- Fitch Ratings lowered its default rate forecast for U.S. leveraged loans to 1.5% from 2.5% as “constricted sectors” reopen from pandemic-induced lockdowns and confidence grows in capital markets.
“The year-end default rate could finish even lower than the projection if the current strong environment continues,” Eric Rosenthal, senior director of leveraged finance at Fitch Ratings, said in a statement.
A 1.5% default rate for this year would be the lowest level since the 0.6% level in 2011, Fitch said, while not altering its 2.5% to 3.5% default rate forecast for next year.
Institutional leveraged loans — high-yielding loans made to businesses with poor credit and high debt — boomed during the decade preceding the pandemic.
The market for leveraged loans surged to $1.2 trillion in 2019 from $500 billion in 2010 as investors seeking high yield snapped up collateralized loan obligations (CLOs), securities backed by pools of leveraged loans, according to the GAO.
After a shock from the coronavirus during March 2020, the leveraged loan market rebounded as the Federal Reserve reduced interest rates to a record low and provided unprecedented support to credit markets.
“Our actions, taken together, helped unlock more than $2 trillion of funding to support businesses large and small, nonprofits and state and local governments between April and December 2020,” Fed Chairman Jerome Powell said today in remarks prepared for testimony to the House Select Subcommittee on the Coronavirus Crisis.
The leveraged loan default rate is still high for some sectors hit especially hard by COVID-19, Fitch Ratings said. The leisure and entertainment default rate forecast remains at 14%, while the year-end rate for the retail and energy sectors stand at 7% and 5%, respectively.
Looking ahead to next year, Fitch said its “higher 2022 default rate forecast reflects uncertainty about the sustainability of the economic recovery for some sectors.”
Dealmaking has fueled leveraged lending this year, Fitch Ratings said. Companies often use the loans to finance mergers and acquisitions. Issuance totaled $46 billion last month, a 39% decline from $75 billion in April but “still healthy compared with the historical average.”
The GAO determined in December that leveraged lending did not pose a significant threat to financial stability. Still, the GAO called on Congress and the Financial Stability Oversight Council (FSOC) to curb risks from leveraged lending and other forms of finance.
The FSOC, a panel of U.S. financial regulators, was created in 2010 after the financial crisis to identify systemic risks.