Leveraged loan market upside revisions outpace Q1 downside revisions by 1.2x
The ratio of loan facility upgrades to downgrades in the S&P/LSTA Leveraged Loan Index fell in the first quarter to 1.2x, after a recent three-month trailing peak of 2. 5x last August, amid growing economic uncertainty.
Leveraged loan ratings have adjusted to, among other things, rising inflation, continued supply chain constraints, relatively low consumer confidence and fears that a reverse yield could bode well for the US economy.
The three-month rolling upgrade/downgrade ratio has steadily increased from a pandemic-driven low in May 2020 of 0.02x (or 43x more downgrades than upgrades) to 2.5x in August 2021, as the US economy recovered from the depths of a brief but fierce recession. But the three-month rolling ratio has now declined steadily since last August, except for a slight uptick in December 2021.
The monthly upgrade and downgrade data shows with some granularity the severity of the pandemic decline, recovery and current environment. In April 2020, there were 228 downgrades versus 5 index loan upgrades. That winter things had improved significantly – between December 2020 and February 2022, monthly downgrades occurred between 6 and 13 each month, with an average of 10. Upgrades during this period were in average of 18 per month.
But downgrades in March 2022 hit 16, while upgrades were at the 15-month average of 18.
The three-month tally of upgrades and downgrades also tells the story. In the three months ending May 2020, there were 432 downgrades versus 10 upgrades. By August 2021, those three-month rolling numbers had reversed and the index’s leveraged loans saw 65 healthy upgrades versus 26 downgrades. But the March 2022 three-month tally saw an almost equal share of activity, with 41 upgrades and 35 downgrades.
The rolling 12-month tally of upgrades and downgrades shows a smoother and currently more constructive ratings environment than the March downgrade spike might imply. The March 2022 rolling 12-month upgrade count is 219, down from 122 downgrades, a ratio of 1.8x, much better than the current nominal monthly ratio of 1.2x.
From a ratings perspective, leveraged loan index issuers rated CCC, CC or C now represent 4.0% of the index, down from 4.9% at end-2021, 9.3% at end of 2020 and a pandemic high of 11.2. % in April 2020. The current figure is well below 6.0%, the average of the past 10 years, and is rapidly approaching the post-financial crisis low of 2.54% set in March 2015.
At the same time, the share of outstanding loans granted to borrowers rated B-minus stood at 26.7% as of March 31, just slightly below the all-time high of 26.8% as of January 31 and rising. down from 25.3% at the end of 2021. Although leveraged loan issuance has fallen from its scorching 2021 pace following Russia’s invasion of Ukraine in late February, January has originated $39.6 billion in new loans to borrowers rated B-minus by at least one rating agency. This was a monthly record, bringing the year-to-date total to $57.1 billion, or 50% of all new issue volume.