Key Takeaways
- The U.S. leveraged loan default rate could rise to 2.75% by June 2024 from 1.9% in August 2023 amid persistently challenging credit conditions.
- Speculative-grade credit quality has deteriorated amid slowing top-line growth and high costs.
- Restrictive primary markets have reduced access to capital, and we expect both liquidity and refinancing risk to increase over the next 12 months.
S&P Global Ratings expects the leveraged loan default rate to climb to 2.75%, near the historical average of 2.5%, by June 2024. To reach this base forecast, 32 issuers would need to default in the Morningstar LSTA US Leveraged Loan Index.
Macroeconomic conditions, including slowing GDP growth, continue to weigh on operating performance as liquidity grows increasingly constrained for speculative-grade (rated 'BB+' or lower) issuers. The leveraged loan default rate stood at 1.9% in August 2023, with 20 issuer defaults in the index year to date, up from just six during the same period a year ago.
The increase in defaults this year largely owes to issuers' inability to refinance debt and deteriorating liquidity. We expect these risks to build over the next 12 months as macroeconomic challenges persist and debt maturities pick up through 2025. Restrictive debt markets will likely lead to a rising cost of debt on issuers' balance sheets in the near term, and we expect this to add to liquidity pressure among stressed issuers.
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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 and Data's 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 June 2024 forecast for the U.S. trailing-12-month speculative-grade corporate default rate is 4.5% | The baseline June 2024 forecast for the Morningstar LSTA US Leveraged Loan Index 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. | ||||
Table 2
| Ratings distributions for Morningstar LSTA US Leveraged Loan Index and all speculative-grade issuers | ||||||
|---|---|---|---|---|---|---|
| (%) | ||||||
| Rating category | All speculative-grade issuers | Morningstar LSTA US Leveraged Loan Index rated issuers* | ||||
| BB | 30.1 | 21.0 | ||||
| B | 57.4 | 68.4 | ||||
| CCC/C | 12.5 | 9.5 | ||||
| B- or lower | 37.1 | 40.0 | ||||
| Data as of July 31, 2023. *The index includes some issuers rated in the 'BBB' category. Sources: Leveraged Commentary and Data (LCD) from PitchBook, a Morningstar company; 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
- The U.S. Speculative-Grade Corporate Default Rate Could Rise To 4.5% By June 2024, Aug. 17, 2023
- The U.S. Leveraged Loan Default Rate Could Hit 2.5% By March 2024 Given Persistent Inflation And Higher Interest Rates, May 25, 2023
- 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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