Bank Loans: Ratings Migration Signals Trouble Ahead

Worrisome pace of downgrades in the leveraged loan market is likely to continue.

December 23, 2019


This Bank Loans sector report is excerpted from the Fourth Quarter 2019 Fixed-Income Outlook.

Some 102 loans were downgraded between June 2019 and September 2019, according to S&P LCD, representing 7.2 percent of the LSTA Leveraged Loan index. Only 21 loans in the index were upgraded over the same period, resulting in a downgrade-to-upgrade ratio of 4.9x—the highest since 2009.

The Number of Downgrades Far Outweighed Upgrades in the Third Quarter

Some 102 loans were downgraded between June 2019 and September 2019, according to S&P LCD, representing 7.2 percent of the LSTA Leveraged Loan index. Only 21 loans in the index were upgraded over the same period, resulting in a downgrade-to-upgrade ratio of 4.9x—the highest since 2009.

The Number of Downgrades Far Outweighed Upgrades in the Third Quarter

Source: Guggenheim Investments, S&P LCD. Data as of 9.30.2019.

The downgrades were not concentrated in any specific industry. Companies operating in commercial services, retail, technology, healthcare, consumer products, media, energy, and several other subindustries have seen loans downgraded, leaving loan investors few places to hide.

Amid the accelerating pace of downgrades and two rate cuts by the Fed in the third quarter, the Credit Suisse Leveraged Loan index delivered a total return of 0.9 percent, losing steam from the second quarter, which delivered a return of 1.6 percent. Lower-rated loans weighed on index performance, with split B and CCC loans losing 3.2 percent and 1.3 percent, respectively. Higher-quality BB loans held on to positive returns of 1.6 percent for the quarter as many fewer BB-rated loans were downgraded compared to the single B or below category. Unfortunately, with a weighted average rating of approximately B+, the market continues to be comprised of more single B loans and fewer BBs. More specifically, the rising share of single B- loans is of concern given that a one-notch rating drops them to CCC+.

Lower-Rated B Loans Flood the Market

Higher-quality BB loans held on to positive returns of 1.6 percent for the quarter as far fewer BB-rated loans were downgraded compared to the single B or below category. Unfortunately, with a weighted average rating of approximately B+, the market continues to be comprised of more single B loans and fewer BBs.

Lower-Rated B Loans Flood the Market

Source: Guggenheim Investments, Loan Syndications and Trading Association. Data as of 9.30.2019. Percentages reflect leveraged loan market composition.

Heavy CCC-rated volume, whether due to downgrades or issuance, would likely be met with very limited demand. Collateralized loan obligations (CLOs), a large buyer of loans, have a limit on their exposure to CCC-rated loans. Intex data suggest that CLOs may be able to absorb about $25–30 billion in CCC loans in aggregate before reaching their limit. Within the Credit Suisse Leveraged Loan index alone, $175 billion par value, or 266 loans, are rated single B- by S&P, of which $28 billion also have a negative outlook. Among the remaining buyers of loans—retail funds, banks, and hedge funds—only the hedge fund group may have appetite for CCC loans. But loans may have to clear at lower prices and wider spreads for hedge funds to absorb the potential volume of single B loans that could get downgraded to CCC. As such, we continue to emphasize an up-in-quality theme.

—Thomas Hauser, Senior Managing Director; Christopher Keywork, Managing Director

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.

©2019, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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