The return of net negative ratings actions that intensified among speculative-grade borrowers in the latter half of 2022 has pushed the share of leveraged loan Weakest Links to the highest level in two years.
Weakest Links represent loans in LCD’s universe with a Corporate Credit Rating of B-minus or lower and a negative outlook from S&P Global Ratings.
Margin compression from rising inflation and softening demand, as well as the prospect of higher debt servicing costs in the rapidly rising rate environment, pressured the more vulnerable lower-rated portion of the market, where concerns are mounting that debt servicing will become more difficult. Underscoring this, the number of leveraged loan Weakest Links tracked by LCD climbed to 143 issuers, up 24% from September’s tally, and up 49% from June when negative ratings actions began to outpace positive ratings actions.
With Software again driving the uptick, the fourth-quarter reading is now on par with pre-pandemic levels at the end of 2019, though it remains well below the June 2020 peak of 329 issuers. Software and Healthcare led the count of Weakest Links by sector. Note that Healthcare has topped the leaderboards of distressed bond and loan indices, as detailed in recent research from LCD.
As a percentage of issuers tracked in this analysis, loan Weakest Links account for 11% of the more than 1,300 observations in December, up from 9% at the end of September and 7% at the end of June.
The latest reading is the highest since December 2020. While this percentage is less than half of the 2020 peak, the share is elevated relative to the late-credit cycle years of 2016 and 2018.
The upswell in Weakest Links unsurprisingly corresponds with a rising pace of ratings downgrades to upgrades of loans backing leveraged companies. In this regard, the second half of 2022 brought an unrelenting streak of negatively skewed ratings actions to loan facilities in the Morningstar LSTA US Leveraged Loan Index. By the end of the year, downgrades were outpacing upgrades by the fastest rate since the default peak of September 2020, at a ratio of 2.77x.
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This article originally appeared on PitchBook News