | 5.4 | 4.2 | 4.4 | 5.2 | |||||||||||
| Mining & minerals | 46.0 | 6.5 | 6.5 | 8.2 | 6.1 | 6.1 | 10.1 | 10.2 | 11.9 | |||||||||||
| Oil & gas | 68.0 | 0.7 | 2.7 | 4.5 | 4.9 | 6.3 | 10.5 | 13.1 | 22.8 | |||||||||||
| Restaurants/retailing | 86.0 | 4.4 | 13.4 | 14.0 | 14.3 | 11.2 | 9.2 | 5.8 | 2.6 | |||||||||||
| Real estate | 20.0 | 5.8 | 6.8 | 10.7 | 6.9 | 3.4 | (1.0) | (0.3) | 2.0 | |||||||||||
| Technology | 95.0 | 3.9 | 7.0 | 8.9 | 9.5 | 9.1 | 7.5 | 6.8 | 6.0 | |||||||||||
| Telecommunications | 45.0 | 2.1 | 4.1 | 6.4 | 4.6 | 3.8 | 3.8 | 3.0 | 2.4 | |||||||||||
| Transportation | 26.0 | 1.7 | (1.8) | (1.2) | 1.3 | 0.7 | 3.4 | 3.3 | 1.0 | |||||||||||
| Total | 1,071.0 | 4.4 | 6.7 | 7.2 | 6.5 | 5.2 | 4.3 | 3.2 | 2.4 | |||||||||||
| FOCF--Free operating cash flow, as reported and without adjustment by S&P Global Ratings. The sample in this study is rebalanced each quarter following selection criteria, as detailed in the "The Data Used In This Report" section. Source: S&P Global Ratings. | ||||||||||||||||||||
EBITDA interest coverage: still healthy but challenges ahead
- For the first half of 2022, EBITDA tailwinds offset rising interest costs, and the net result is healthy 3.5x coverage. While the full effects of tightening policy have not yet materialized in our LTM credit measures, we expect the rapidly rising benchmark rates and widening credit spreads to bite deeper in 2023. Issuers' ability to service higher debt costs will become meaningfully more difficult for highly leveraged firms rated 'B' and lower, unless they can materially manage expenses and capital spending plans.
- This represents a challenge for health care, being the sector with the most leverage and weakest interest coverage (technology, another highly leveraged sector, is much stronger in delivering stable cash flow). The low speculative-grade health care equipment players, given their limited scale, employee turnover, and supply chain disruptions, were a notable drag on health care's overall median. While the sector is typically recession resistant, declines in health care demand due to recessionary pressures will put additional strain on the sector's ability to maintain interest coverage level.
Table 7
| Median EBITDA Interest Coverage (x) By Issuer Credit Rating | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Median EBITDA interest coverage (x), reported last 12 months | ||||||||||||||||||||
| Issuer credit rating* | Entity count | 12 months ended Dec. 31, 2019 | 12 months ended Dec. 31, 2020 | 12 months ended March 31, 2021 | 12 months ended June 30, 2021 | 12 months ended Sept. 30, 2021 | 12 months ended Dec. 31, 2021 | 12 months ended March 31, 2022 | 12 months ended June 30, 2022 | |||||||||||
| BB+ | 117 | 6.4 | 6.1 | 7.0 | 7.9 | 9.1 | 8.6 | 9.0 | 9.3 | |||||||||||
| BB | 115 | 5.6 | 5.1 | 5.7 | 6.1 | 6.4 | 7.1 | 7.8 | 8.1 | |||||||||||
| BB- | 102 | 4.6 | 3.9 | 4.1 | 5.4 | 6.0 | 6.4 | 6.5 | 6.3 | |||||||||||
| B+ | 157 | 3.1 | 2.7 | 3.2 | 3.5 | 4.0 | 4.3 | 4.3 | 4.4 | |||||||||||
| B | 206 | 2.7 | 2.3 | 2.5 | 2.6 | 2.7 | 2.9 | 3.1 | 3.1 | |||||||||||
| B- | 266 | 1.6 | 1.6 | 1.7 | 1.8 | 1.8 | 1.8 | 1.9 | 1.9 | |||||||||||
| CCC+ | 74 | 1.3 | 0.9 | 0.9 | 1.0 | 1.0 | 1.1 | 1.1 | 1.1 | |||||||||||
| CCC | 26 | 1.4 | 0.9 | 1.0 | 1.1 | 0.7 | 0.7 | 0.7 | 0.9 | |||||||||||
| CCC- | 6 | 0.9 | 1.1 | 1.3 | 1.5 | 1.2 | 0.8 | 0.7 | 0.3 | |||||||||||
| CC | 2 | 1.2 | 1.7 | 1.8 | 1.7 | 1.8 | 1.7 | 1.5 | 1.5 | |||||||||||
| Total | 1,071 | 2.9 | 2.4 | 2.6 | 2.9 | 3.0 | 3.3 | 3.5 | 3.5 | |||||||||||
| *Rating as of Sept. 29, 2022; coverage is calculated as reported EBITDA over reported interest expense, without adjustment by S&P Global Ratings. The sample in this study is rebalanced each quarter following selection criteria, as detailed in the "The Data Used In This Report" section. Source: S&P Global Ratings. | ||||||||||||||||||||
Table 8
| Median EBITDA Interest Coverage (x) By Industry | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Median EBITDA interest coverage (x), reported last 12 months | ||||||||||||||||||||
| Industry | Entity count | 12 months ended Dec. 31, 2019 | 12 months ended Dec. 31, 2020 | 12 months ended March 31, 2021 | 12 months ended June 30, 2021 | 12 months ended Sept. 30, 2021 | 12 months ended Dec. 31, 2021 | 12 months ended March 31, 2022 | 12 months ended June 30, 2022 | |||||||||||
| Aerospace/defense | 27 | 4.0 | 2.5 | 2.6 | 2.7 | 2.9 | 3.7 | 3.8 | 3.8 | |||||||||||
| Auto/trucks | 34 | 3.3 | 2.6 | 3.0 | 4.2 | 4.3 | 4.1 | 3.9 | 3.9 | |||||||||||
| Business and consumer services | 92 | 2.0 | 2.0 | 2.3 | 2.3 | 2.3 | 2.6 | 2.8 | 2.8 | |||||||||||
| Cap goods/machine & equip | 115 | 2.7 | 2.8 | 2.9 | 3.0 | 2.8 | 3.2 | 3.6 | 3.4 | |||||||||||
| Chemicals | 33 | 3.0 | 2.3 | 3.0 | 3.4 | 4.4 | 4.1 | 4.7 | 4.7 | |||||||||||
| Consumer products | 98 | 2.8 | 2.7 | 3.0 | 3.1 | 2.9 | 2.9 | 3.0 | 3.0 | |||||||||||
| Forest prod./bldg. mats/packaging | 44 | 3.3 | 4.4 | 4.0 | 4.8 | 4.8 | 5.3 | 5.4 | 5.2 | |||||||||||
| Health care | 94 | 1.8 | 1.8 | 2.0 | 2.0 | 2.2 | 2.1 | 2.1 | 2.0 | |||||||||||
| Media, entertainment & leisure | 148 | 3.1 | 1.7 | 1.8 | 2.0 | 2.1 | 2.4 | 2.6 | 2.6 | |||||||||||
| Mining & minerals | 46 | 4.6 | 3.1 | 3.3 | 4.8 | 5.2 | 6.3 | 7.3 | 7.3 | |||||||||||
| Oil & gas | 68 | 5.7 | 2.6 | 2.7 | 3.5 | 4.6 | 6.3 | 7.6 | 9.8 | |||||||||||
| Restaurants/retailing | 86 | 2.8 | 2.1 | 2.6 | 3.7 | 3.5 | 3.9 | 4.1 | 4.4 | |||||||||||
| Real estate | 20 | 3.6 | 3.3 | 3.3 | 3.4 | 3.2 | 3.5 | 3.8 | 3.6 | |||||||||||
| Technology | 95 | 1.8 | 2.2 | 2.2 | 2.4 | 2.4 | 2.4 | 2.5 | 2.4 | |||||||||||
| Telecommunications | 45 | 2.8 | 3.2 | 3.4 | 3.5 | 4.0 | 4.5 | 4.5 | 4.3 | |||||||||||
| Transportation | 26 | 4.3 | 1.9 | 1.9 | 2.3 | 2.5 | 2.7 | 2.9 | 3.2 | |||||||||||
| Total | 1,071 | 2.9 | 2.4 | 2.6 | 2.9 | 3.0 | 3.3 | 3.5 | 3.5 | |||||||||||
| Coverage is calculated as reported EBITDA over reported interest expense, without adjustment by S&P Global Ratings. The sample in this study is rebalanced each quarter following selection criteria, as detailed in the "The Data Used In This Report" section. Source: S&P Global Ratings. | ||||||||||||||||||||
First-Lien Recovery Expectations Have Been Stable In The Mid-60s Percent Area
Recovery prospects take on greater importance as default rates rise. During the COVID-19 recession, recovery rating movements were less frequent and of lesser magnitude than entity-level rating changes, since our recovery ratings already consider a default scenario. New-issue recovery estimates have been relatively stable thus far in 2022 despite economic conditions worsening considerably since the year's start. Our recovery expectations for first-lien debt issued in the third quarter weakened marginally, with the average recovery point estimates declining to 63%, from 64% in the previous quarter. We note that datasets of the past two quarters have been unusually thin; each saw only 152 and 72 new first-lien issuances, respectively, compared with a quarterly average of 319 last year (see chart 5).
Over the longer horizon, aggressive structures led by high secured leverage and little junior cushion have eroded first-lien recovery prospects. The past decade marked a period of declining first-lien recoveries relative to the historical average. Based on data collected from North American companies that exited Chapter 11 bankruptcy, actual recoveries of first-lien debt averaged 78% before 2020 (2008-2019) and 68% from 2020 to the second quarter of 2021.
Chart 5
We continue to see a high concentration of '3' recovery ratings (indicating an estimated recovery of 50%-70% in a payment default) for new issues, which comprised about two-thirds of the total (see chart 6). The growing share of '3' recovery ratings reflects a balance of increasingly aggressive debt structures (high total debt leverage and limited junior debt cushions), tempered somewhat by the need for CLOs to satisfy their collateral quality tests (e.g., a maximum weighted average recovery rate), which limits the ability to syndicated term loans with recovery ratings of less than '3'.
The third quarter featured a rare assigning of a '6' recovery rating (indicating negligible recovery expectations of 0%-10%); however, this was due to a restructuring rather than a new issuance. We assigned a '6' recovery rating (rounded estimate of 0%) to the first-lien term loan (third-out tranche) of Envision Healthcare Corp., which recently completed a two-part restructuring that consisted of a collateral transfer in April and a priming up-tiering loan exchange in August. Each of the steps led to material negative recovery implications for Envision's legacy first-lien lenders and more for those who did not participate in the up-tier exchange. We discussed the mechanics, recovery implications, and protections that are increasingly being put in place to mitigate these outcomes in "Credit FAQ: Envision Healthcare Corp.'s Two Major Restructurings In 100 Days," published Sept. 2, 2022.
Chart 6
Data Used In This Report
Our large data set contains all speculative-grade corporate entities that we rate in the U.S. and Canada, covering both public and private companies. Each quarter, we construct a sample pool from the large set where we have quarter-end reported financial results for every quarter since Dec. 31, 2018. This sample set varies somewhat quarter by quarter because it excludes entities rated 'S.D.' (selective default) or no longer outstanding as of each quarter-end (either due to default or being withdrawn) but includes new issuers where we have their historical financial results. The sample set is generally smaller than the large set but is nonetheless a representative sample of the North American speculative-grade universe.
The sample in this report consists of 1,071 companies because some private companies have yet to report financial results for the second quarter of 2022 before our extraction date of Sept. 29, 2022. These companies will re-enter the sample once we have all the financial results and when we build the next sample.
Related Research
- Credit Trends: Global Financing Conditions: Bond Issuance Set To Remain Weak Through Year-End, Expand Modestly In 2023, Oct. 26, 2022
- Business Cycle Barometer: Worsening Near-Term Growth Prospects, Oct. 24, 2022
- Risky Credits: U.S. And Canada Default Risk Rises As Lower Ratings Deteriorate, Oct. 24, 2022
- CLO Insights 2022 U.S. BSL Index: Trick Or Treat? BSL CLO Credit Metrics Aren’t Scary Yet, But They’re Starting To Tremble, Oct. 11, 2022
- Default, Transition, and Recovery: Weakest Links Jump As Rating Trends Turn Negative, Oct. 6, 2022
- Economic Outlook U.S. Q4 2022: Teeter Totter, Sept. 26, 2022
- Credit FAQ: Envision Healthcare Corp.'s Two Major Restructurings In 100 Days, Sept. 2, 2022
- U.S. Leveraged Finance Q2 2022 Update: Corporate Borrowers Brace For Slow-Growth Recession, July 27, 2022
- Recovering From COVID-19: Why The Timing Of Bankruptcy And Emergence Matters For Debt Recovery, Feb. 7, 2022
This report does not constitute a rating action.
| Primary Credit Analysts: | Hanna Zhang, New York + 1 (212) 438 8288; Hanna.Zhang@spglobal.com |
| Daniel Hu, FRM, New York + 1 (212) 438 2206; daniel.hu@spglobal.com | |
| Secondary Contacts: | Steve H Wilkinson, CFA, New York + 1 (212) 438 5093; steve.wilkinson@spglobal.com |
| Minesh Patel, CFA, New York + 1 (212) 438 6410; minesh.patel@spglobal.com | |
| Stephen A Anderberg, New York + (212) 438-8991; stephen.anderberg@spglobal.com | |
| Analytical Manager: | Ramki Muthukrishnan, New York + 1 (212) 438 1384; ramki.muthukrishnan@spglobal.com |
| Research Contributor: | Maulik Shah, Mumbai + (91)2240405991; maulik.shah@spglobal.com |
No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.