Key Takeaways
- We expect the U.S. leveraged loan default rate to fall to 1% by September 2025, from 1.26% in September 2024. Lower benchmark interest rates will mean lower funding costs, and this will benefit issuers' coverage ratios and free operating cash flows.
- Favorable financing conditions this year have enabled borrowers to refinance most of next year's maturities, further reducing default risk.
- While default risk over the next 12 months appears to be moderating, the prospect of policy shifts on tariffs, trade, and immigration heighten uncertainty. In our pessimistic scenario, we project that the leveraged loan default rate will nearly double (to 2.5%).
S&P Global Ratings Private Markets Analytics and S&P Global Ratings Credit Research & Insights expect the U.S. leveraged loan default rate to fall to 1% by September 2025. This would mean a further decline from the 1.26% default rate in September 2024.
Supportive financing and macro conditions have contributed to this year's decline in the leveraged loan default rate while also positioning borrowers for further improvement over the next 12 months. With loan issuance more than doubling year over year through September, borrowers have refinanced many upcoming maturities--they have reduced U.S. speculative-grade maturities in 2025 by 50%.
Furthermore, after cuts to the benchmark federal funds rate in September and November, funding costs on floating-rate loans will lessen as rates adjust.
The trailing-12-month leveraged loan default rate has fallen by over three-quarters of a percentage point this year, to 1.27% in October; it was just over 2% at the beginning of the year. With the default rate already at such a low level, further reductions will likely be incremental. Our baseline forecast implies that there will be 11 defaults of issuers from the Morningstar/LSTA US Leveraged Loan Index through September 2025, which would be down from the 19 that defaulted over the last 12 months.
In our pessimistic scenario, we forecast that the leveraged loan default rate could nearly double, to 2.5%. Higher-than-expected inflation, possibly exacerbated by higher tariffs or changing immigration policies, could result in a slower pace of rate cuts. Both tariffs and immigration policy can take time to implement, and so the impact could stretch past the horizon of this forecast. Still, these policy shifts, as well as several fronts of global geopolitical instability, could raise the level of uncertainty in the market.
A recession is not in our baseline forecast, and S&P Global Ratings economists consider one to be unlikely.
In our optimistic scenario, we forecast that the default rate could fall further, to 0.75%. The growth slowdown wouldn't be as pronounced as we expect in coming quarters--that is, an upside surprise, without a slowing in the expected pace of interest rate cuts. This combination would give borrowers a boost in sales and revenue from a strengthening economy, while funding costs continue to come down, boosting cash flows.
Even in this scenario, the default rate would fall by just over half a percentage point over the next 12 months. This would mark a slowing of the default rate's decline since the beginning of the year.
Robust Issuance Has Eased Near-Term Refinancing Needs
Constructive financing conditions have supported refinancing. Institutional loan issuance has more than doubled year over year through September, and this year is second only to 2021 for annual volume, according to PitchBook | LCD. Speculative-grade bond issuance and private credit are also providing borrowers with debt funding.
A total of $730 billion in high-yield bonds and leveraged loans was issued in the first three quarters of 2024--second only to record volume in 2021. Even though loan issuance modestly declined in third-quarter 2024 from the prior quarter, it still surpassed volume in third-quarter 2023 by more than 50%. The strong issuance rebound and a historic tightening of spreads helped many issuers refinance their upcoming maturities.
And while near-term maturities in 2025 saw the greatest reduction, borrowers also chipped away at maturities that are further out--in 2026 through 2028.
With the strong demand for new issuance, funding costs have already started to come down. The average yield on a new-issue loan rated 'B+' or 'B' was less than 9% in October, down from over 10% at the beginning of the year.
Defaults, Distress, And Weakest Links All Show Declines
The decline in the leveraged loan default rate this year has been steeper than the decline in the broader speculative-grade default rate. The leveraged loan default rate has fallen by nearly 0.8 percentage points (to 1.26% in September), while the U.S. trailing-12-month speculative-grade default rate saw a more modest decline of 0.1 percentage points. The leveraged loan default rate has been steadily declining since the beginning of the year, while the speculative-grade default rate rose in the first four months of 2024--it has only been declining since April.
We expect that the U.S. speculative-grade default rate will fall to 3.25% by September 2025 (from 4.4% in September 2024). Declining interest rates, easing inflation, and lower upcoming maturities--alongside a still resilient economy and earnings growth--are several of the factors that lead us to expect a lower speculative-grade default rate ahead.
A key difference between the leveraged loan and speculative-grade default rates is the inclusion of distressed exchanges in the latter. Distressed exchanges are the leading cause of speculative-grade defaults, and they're excluded from this measure of the leveraged loan default rate.
Distressed exchanges account for 55% of the U.S. speculative-grade defaults that have occurred this year (through October)--one of the highest shares since 2009.
These defaults are also affecting the pool of weakest links (issuers rated 'B-' or below with a negative outlook or on CreditWatch with negative implications). These lowest-rated issuers have historically had a much higher default rate, and we expect them to remain vulnerable to potential default going forward.
The number of weakest links in the U.S. dropped to 182 as of the end of third-quarter 2024 (down from 228 at the start of the year and below the five-year average of 214). Most of the removals from the weakest links list have been due to defaults rather than upgrades or outlook revisions.
While the number of weakest links is shrinking, they're still a sizable pool of issuers that are at elevated risk of default. Just over 10% of the issuers in the leveraged loan index are rated 'CCC+' or below.
Despite there being this pool of borrowers with ratings at these levels, market measures suggest that investors are taking a more favorable view of default risk within the index. One of these measures is the leveraged loan distress ratio (the percentage of performing loans from the index that are priced below 80). At 5.09% in October, this distress ratio is down by more than a percentage point since the beginning of the year, and down by about half of a percentage point since June.
The decline in the distress ratio suggests that loan investors may also be expecting fewer defaults from borrowers within the index.
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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 (see table 1). There are important differences in the definitions of default for each default rate series and forecast that we analyze in our reports:
- S&P Global Ratings' definition of default determines the U.S. trailing-12-month speculative-grade corporate default rate.
- Within the Morningstar/LSTA US Leveraged Loan Index, we measure the trailing-12-month default rate by number of issuers. This default rate excludes selective defaults from distressed debt exchanges.
Table 1
| Summary of differences in default definitions | ||||
|---|---|---|---|---|
| S&P Global Ratings' definition | Morningstar/LSTA US Leveraged Loan Index's definition | |||
| --Issuer files for bankruptcy (results in a 'D' rating) | --Issuer files for bankruptcy | |||
| --Issuer missed principal or interest payment on a bond instrument (results in a 'D' or 'SD' rating)* | --Issuer downgraded to 'D' by S&P Global Ratings | |||
| --Issuer missed principal or interest payment on a loan instrument (results in a 'D' or 'SD' rating)* | --Issuer missed principal or interest payment on a loan instrument without forbearance | |||
| --Distressed exchange (results in a 'D' or 'SD' rating) | ||||
| The baseline June 2025 forecast for the U.S. trailing-12-month speculative-grade corporate default rate is 3.75% | The baseline June 2025 forecast for the Morningstar/LSTA US Leveraged Loan Index default rate by number of issuers is 1.5% | |||
| *Under S&P Global Ratings' definition, an issuer is considered to be 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 | ||||||
|---|---|---|---|---|---|---|
| Rating category | All speculative-grade issuers | Rated issuers that are in the Morningstar/LSTA US LL Index* | ||||
| BB | 33% | 23% | ||||
| B | 56% | 61% | ||||
| CCC/C | 11% | 11% | ||||
| BBB- or above | N/A | 5% | ||||
| B- or below | 33% | 35% | ||||
| Data as of Sept. 30, 2024. *The index includes some issuers rated in the 'BBB' category. N/A--Not applicable. Sources: PitchBook | LCD, S&P Global Market Intelligence's CreditPro, and S&P Global Ratings Private Markets Analytics. | ||||||
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. We consider, among various factors, 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 in the distribution of rated loans toward higher or lower ratings, and the unemployment rate.
Related Research
- Economic Outlook U.S. Q1 2025: Steady Growth, Significant Policy Uncertainty, Nov. 26, 2024
- Default, Transition, and Recovery: Spotlight On U.S. Defaults In October, Nov. 19, 2024
- Default, Transition, and Recovery: U.S. Speculative-Grade Corporate Default Rate To Fall Further To 3.25% By September 2025, Nov. 15, 2024
- Credit Trends: Global Refinancing: Reductions In Near-Term Maturities Continue Ahead Of Further Rate Cuts, Oct. 23, 2024
- U.S. Business Cycle Barometer: Recession Risk Remains Above Historical Norm, June 18, 2024
This report does not constitute a rating action.
| Private Markets Analytics: | Evan M Gunter, Montgomery + 1 (212) 438 6412; evan.gunter@spglobal.com |
| Ruth Yang, New York (1) 212-438-2722; ruth.yang2@spglobal.com | |
| Credit Research & Insights: | Ekaterina Tolstova, Frankfurt +49 173 6591385; ekaterina.tolstova@spglobal.com |
| Research Assistants: | Claudette Averion, Manila |
| Charlie Cagampang, Manila | |
| Johnnie Muni, Manila |
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