U.S. Markets

U.S. leveraged loan downgrade ratio five times worse than 2008-09

LONDON (Reuters) - The ratio of leveraged loan credit rating downgrades to upgrades has spiked to a record level five times above that hit during the last global financial crisis, reflecting the unprecedented stress in risky assets due to the coronavirus pandemic.

Traders wear masks as they work on the floor of the New York Stock Exchange as the outbreak of the coronavirus disease (COVID-19) continues in the Manhattan borough of New York, U.S., May 27, 2020. REUTERS/Lucas Jackson TPX IMAGES OF THE DAY

Leveraged loans - taken out by companies that have high levels of debt, usually with non-investment grade credit ratings - tend to be used by private equity firms as a way to fund acquisitions of such companies.

The U.S. leveraged lending market has grown to more than $2 trillion, up 80% since the early 2010s, according to credit rating agency Moody’s.

The downgrade-to-upgrade ratio in S&P’s LSTA Leveraged Loan index hit 43.20 in the U.S. in May, well above the peak of around 8.45 in January 2009, according to data from S&P Global’s LCD.

In Europe, the ratio hit 56.00 in April before easing to 37.00 in May, but that is still nearly four times higher than at the start of this year and more than ten times higher than a peak of 3.00 during the euro zone debt crisis.

“In post world war history economic activity has never been scaled down to such a large degree in such a short amount of time,” said Commerzbank credit strategist Cem Keltek, stressing the unprecedented downgrade pressure across the entire corporate debt universe, be it bonds or loans.

The data illustrates why credit markets are worried about a ripple effect from loan defaults.

Leveraged loans can be packaged into collateralized loan obligations (CLOs), which then issue bonds and pay bondholders using cashflows from the loans. A flurry of defaults could push CLO tranches into default too. CLOs have been a key factor behind the increase issuance of these risky loans over the last decade.

(Graphic: U.S. leveraged loan downgrades at record high, )

Reporting by Yoruk Bahceli, graphics by Ritvik Carvalho; Editing by Kirsten Donovan