Key Takeaways
- The leveraged loan default rate could rise to 2.5% by December 2023 from 0.85% in January 2023 amid persistently challenging credit conditions.
- We continue to see evidence that cushions built up after the 2020 recession are thinning for speculative-grade issuers.
- Restrictive primary markets have reduced access to capital, and we expect refinancing risk to rise during the year for issuers that face liquidity constraints.
- We expect the default rate to quickly rise over the next 12 months, but our baseline forecast for the leveraged loan default rate is in line with the historical average of 2.5%.
Macroeconomic conditions continue to weigh on operating performance and constrain liquidity, and this is thinning cushions that supported speculative-grade issuers in 2021 and 2022. During the trailing-12-month period that ended in January 2023, leveraged loan defaults have increased largely due to issuers' inability to refinance debt.
Between October 2022 and January 2023, two leveraged loan issuers defaulted in the index. This returned the default rate as of January 2023 to 0.85%, where it stood at the end of the third-quarter 2022.
Two more issuers in the index have defaulted in February, bringing the year-to-date tally up to four from zero defaults during the same period a year ago. We expect the leveraged loan default rate to quickly rise to 2.5% by December 2023 as refinancing risk increases later this year. To reach our base forecast, 30 issuers would need to default in the index (see chart 1).
Chart 1
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Differences In Default Rate Measurements
The high proportion of selective defaults in 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 much narrower.
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.
Leveraged Commentary & Data's (LCD) definition of default determines the Morningstar LSTA US Leveraged Loan Index trailing-12-month default rate by number of issuers. This definition of default only includes defaults on loan instruments and excludes selective defaults from distressed debt exchanges. The differences in default definitions are important sources of variation between the two series (see table 1).
Table 1
| Summary Of Differences In Default Definitions | ||||
|---|---|---|---|---|
| S&P Global Ratings definition | Morningstar LSTA US 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) | ||||
| • The baseline December 2023 forecast for the U.S. trailing-12-month speculative-grade corporate default rate is 4.0% | • The baseline December 2023 forecast for the Morningstar LSTA US Leveraged Loan Index default rate by number of issuers is 2.50% | |||
| *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. | ||||
Table 2
| Morningstar LSTA US Leveraged Loan Index Issuers By Rating Category Compared With All Speculative-Grade Issuers | ||||||
|---|---|---|---|---|---|---|
| % | All speculative-grade issuers | Morningstar LSTA US Leveraged Loan Index rated issuers¶ | ||||
| 'BB' | 28.8 | 20.1 | ||||
| 'B' | 60.2 | 70.9 | ||||
| 'CCC/C' | 11.0 | 8.2 | ||||
| 'B-' or lower | 36.8 | 39.5 | ||||
| Data as of 1/31/2023. ¶The index includes some issuers rated in the 'BBB' category. Sources: Leveraged Commentary & Data (LCD), S&P Global Market Intelligence's CreditPro®, and S&P Global Ratings Credit Research & Insights. | ||||||
How We Determine Our Default Rate Forecasts
The Morningstar LSTA US 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 our proprietary analytical tool for the Morningstar LSTA US Leveraged Loan Index issuer base. The main components of the analytical tool are the U.S. trailing-12-month speculative-grade corporate default rate, the ratio of selective defaults to total defaults, a leveraged loan debt-to-EBITDA ratio, the Morningstar LSTA US Leveraged Loan Index distress ratio, changes to the mix of rated loans toward higher or lower ratings, and the unemployment rate.
Related Research
- Growing Strains Could Push The U.S. Speculative-Grade Corporate Default Rate To 4% By December 2023, Feb. 16, 2023
- The Morningstar LSTA U.S. Leveraged Loan Index Default Rate Could Rise To 2.5% By September 2023, Dec. 7, 2022
- The Morningstar LSTA U.S. Leveraged Loan Index Default Rate Could Rise To 2.0% By June 2023, Aug. 31, 2022
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, Austin 212 438 1989; jon.palmer@spglobal.com |
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