Deep in junk: more than one third of US leveraged loans now carry B minus or lower ratings

A spree of downgrades has pushed the ratings on more than one-third of the $1.2tn US leveraged loan market to B minus or lower, the highest share on record, as the fallout from the coronavirus pandemic weighs on businesses across the US.

Ratings on loans worth $369bn have been cut by S&P Global this year. The credit quality of more than one-tenth of the loans within the benchmark S&P/LSTA leveraged loan index is now judged at C, double C or triple C — ratings that often signal a company is facing severe financial distress.

The weakening creditworthiness of a large number of the companies that borrow through the leveraged loan market has raised red flags for investors, even as stock markets have surged back towards record highs. The loan market is a critical source of funding for midsized US businesses and leveraged buyout firms. It has more than doubled in size over the past decade.

Even as loan prices have recovered over the past ten weeks, the pace of rating cuts has been eye-catching. Downgrades have outnumbered upgrades by a ratio of 43 to 1 over the past three months, according to analysts with LCD, a unit of S&P Global.

Among the downgraded issuers are Bass Pro Group, the fishing and hunting supplies retailer, hospital owner LifePoint Health and medical staffing business Envision Healthcare.

“We expect the coronavirus pandemic will lead to a weakening US economy, with high unemployment, and reduced consumer spending this year,” Mathew Christy, an analyst with S&P, said when downgrading Bass Pro Group to single B from B plus.

He added that S&P expected the drop in revenues and profitability would bump Bass’s debt ratios significantly higher. Investors fear that many other businesses will struggle to repay their debts if revenues remain depressed.

The rating cuts are already proving problematic for the managers of pools of loans known as collateralised loan obligations, which are among the largest owners of leveraged loans. CLOs have restrictions on their ownership of loans rated triple C, and many are nearing or breaching those limits, S&P data showed.

Dan Ivascyn, chief investment officer at Pimco, warned the consequences of the deteriorating loan quality will be rippling through the market for some time to come. Downgrades will keep coming “even in a fairly robust recovery,” he said.

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