Jump in US leveraged loan defaults

November 2022 | DEALFRONT | BANKRUPTCY & CORPORATE RESTRUCTURING

Financier Worldwide Magazine

November 2022 Issue

Concern is mounting over growth in US leveraged loan defaults. Indeed, default activity in the US leveraged loan market increased markedly in August, after bankruptcy filings from four issuers in the Morningstar LSTA US Leveraged Loan Index pushed $4.46bn of institutional loan debt into non-performing status.

Increasing from historic lows, the default rate of the index rose to 0.69 percent by issuer count, and to 0.60 percent by amount in August, from a respective 0.43 percent and 0.28 percent in July.

Defaults on leveraged loans hit $6bn in August, the highest monthly total since October 2020, when coronavirus (COVID-19) pandemic shutdowns crippled the US economy, according to Fitch Ratings. While the figure represents a fraction of the sprawling loan market, which doubled over the past decade to about $1.5 trillion, more defaults are expected as interest payments on loans increase alongside benchmark interest rates set by the US Federal Reserve.

Going forward, the rate of defaults on leveraged loans is expected to more than triple from around 1 percent in early September to about 3.25 percent in mid-2023, according to Barclays PLC. By September 2023, that number could rise to 4.5 percent. And though the rate of defaults is likely to be much lower than the 7 percent spike recorded in 2020 at the height of the pandemic, when the Federal Reserve took steps to cut interest rates and add cash to markets, similar interventions are not expected to be forthcoming. Jerome Powell, chair of the Federal Reserve board, made it clear in a speech outlining the Fed’s strategy to fight inflation that it was willing to put businesses through “some pain” now to prevent “far greater pain” further down the line.

And pain is already being felt, with a number of companies entering a perilous state in recent months. To that end, there was more defaulted loan volume in August than in the prior 17 months combined.

Among the most notable defaults was Endo International, which filed for Chapter 11 protection in New York’s Southern District bankruptcy court to reduce debt and address lawsuit liabilities stemming from its alleged role in the US opioid epidemic. The company’s term loan B, which was placed in 2021 to refinance existing debt, had $1.975bn outstanding at the time of filing, marking the largest issuer default since Seadrill Partners’ $2.6bn loan in July 2020. Endo’s Chapter 11 filing listed total assets of $6.33bn and total debts of $9.54bn. Among the shareholders listed on the petition were the Vanguard Group with a 12.07 percent stake, BlackRock with a 7.93 percent stake, Paulson & Co with a 7.37 percent stake and Renaissance Technologies with a 7.07 percent stake.

Endo is one of several high-profile Chapter 11 filings relating to opioid claims in the US. Among other loan index issuers, Mallinckrodt recently emerged from bankruptcy after placing $1.9bn of index loans into bankruptcy in October 2020.

Medical imaging company Carestream Health also filed for bankruptcy in the District of Delaware. The company’s announced prepackaged bankruptcy plan will reduce its outstanding debt by around $470m. Carestream’s term loan had $507.7m outstanding, according to court filings.

OSG Billing Services also filed for Chapter 11 bankruptcy with a plan that would leave all creditors either unimpaired or with a recovery valued at 100 percent. According to the company’s disclosure statement, OSG cited rising print costs and reduced mail demand for its filing and said its proposed reorganisation plan would amend and restate the company’s existing first-lien term loan, outstanding in the amount of about $599m, with a larger facility of $601.4m.

Lighting product manufacturer Lumileds also filed for Chapter 11, citing challenges caused by supply chain constraints, COVID-19-related issues and the conflict in Ukraine for the company’s excessive leverage. Lumileds, whose products generally serve the auto, smartphone and industrial end markets, had $1.61bn outstanding on its term loan B due 2024, according to court documentation.

Richard Summerfield